Alberta Oilsands (AOS) – The Plot Thickens

Only a week ago we posted about Alberta Oilsands, that oil company without any oil. Well now they might have some, maybe, and sparks are flying. That underpriced cash rich company just got a lot more interesting.

 

On Friday the Company announced a merger proposal with Marquee Energy Ltd., an unknown to us but probably troubled small oil and gas company. Under the terms of the Arrangement Agreement, common shareholders of Marquee will receive, for each Marquee Share held, 1.67 common shares in the capital of Alberta Oilsands. On completion of the Arrangement, Marquee Shareholders will own approximately 49% of the common shares of New Marquee.

 

After a year and a half “strategic review” shareholders of AOS end up losing their cash and owning half of a tiny upstart oil and gas company in the middle of the worst energy downturn in a generation. Not exactly a fantastic outcome. Management also agreed to a $1.5 million break fee if the deal doesn’t go through.

 

On top of this, management is trying to complete the transaction without even having a shareholder vote! They have stated that the merger is “subject to receipt of the approval of the Alberta Court of Queen's Bench”. Unbelievable.

 

Enter Smoothwater Capital Corporation; That Canadian activist shareholder that claims to own 16.6% of AOS along with another key party. They issued a press release just today stating that they “will not support the proposed merger (original emphasis) by way of a plan of arrangement as it would significantly destroy value for all AOS shareholders by effectively using its risk free cash to bailout a distressed junior energy company with little prospects of success unless energy prices increase dramatically.” They even stated that “either the AOS board and management are hiding important facts from shareholders or are incompetent – or both".

 

What’s the next step? It’s straight from Smoothwater’s press release. “…Smoothwater has contacted the Venture Exchange to ensure that the exchange requires a vote of two thirds of the shareholders of both AOS and Marquee to approve the arrangement.  Smoothwater also intends to appear before the Alberta Court of Queen's Bench to request an AOS shareholder vote as a key determinant of the fairness of the arrangement.”

 

What a show with a thrilling and unexpected twist. It’s rare to get this kind of excitement in finance. We will be watching this closely and are off to make some popcorn.

 

Press releases can be found via - https://www.google.ca/finance?cid=704980

Alberta Oilsands (TSX Venture: AOS, $0.12) – An Oil Company Without Oil

Disclosure – We bought this one. Buy at your own risk and, as always, do your own due diligence.

What would you want to do with an oil Company without any oil and a bunch of cash? Well, it depends who you are.

Earlier this year, we wrote about Kobex Capital (formerly TSX Venture), which was a shell company trading at a discount to its mostly-cash NAV that had a near-term catalyst. It was ultimately bought out in a reverse takeover the worked out quite well (recap coming soon). We have found another, maybe.

Today, we are writing about Alberta Oilsands ("AOS" or the "Company"), which is also another cash-rich company (but with a bunch of exploration assets all over the world) trading at a discount. It has a concentrated group of activist shareholders owning over 30% of shares pushing hard for a cash distribution.

AOS – A Brief History

In October 2013, AOS received notice from the Province of Alberta that its oil sands leases on 4.3k hectares were to be cancelled. As a result of this, AOS applied for compensation and received $35.1MM in May 2015. The cash has been sitting on its balance sheet since then (less expenses, which we will get into).

Fast-forward to Q1 2016, and AOS now has $31.3mm of cash, net of all on-balance sheet liabilities. Quarterly cash burn is currently around ~$0.4mm, which is primarily G&A. Considering the lack of meaningful operations, we view this as high though some of this is likely due to the strategic review they are currently undertaking. Enter the activist shareholders.

The Catalyst

Current activists who are publicly pushing for a dividend of all liquid assets are Bruce Mitchell (15.9% ownership), Smoothwater Capital (13.8%), Goodwood Inc (4%), and Walied Soliman (1.9%). They have all pushed for a special meeting of shareholders, which the Company has finally agreed to, for September 23, 2016.

The Risks

Risk #1 - Not many people want to sell themselves out of their own job, and this applies to management teams too. While we are sure the managers at AOS are pleasant folk, we also know you should always beware when someone is losing a paycheque. In this case, should AOS be wound up their jobs (and the fees Directors get) go away, which provides plenty of incentive to “strategically review” the landscape (more money out the door) or even buy something (blowing up the wind up idea). It should be noted that OAS recently hired its second investment bank in the last year. That said, although there are 2 executives and 7 Board members' positions at stake, we believe the activist shareholders that together own ~36% of AOS stock reduces this probability.

