Mohnish Pabrai - The Ten Commandments of Investment Management

Mohnish is one of our favorites and is the core of some of our articles, including on cloning investments (http://www.canadianvalueinvestors.com/cloning-investments-101/). A new talk by him has been posted where he spoke to Arvind Navaratnam’s class about the Ten Commandments of Investment Management. We think it’s worth a listen!

OvaScience – Cash Flows Like Sand

Note: None of us own this or are providing advice. As always, do your own research.

Buying dollar bills for 60 cents is usually a winning strategy…unless of course, the dollar bills are being incinerated or being sold by someone else on your behalf for 30 cents. As we continue on our journey of value investing we should all be wary of value traps….

Not necessarily related – but enter OvaScience! It’s a sad story, but sometimes things just don’t work out. It was once billion+ dollar market cap company that is “focused on the development of new treatment options for women and couples struggling with infertility.” About a year ago, the management team realized that <$100k in quarterly revenues was not sufficient to cover $14 million in quarterly G&A and R&D. After a severe restructuring this year, all but 8 employees remain in OvaScience as of September 2018. They did not reach the point of commercialization, as shown in their financials below:

With this newly lean, mean, non-revenue generating business model (as opposed to a large, cash-burning, non-revenue generating business model), OvaScience was able to woo Millendo Therapeutics into an all-stock merger. OvaScience shareholders would own ~20% of the combined entity. Millendo is in the middle of commercializing their own ideas as shown in their financials:

The merger S-4 filed with the SEC makes for an interesting read. https://www.sec.gov/Archives/edgar/data/1544227/000104746918006443/a2236510zs-4.htm

 Let’s look at some numbers.

As of quarter-end June 2018, OvaScience had $48.3 million of cash and equivalents, net of all on-balance sheet liabilities, compared to a market cap of $27 million and change. Pro-forma for the merger, the combined entity would have $74.4 million of cash and equivalents, net of all on-balance sheet liabilities… which would be about $15 million ($74.4 X ~20%) for current NovaScience shareholders.

So OvaScience, instead of liquidating (recall – most of the employee severance had already been paid as of Q2 2018) and allowing shareholders to recoup let’s say around $40 million, decided that it was a “better” deal for shareholders to instead own 20% of a new entity, where current shareholders can claim interest to $15 million of net cash. Cash that soon, too, would be use for commercializing the next best thing.

Out of all of this emerges BML Investment Partners, which together with its principal Braden Leonard, have been buying OvaScience and recently raised their stake to about 10%. BML believes it would be better if “the company terminates the merger and liquidates.” The full filing can be found here: https://www.sec.gov/Archives/edgar/data/1373604/000156761918002599/doc1.htm

As individuals who (i) can add, and (ii) believe in the “bird in hand” concept, that might not be such a bad idea, in spite of the termination fee of up to $4 million to pay to back out of the merger.

We’re on the sidelines at the moment though, and wish BML all the best.

Corridor Resources Inc. (TSX:CDH) – Oil and Gas Stuck Between a Rock and a Hard Place

Note: None of us currently own this.

What would you call a cash rich Canadian natural gas producer with good netbacks? There’s really only one thing you can call it - Corridor Resources Inc.

It’s 2014 – Katty Perry is near the top of the charts with Dark Horse and Corridor is riding high at over $2.00 a share. There is widespread optimism for Corridor’s New Brunswick natural gas properties and prospects offshore in the Gulf of St. Lawrence.

Fast forward to today – Katty Perry continues to have a great run but has unfortunately announced that she is going to “take a break” from making those great tunes, while Corridor can’t get a break. Their Quebec prospects are snuffed out by the province declaring the area their assets are in a UNESCO World Heritage site (leading to a payment from the province to Corridor of $19.5M). Their main asset in New Brunswick is performing well but there’s a fracing moratorium and the drama heats up with the David Suzuki Foundation going after their prospective licenses. This all comes to a head on June 12, 2018, when the Company announced it has suspended exploratory work on Old Harry (the gulf assets) for the foreseeable future.  

Lemons to Lemonade

In spite of these challenges, the Company has done a remarkable job with their NB asset. When looking at them we think it is prudent to viewed and analyzed from when Steve Moran became CEO in 2014, where the Company’s various prospects and ventures pre-date him. Over the last four years they have hammered down costs and, as shown in the chart below, they have taken a very creative approach to natural gas production. There is a huge disparity between summer and winter prices at the hub they ship to because of certain structural capacity constraints, created by the same NIMBYism against fracing. They shut in for the summer and produce in the winter at hedged prices, which let them sell gas at a realized price of $12.90/mcf in Q1 2018. For context, gas in western Canada was trading at ~$2.00/mcf and cheap cheap cheap in the summer. Overall the hostility to natural resource development has been a net negative but this is definitely a case of turning lemons into lemonade. We don’t want to double up management’s comments, you can find a good discussion of the dynamics in their presentation: https://www.corridor.ca/wp-content/uploads/2018/05/Corp-Presentation-May18.pdf

What’s Up Today

Corridor currently trades at $0.66. Now this price is interesting for two reasons:

1)      From the various settlements and just plain cash coming in, the Company has stockpiled $56 million of cash.

2)      The Company is bringing in cash flow of ~$8-9 million a year with and has a market cap of $58.6 million and has natural gas reserves valued at PDP NPV10% of $55.1M (we’re using a different price assumptions. See our article on oil and gas 101 for discussion of reserve types).

3)      A + B leads to a market cap of….. $58.6 million… i.e. trading at half of book value.

So a Company with positive cash flow and lots of cash, trading at cash; what can they do?

Internal Options = not much

-Old Harry and Elgin Sub-Basin – They are largely dead. They are very complicated plays that would likely require a large partner and there is no appetite for fracing in Quebec/New Brunswick.

-Existing producing McCully field – Current management is taking a different approach than the prospector-style management team of yesterday. The Company would be hard pressed to further develop these assets. We believe the wells would cost something like $10 million each and the Company would want to spread the risk over several wells, with results likely lower return than other plays. This would be very hard to justify, particularly given the hostility towards energy development. We view these assets are going into a true wind-down.

External Options

-Idea #1 - They could do a deal with another junior. Based on the fact that they have already been sitting on cash for two years, it appears that they are very prudently selective on finding the right transaction. And frankly, we think it will be hard to find a transaction that is just right – not too big, not too small, and not too terrible.

-Idea #2 - Return capital

 Where do they go?

We think that this Company is a great example of management doing what you can with what you have. That said, the (local) world is against them on their home turf so they have to do a creative deal or ship the cash back to shareholders. There is one key shareholder based on filing - TCI Fund Management Limited with 19.5% we believe. They’re an activist fund but their holdings go back several years to the booms times for Corridor, where they are likely heavily underwater and they are not very active on this file (including their representative on the Board not attending a single meeting last year..).

 This is the strangest oil and gas company we have come across in Canada and is a good case study of how regulations can really hinder a company. They have done the best they can with the hand they were dealt and we’re on the sidelines and wishing them the best.