MCF - Contango Oil & Gas

[ItsAValueTrap]

http://www.valueinvestorsclub.com/value2/Idea/ViewIdea/26889 - 2010 VIC writeup

http://www.valueinvestorsclub.com/value2/Idea/ViewIdea/3571 - 2008 VIC writeup

 

Background:

Independent oil & gas stocks may be something you want to avoid as the industry is sometimes a destroyer of capital.  Many value investors don't realize that reserves can be inflated (yes, many technical disclosures may be erroneous).  Go on VIC and look at the various long writeups on ATPG... then look up the ticker symbol PINK:ATPAQ.

 

Contango has some excellent presentations on its website that provide information on the industry and how it works.  These are a must-read in my opinion.

 

What Contango does:

1- Venture capital.  Lost half their money.

2- Their bread and butter is leveraging the expertise of Brad Juneau and his team of superstar explorationists.  Originally Contango owned the explorationists' company.  Eventually the explorationists owned their own company and now they currently work with Contango as a partner.

3- Made a home run investment in shale gas with Joe Alta.  Currently in a small JV with Alta resources for a second time.  There is also the Exaro JV.

4- Made a home run investment in LNG and got out in time.  Lucky.  LNG's original plan was to IMPORT natural gas... the shale gas thing happened and now it makes sense for the US to EXPORT natural gas.

5- Some financial management, e.g. using preferred shares to raise equity, buying back its shares when cheap, etc.

 

Originally Contango started off vaguely sketchy.  It was a microcap stock that small brokers sell to get commissions.  It can be hard for microcap stocks to make money as overhead costs are high.

Contango played that game again when it spun off Contango Ore.  My guess is that because Ken Peak did such an incredible job with the original Contango (up more than 40X) the brokers will happily raise money for Contango Ore at high prices.  So in that sense the split off makes sense.  Otherwise it doesn't make too much sense since exploration stocks almost always suffer from a lack of capitalization; keeping it as a part of Contango would have solved that problem.  It can take $25M-$100M+ to bring a mine to a production decision, and then you are looking at hundreds of millions of dollars to build the mine.

 

What Contango will do:

Right now Ken Peak has serious health issues and it's unclear if he will return as CEO.  I don't think anybody will ever be as good as Ken Peak.  However, I think his friend/business partner Brad Juneau will definitely be an above-average CEO.

 

Contango is trading at a 52wk low and I think it is likely that it will use any excess cash to buy back some shares.  If you do the math, it is probably better for Contango to go drill some wildcat wells and find gas at $1.50/mcfe (may cost more now) than to buy back shares.  16.78mcfe/share, Contango is paying roughly $2.92/mcfe (ignoring Contango's cash) with shares at $49.14.  The reason I think it is buying back shares is because it wasn't able to put capital to work right away since its wildcat wells were delayed for a year (waiting on rig availability).

In an ideal world, it would sell its producing assets and put that cash to work on a lot of wildcat wells.  The return on investment on high-risk drilling is far, far higher than holding onto producing assets.

So the share repurchases, in a way, aren't that great.  But it's probably better to own Contango shares than cash with 0% yield.  Contango shares are probably only slightly cheap right now.

 

Its Exaro JV presumably holds a lot of land.  Land is usually highly leveraged to a rebound in ngas prices.  I am guessing most of the revenue will come from natural gas liquids though, since ngas with few liquids isn't economic right now.

 

In the long run

Let's say Brad Juneau takes over the CEO position permanently.  If he just sticks to Contango's bread and butter... developing assets at low cost and then sell them... Contango will do very well in the long run.  He doesn't need to get into the wheeling and dealing that Ken Peak does.

 

Options

The options are somewhat cheap.  In November Contango may announce the results of their 2 wildcat wells spud in June... this may create volatility that is good for those long Contango call options.  Ken Peak was really excited about the potential of one of the wells if you read the old press releases.