Risk #2 – Namibia. The Company has various exploration assets around the world (of which we assign no value to, see valuation below), but as part of the Company’s global gallivanting they agreed to capital commitments in Namibia for which AOS itself has guaranteed 10%. It originally appeared to be $600K of guarantees per the initial purchase press release in January 2013, but later annual reports imply that it adds up to $6MM "subject to terms and conditions to be agreed to between Alberta Oilsands and the government of Namibia" and may have to be spent some time between Dec 2016 and Dec 2018. It is hard to believe that an under negotiation project of this type would go ahead today given where oil prices are but it is a tool management can use to keep the wheels turning. This is somewhat complicated by a somewhat-ominous news release on March 22 where AOS stated that under the Alberta Business Corporations Act, it may be restricted to pay dividends if it would impede its ability to meet any obligations (supposedly very standard wording in business corporations acts across all provinces). Perhaps some comfort can be taken by one of the key shareholders, who is the co-chair of a bulge bracket law firm's special situations team in Canada.

Upside and downside

The upside is quite simple. At the special meeting of shareholders in late September, a full cash distribution is announced, and all that is left in AOS is exploration assets that may or may not be worth anything (we assume they are not). Assuming this is completed in a couple of quarters, ~$30MM will be paid out assuming the current cash burn rate, which is already high and we believe is conservative. There are some options outstanding, but they have an average strike price of $0.12, so dilution will be minimal. All in, it's ~20% upside in about 6 months. 

The downside is anything besides that. We will likely hold on but sell out if it looks like there will be a protracted battle and/or if AOS ends up buying something (in which case, a loss is likely). 

Valuation

A few quick assumptions – We assume it will take until the end of 2016 to wind up (and cash burn stays as bad as it is), its international assets have no value (i.e. additional upside for optimists), and it is bought at $0.12/share.

 

State Budget Shortfalls and Oil and Gas Revenues

http://www.reuters.com/investigates/special-report/usa-oklahoma-bust/

This is really quite an interesting article that I finally got around to reading, after I had it in one of my many browsers' tabs in the last month.

Summary

It focuses on Oklahoma, which is dealing with budget shortfalls due to the decline in oil and gas prices. However, it points out that Oklahoma production taxes (I assume they really mean royalties) have actually declined over the last several years despite substantial increases in drilling activity. What the Reuters article doesn't note though, is that Oklahoma is mostly a gas-producing state, which has been in a longer and more severe bear market than oil. But the logic is the same.

Now that crude and natural gas prices are in the tank, how is the state dealing with this? Well, if you are a small city that is now receiving less funding from the state, one of the biggest expenditures in your budget that you can cut is likely education - and as a result, some school districts are shortening weeks, planning to lay off staff, and...well you get the point.

Is it a big deal that school funding is lower?

Data shows that "dollars per student" is actually not a good metric of how effective school systems are. I would personally measure effectiveness by math/science/literacy international test scores, dropout rates, and post-secondary admission - and you may be surprised at how some even low-income neighbourhood schools can effectively teach students at lower-than-average costs per student!

But when it is forced dramatic cuts, my opinion is yes it is very likely bad, especially when you're shortening school hours. It is disheartening to also note that Oklahoma is probably one of the states that can least afford to do this. It ranks #43 among other States in math proficiency (interactive map in http://educationnext.org/us-students-educated-families-lag-international-tests/).

Ok, so Oklahoma doesn't have the best school system, but you can't blame them for lower commodity prices! Right?

The Reuters article shows that Oklahoma had a very small rainy-day fund on an absolute and per-capita basis compared with North Dakota. On top of that, Oklahoma lawmakers still voted in favour of making permanent what was supposed to be a temporary tax break on oil/gas wells' early-life production.

Admittedly this is a very complex subject, and I don't know what the right solution is. As a Canadian though, it is good to see Alberta has not dramatically reduced education spend (but with a $10 billion deficit for 2016 some might say it is unclear what the long-term plan is). That said, while Alberta loves to brag that it has one of the highest funding-per-student in Canada, it does not publicize how it has one of Canada's highest high-school drop-out rates. I guess the conclusion is that, the best thing for Oklahoma and Alberta to do is to seek ways to achieve more with lower funding-per-student, because data shows they aren't necessarily correlated.