market folly

We've posted up notes from the Value Investing Congress in Las Vegas and next up in the series is Michael Kao of Akanthos Capital who pitched TAG Oil (TAO.CN).


Michael Kao's Value Investing Congress Presentation

•    Returned 34.5% net to LPs with under 40% net common stocks and virtually no exposure to traditional credit.
•    Key tenants – capital structure L/S fund with an event driven bias. Look at the capital structure as a spectrum of opportunities. Agnostics between all securities in the structure – looks for the best bang for the buck – asymmetry – more upside than downside. Will create them by combining different pieces.
•    Concentrate in your best ideas.
•    Construct a portfolio of thematically diverse but asymmetric payoffs.
•    Thematic drivers – presenting a common equity idea
•    In FY10 presented GM distressed bonds as post-reorg equity would be valuable – one of their best investments – an 8 bagger since 09.
•    Look for off the beaten track securities
•    In bankruptcy – many interesting securities are created – a different resolution stub with no relation to the common equity was created – a 3 bagger.
•    Pitched Freddie/Fannie preferreds – likened them to railroad bonds – a 20 bagger for them and their largest event-driven position – very strong legal 


•    Common equity is today’s idea: TAG Oil (TAO.CN). E&P equity domiciled in Vancouver – operational assets on 2.8MM acres on conventional and unconventional assets are based in New Zealand.
•    Most prolific driller in New Zealand. Goal is to be the biggest E&P producer.
•    Company has a $140MM EV – 60MM in cash. $40MM in EBITDA.
•    TAO equity looks like a distressed convertible bond. If assets appreciate bond is only worth par. If asset value detriotiates, bond falls in value. If assets go way up, converts participate in equity. 
•    Believe it is trading below its bond floor and multiple option components.
•    Currently operates 26 wells in the Teranyaki basin in NZ. 1400 barrels a day or $40MM EBITDA. •    Event component – low risk drilling opportunities. East coast opportunity – 13B barrels of shale oil available alone, similar to the Bakken. Pie in the sky option – basin with no drilling, but seismic studies show favorable prospects. Valuation scenario assumes no value.
•    Valuation – base case of $6.0 – could double or more if other wells come online.
•    Company has made good acquisitions. Bought a permit for $2MM – huge find. Stock spiked and the Company raised capital at the peak. High flow rates showed high depletion rate in FY13, in January 2013 – APA (drilling partner) drilled out. 
•    Believe Apache pulled out for internal issues. During the period when APA pulled out, Nat Gas was in a trough level – hence Apache needed to focus on unconventional plays and were fed up with NZ environmental delays. APA committed $100MM but paid $26MM to TAO – TAO lost a partner but received $15MM from APA no strings attached for APA pulling out.
•    The Company has raised capital at astute times – never raised debt.
•    Why is it training in deep value territory.
•    Revenue and Book value have grown 4x and 13x respectively. Very asymmetric.
•    Chief risks – commodity risk, the company is 85% oil. Environmental opposition. TAO has had a better chance without APA in obtaining permits.
•    Limited operating history to the wells.
•    Lack of oil and gas infrastructure. If they have a big find, might need a JV partner.
•    CapEx – will spend $100MM plus through FY15 – but it is success based i.e. they can shut it off. •    Any day now the Company will announce results for a basin. If it disappoints – worst case $2 - $2.5. If the play works out, $4 - $5 per share.
•    Question – why are they not using debt? Being conservative – always self-funded themselves.
•    Owns Fannie/Freddie Preferred – question is the common better? If the $210B is paid to treasury is assumed gone to a sink hole- the run down value of entities will fall in waterfall method – common stock will be wiped out – preferreds fully covered. Common does have upside. Preferreds could be a triple.
•    Fairholme has been granted early discovery – will show how certain agencies planned their actions in regards to Fannie/Freddie was blatantly illegal.

Be sure to check out the rest of the Value Investing Congress presentations.