 

"Should Eagle be a discovery, however, we will have a 65% net revenue interest in what we believe would likely be an oil discovery with a prospect size – net to Contango – of 7 to 10 million barrels."

http://www.contango.com/investor/news/pr223_080811.pdf

At $90 oil, 10 million barrels is $900M in revenue.  Suppose the NPV is $300M... this would move Contango's market cap of $751M.  (Some % of a successful discovery may already bereflected in Contango's current share price though.)

 

Insider selling

Ken Peak is selling some of his shares.  I am fine with that... he has some serious health issues.  I wish him good health.

[compoundinglife]

 

What Contango does:

1- Venture capital.  Lost half their money.

 

I worked for a start up that got funding from MCF's VC leg. They were out of the investment before I started working there. I had been working there for couple of months when I was reading an old MCF filing and noticed they mentioned exiting an investment in my (now former) employer. I know very little about VC , but after being there a few months and experiencing the management I was not surprised they got out and was actually kind of surprised that MCF would have invested in the first place. To their credit though they got out of something that would eventually get worse and they figured out that Venture Capital was something they were not good at.

 

What Contango will do:

Right now Ken Peak has serious health issues and it's unclear if he will return as CEO.  I don't think anybody will ever be as good as Ken Peak.  However, I think his friend/business partner Brad Juneau will definitely be an above-average CEO.

 

When I first bought MCF (2009) after doing my initial research, one of my concerns was how dependent they appeared to be on Ken Peak. But the more I learned about MCF the more I changed my perspective. For a small company like that scale up over the years, I feel the model must be fairly solid. With 7 (think its up to 10 now?) employees you can only work so much, it's finite. So their model of outsourcing the majority of the work to trusted partners makes sense. It also seems like a model that should be able to stay in place were Mr. Peak to step down permanently.

 

Options

The options are somewhat cheap.  In November Contango may announce the results of their 2 wildcat wells spud in June... this may create volatility that is good for those long Contango call options.  Ken Peak was really excited about the potential of one of the wells if you read the old press releases.

 

"Should Eagle be a discovery, however, we will have a 65% net revenue interest in what we believe would likely be an oil discovery with a prospect size – net to Contango – of 7 to 10 million barrels."

http://www.contango.com/investor/news/pr223_080811.pdf

At $90 oil, 10 million barrels is $900M in revenue.  Suppose the NPV is $300M... this would move Contango's market cap of $751M.  (Some % of a successful discovery may already bereflected in Contango's current share price though.)

 

I don't see any 2014 leaps? I thought MCF had leaps in the past. The latest expiration I see is April 20 2013.

[ItsAValueTrap]

I worked for a start up that got funding from MCF's VC leg.

Very interesting!

 

It also seems like a model that should be able to stay in place were Mr. Peak to step down permanently.

As mentioned before, there is a wheeling and dealing aspect to Contango that is dependent on Ken Peak.  Even in the core business, there are certain things that Ken Peak may be unusually good at.

1- Knowing how to sell for maximum value / how to negotiate.  (???) 

2- All the things that Contango does NOT do.  It does not chase yield on short-term investments.  It does not drill for tax deductions.  It stopped hedging (because most hedging programs, with the exception of put options, tend to swap one set of risks for another).  It has few employees.  It does not sign long-term contracts for rigs or own rigs.  It does not use any debt that may be dangerous.  It does not go crazy in expanding production when commodity prices are high.  It does not have many employees.

3- #2 is very unusual in the whole E&P field.

 

I think there will be reversion to the mean since Ken Peak was an unusually good CEO.  Contango's early track record is incredible.

 

I don't see any 2014 leaps?

You are right... there are no LEAPs.

 

Whether options are part of value investing is debatable.  In the short term, fundamentals rarely matter.  So it is different from value investing in that sense.  (Unless you keep rolling the short-term options to create your own LEAP.  Obviously if the options get more expensive then you stop rolling them over and let go of the trade.)

A "value" approach to options would involve figuring out whether the volatility (or options premium) is way too cheap or expensive.  A "greater fool" approach would be to flip them to somebody who is willing to pay a worse price (this is what some market makers do, though they have a trading advantage... especially the HFT guys).

[ItsAValueTrap]

Brad Juneau just bought around 46k shares of Contango... a little over $2 million.  So it's not token purchase.

 

He probably still has most of his net worth tied in his exploration business (which I doubt is liquid).  But this is somewhat of a good sign for Contango as it shows that he is making an effort to align his incentives with that of shareholders.  And he is probably smart for buying Contango near its yearly low.

 

http://www.sec.gov/Archives/edgar/data/1071993/000118143112052564/xslF345X03/rrd357277.xml

[Evolveus]

Here is latest investor presentation from mcf. They typically make a ton of sense which is why a nat gas play like mcf still has a 13x multiple, Ken Peak illness and all. I've been a holder since 06, so I've seen my ups and downs. But share count has consistently shrunk and they have adhered to their truly "low cost operator" model which is absolutely necessary in commodity production.

 

http://www.contango.com/investor/events/20120417/Contango_IPAA2012.pdf

[ItsAValueTrap]

http://www.4-traders.com/CONTANGO-OIL-GAS-COMPAN-15584/news/Contango-Oil-Gas-Company-Contango-Updates-Operations-15444092/

 

Contango is 0 for 2 on its wildcat wells.  :(

[compoundinglife]

Permanent CEO and special dividend:

 

http://www.4-traders.com/CONTANGO-OIL-GAS-COMPAN-15584/news/Contango-Oil-Gas-Company-Contango-Elects-New-Chief-Executive-Officer-and-Declares-Special-Divide-15557991/

[ItsAValueTrap]

Mr. Romano assisted Mr. Peak in founding the Company in 1999. Mr. Romano has worked in the energy industry since 1977. Mr. Romano served as Senior Vice President and Chief Financial Officer of Zilkha Energy Company until its sale in 1998

 

Some background info on Zilkha Energy here:

http://www.bizjournals.com/houston/stories/2003/04/28/story5.html?page=all

I believe the company generated a lot of value based on finding oil&gas reserves cheaply.

 

2- I'm not sure what to make of the dividend.  This seems like a great time to repurchase shares or to invest capital in new wells?  (Though the outlook for natural gas liquids may be bad?)

 

3- Contango shares are trading at a really low price right now... low $40s.

[Evolveus]

I was surprised as well at the special dividend.  I expected a large share repurchase, as they have done a great job shrinking share count over the last several years.  Off the top of my head, I remembered in a company slide presentation they indicated that they had repurchased shares with a blended costs in low 40's.  The new CEO seems to have a long and intimate relationship with MCF and a lengthy track record with other energy (and non-energy) related companies, but I know that Ken Peak's shoes will be big ones to fill.  Low cost production, zero debt, and optionality of remaining wildcat well inventory, plus the mild strength in Nat Gas give me reassurance.

[compoundinglife]

I was actually expecting that they might issue a special dividend. They mentioned few years ago that they were considering it, I think it was before the tax cuts were renewed in 2010. Considering how much more uncertainty there is around the tax cuts this go around I was expecting them to revisit the idea.

 

I would have been happier with buy backs. It looks like the average daily volume is around 3 million worth of stock, the div is around 30 million total. 30 million in buybacks would have reduced the float by %5.

 

Brad J. used to work Zilhka way back when: http://www.nytimes.com/1998/03/20/business/a-wildcatter-on-the-tame-side-replacing-roughnecks-with-computers.html?pagewanted=all&src=pm  (his name is mentioned at the end of this article)

 

 

 

[ItsAValueTrap]

That's the Contango origin story right?

 

It's more or less the star explorationists from Zilkha.  Contango put up some capital so that they can buy computers and other things (e.g. leases).  (Currently Juneau Exploration has an IT budget of millions... maybe $14M or so but this could definitely be wrong.)  Without that capital the explorationists may have had a hard time starting the business on their own.

 

Initially the exploration business was not well capitalized enough to drill, so they would farm everything out to other companies.  Eventually the business grew and they started drilling their own wildcats and the rest is history.  Both Contango and the explorationists made a lot of money.  The explorationists eventually starting owning a greater and greater share of their business.  I think that there is definitely a deep relationship between Ken Peak and Brad Juneau as they helped each other make a lot of money.  The explorationists made far more money than they would have made as salaried employees.

[bathtime]

I have the feeling the divided is more a way for Peak to divest himself without having to sell more shares. Will mean $4+m to him. Is $30 in remaining cash enough of a surplus to fund wildcat plus onshore from cashflow? I'm not sure how the reduced cash affects the company's strategy. Might they conceivably tap their credit line?

[ItsAValueTrap]

It might depend on how long permitting takes?  And then after that it would depend on rig availability depending on their rig contract.

 

Contango initially said that it would spud the two wildcat wells last year.

[ItsAValueTrap]

Brad Juneau, who is not the interim CEO anymore, has bought more shares on the open market:

 

http://www.sec.gov/Archives/edgar/data/1071993/000118143112063204/xslF345X03/rrd362849.xml

[muscleman]

Can anyone please tell me how they come up with the 20 MCF per share number?

I think that would be interesting to see how it is calculated so I can compare with other O&G companies, such as UPL and XCO.

[ItsAValueTrap]

I believe you take their reserves and divide that by the share count.

 

I would try to use the latest figures as they had to revise the reserves on one of their wells. 

*In the past, when Ken peak was running the company, he was a big proponent of oil/gas companies not overstating their reserves especially with PUDs.  When Contango had to do a major downward revision to reserves, he announced that he would not be taking any bonuses that year.  The latest revision was kind of quiet... so maybe this signals a change in the company.  Also, there's a new website and a lot of the old awesome presentations aren't there anymore.

 

---

Here's what I wrote about Contango on Feb 2013:

 

Contango Oil and Gas (MCF):  Natural gas liquids prices have crashed and production from Contango’s wells has been disappointing (Contango had to write down one of its wells after revising its reserves).  Eventually natural gas prices should rebound (because the industry is losing money at current prices and reducing supply) and Contango should make a killing.

 

As of June 30, 2012 the 10-K lists the present value of Contango’s reserves at $513M after tax.  Strip prices for natural gas are far higher than the spot price at the time ($3.13 natural gas, $96.07 oil and $59.39 per barrel of NGLs).  Using a discount rate less than 10% would increase the present value.  Contango should be close to fairly valued as its current market cap is $668M if not a little undervalued.

 

A small ~9% adjustment should be made to the reduced estimates to Ship Shoal 263 (9.2 Bcfe decrease) and Vermilion 170 (11.5 Bcfe).  As of June 2012 Contango had 256,567 Bcfe in reserves.  In the next 6 months, reserves dropped 35.5 Bcfe due to production (13 Bcfe) and the two drops in reserve estimates.

 

Management at Contango should continue to be excellent without Ken Peak.  Contango’s exploration partners used to work for Zilkha Energy and Zilkha’s ex-CFO is now Contango’s CEO.  This is a great business (but only due to management) at a fair price.

 

Insiders have been buying small amounts of stock.  Ken Peak, the former CEO and Contango’s founder, has been selling (but he may die soon and can’t take his money to his grave so I don’t read too much into it).

https://glennchan.wordpress.com/2013/02/20/portfolio-updates-feb-2013-2/

[muscleman]

I believe you take their reserves and divide that by the share count.

 

I would try to use the latest figures as they had to revise the reserves on one of their wells. 

*In the past, when Ken peak was running the company, he was a big proponent of oil/gas companies not overstating their reserves especially with PUDs.  When Contango had to do a major downward revision to reserves, he announced that he would not be taking any bonuses that year.  The latest revision was kind of quiet... so maybe this signals a change in the company.  Also, there's a new website and a lot of the old awesome presentations aren't there anymore.

 

---

Here's what I wrote about Contango on Feb 2013:

 

Contango Oil and Gas (MCF):  Natural gas liquids prices have crashed and production from Contango’s wells has been disappointing (Contango had to write down one of its wells after revising its reserves).  Eventually natural gas prices should rebound (because the industry is losing money at current prices and reducing supply) and Contango should make a killing.

 

As of June 30, 2012 the 10-K lists the present value of Contango’s reserves at $513M after tax.  Strip prices for natural gas are far higher than the spot price at the time ($3.13 natural gas, $96.07 oil and $59.39 per barrel of NGLs).  Using a discount rate less than 10% would increase the present value.  Contango should be close to fairly valued as its current market cap is $668M if not a little undervalued.

 

A small ~9% adjustment should be made to the reduced estimates to Ship Shoal 263 (9.2 Bcfe decrease) and Vermilion 170 (11.5 Bcfe).  As of June 2012 Contango had 256,567 Bcfe in reserves.  In the next 6 months, reserves dropped 35.5 Bcfe due to production (13 Bcfe) and the two drops in reserve estimates.

 

Management at Contango should continue to be excellent without Ken Peak.  Contango’s exploration partners used to work for Zilkha Energy and Zilkha’s ex-CFO is now Contango’s CEO.  This is a great business (but only due to management) at a fair price.

 

Insiders have been buying small amounts of stock.  Ken Peak, the former CEO and Contango’s founder, has been selling (but he may die soon and can’t take his money to his grave so I don’t read too much into it).

https://glennchan.wordpress.com/2013/02/20/portfolio-updates-feb-2013-2/

 

In their presentation, they said that 20 MCF per share is calculated after reduction of debt and senior notes.

Well, I think for cases like XCO, it will be much harder to do. Maybe the better way is to use the PV-10 of the assets to deduce debt.

I think XCO and CHK look cheaper, but they have more debt.

[udravi]

Contango Oil & Gas Company (NYSE MKT: MCF) announces that the Company's founder and visionary, Mr. Kenneth R. Peak, passed away Friday evening at the age of 67.

 

http://ir.contango.com/releases.cfm

 

I have an impression that Mr Peak was an exceptional individual and will indeed be missed. 

 

Curious to see what will happen to the company...

 

[ItsAValueTrap]

That's sad news.

 

He ran the company with a lot of integrity.

[bathtime]

That's sad to hear. Mr. Peak was one of the rare value creator's who put the shareholder first in the energy business.

 

Here's an interview with him on Bloomberg last summer:

 

http://www.youtube.com/watch?v=7V-7878mNSw

[onyx1]

Sad indeed.

 

Years ago on a whim, I called the home office in the middle of the day hoping to get a few questions answered.  A guy answered with a "Hello", and said he would try to help.  Thirty minutes later, after a bunch of really helpful answers and some great insight into the industry, I thanked him for his time and asked for his name for future reference.  He said Ken Peak!  Very generous and down to earth guy.

[muscleman]

Sad indeed.

 

Years ago on a whim, I called the home office in the middle of the day hoping to get a few questions answered.  A guy answered with a "Hello", and said he would try to help.  Thirty minutes later, after a bunch of really helpful answers and some great insight into the industry, I thanked him for his time and asked for his name for future reference.  He said Ken Peak!  Very generous and down to earth guy.

 

Wow! You had the chance to talk to the CEO!

What do you think would happen now? If any of his successor has learned his way of doing things, MCF will still be a good company.

[Williams406]

When I began my initial research on Contango in 2007 I was likewise surprised to have Peak answer the phone. He took time to explain some exploration basics to me. He closed our conversation as follows (paraphrasing): "I don't know who you clients are, but understand that we drill wildcat wells. Sometimes we're successful and sometimes we strike out. This isn't a widow's and orphans' stock." Being neither, I opted to ignore his warning. Peak was certainly unconventional and I regard him as one of the best CEO/partners I've had.

[oldye]

Sad day. I flew down to houston a few years ago, found myself in an elevator with Ken but had no idea it was him.  Later on he wanted to know why we were there, aside from his employees there were maybe 5 shareholders there.  He went on to do a very informative and humor filled presentation. 

 

 

[Guest deepValue]

Ken was an outstanding steward of shareholder capital. I wish there were more information available about the making of Ken Peak. I'd commission a biography of the man if I weren't so stingy myself.