Odyssey Marine: An Open Letter To Ryan Morris Of Meson Capital

| About: Odyssey Marine (OMEX)

Mr. Morris,

The "Investigative Report" you published last week regarding Odyssey Marine Exploration Co. (NASDAQ:OMEX) titled "Do Investors Know What Lies Beneath the Surface?" was deceptive and harmful to Odyssey's shareholders. The stock is heavily owned by retail investors, many of whom didn't have the resources to detect your deception, and were frightened into selling their shares at artificially deflated levels. These investors may have lost as much as one-third of their investment as OMEX declined from $3.10 on Monday, 10/28 to a low of $2.00 on the date of official publication, 10/31.

You present your research under the guise of truth-seeking and shareholder advocacy. You characterize the paper as an "Investigative Report," implying an unbiased, comprehensive view of the topic. You convince shareholders you are on their side, telling them, "you deserve answers more than anyone, so demand them from YOUR company." Your own website extensively highlights your truth-seeking expertise with claims of "Emotional Independence" and "Critical and Logical Thinking" as it notes that you question everything until you "understand the core reasons for things." Even your report's website title "Omextruth" makes a claim to an unbiased, truthful account. Finally, you use the CFA designation following your name, implying that you abide by that organization's Code of Ethics.

Yet your OMEX research report is woefully incomplete, biased, and misleading. If anything, you appear to have gone out of your way to avoid the truth in your report. And though you present yourself as a friend of shareholders, you are anything but an advocate for their cause. You and your investors are short OMEX shares and your financial interests are therefore directly opposed to those of OMEX's shareholders. Manipulating shareholders into thinking that you had their best interests in mind, and that you were seeking an unbiased truth about OMEX, enabled you to deceive investors into selling their shares so that you could profit personally. Your actions seem to directly contravene many of the CFA's ethical requirements including those surrounding manipulation, diligence, and objectivity.

Your "due diligence" on OMEX relies mainly on the company's filings, related entity filings, and public commentary. While this is a solid initial step in understanding a company, any professional investor (especially an activist) understands the need to dig much deeper. Further, any professional investor who makes his research available to the public with claims of truth-seeking and investor advocacy, owes an obligation to live up to his claims and present comprehensive, unbiased material that genuinely informs.

As you are aware, based on your role as an activist, it is only through spending time with management, doing field diligence with customers, suppliers, employees, and other related parties, that you can hope to gain an elementary understanding of "the core reason for things" within a company.

Yet, you didn't even take the rudimentary step of speaking with the management team at OMEX while conducting your research. How can anyone claim to have done an "investigative report" on any subject matter while ignoring the most important and comprehensive source of information on that very subject? Regardless of the fact that you find them promotional, you would have to understand that OMEX management team members are the world's most knowledgeable experts on the subject of Odyssey Marine. Had you spoken with management (they are highly accessible), each of the questions you raise in the report would have been answered. More importantly, you would have been corrected in many areas where you've made incorrect inferences based on corporate filings. Understand, of course, that the filings are perfectly correct - but they cannot include every piece of relevant information.

It is obvious that you aren't seeking the truth with respect to Odyssey. You didn't make the smallest of efforts to have your questions answered. You've asked questions in a deliberately misleading manner to swindle investors into selling their shares so that you and your clients can make a quick profit. You did this at the end of the month (and the end of the fiscal year for many funds) to generate and crystallize returns. In the process, you have harmed investors who parted with their shares at an artificially deflated price due to a hysteria you created with distorted and incomplete "research." Odyssey Marine is now taking legal action to prosecute you for your illegal manipulation.

You are an intelligent and successful activist investor. In the past you've produced objective, informed research and have been rewarded with strong performance. Had you applied your substantial skill and expertise to gain a full understanding of Odyssey Marine, you would have seen that this company is in the later stages of a dramatic turnaround. The company is focused on using its considerable expertise and institutional knowledge about the ocean floor to deliver immediate returns to shareholders. Seabed mining, commodity wreck salvage, and exploration services are viable businesses and they are already earning significant returns for shareholders. This will become more clear over the next twelve months.

Below we will walk through some of the major points in your report, providing strong evidence that directly contradicts your conclusions. We will also turn the tables, and put some questions to you on behalf of Odyssey's shareholders.

Off Balance Sheet Value

On page 4 of your report you state "We believe that management representations of "$179mm of Off Balance Sheet Value" in equity stakes are inflated by at least a factor of 10 and we question whether they are based on non-arm's length transactions." This is a very strong statement. What work have you done to support your estimated maximum value of $17.9mn attributed to these assets? How deep is your knowledge of the assets behind Oceanica, Neptune Minerals, and Chatham Rock Phosphate? Do you even know what these resources are? If so, you do not mention it in your report.

Given that both Oceanica and Neptune are private entities (not subject to Reg. FD), their investors would have signed non-disclosure agreements (NDAs) and been made privy to extensive private information with respect to these resources. Logically speaking, they would possess knowledge of these assets that is far superior to that which you or I might claim. These investors would have gotten a look at material such as well-logs, assay results, and license maps. They might understand through their research the potential size and grade of whatever resource is to be mined. Based on this information, these investors risked hard-earned cash in substantial size, and fixed a value to the asset which would ostensibly leave them plenty of upside if the operation is successful. Yet you've decided that their investments are worth at most 10% of what they paid. Again, what do you know that has convinced you of this great discrepancy? How is your information superior to that which these investors possess?

You imply that since some of these investors may have connections with OMEX, they would be motivated to overpay for these assets. Doing so would artificially inflate the value of OMEX's portfolio so they could benefit as OMEX shareholders. Think about what you're saying for a moment. To support such a strong statement, you would want to present compelling evidence that each of the private investors in Neptune and Oceanica held proportionately larger stakes in OMEX, however you provide none.

Do you really believe that investors would capitalize Neptune with $20.5mn in cash at a $300mn valuation (this includes the $17mn raise and the additional $3.5mn raise in August) to inflate Odyssey's 30% stake in this private company? This would involve possibly hundreds of Neptune investors colluding to defraud all of OMEX's investors. I know investors in these entities, and I can assure you that they have invested in these private enterprises because they believe they are worth a lot of money. Moreover, we have no reason to believe that all of these investors are all investors in OMEX. There's no evidence.

Practically speaking, your scheme doesn't make a lot of sense either. Say you're right and all of the investors in Neptune realize the company is worth less than $30mn, but they capitalize it at $300mn because they're big investors in OMEX. They might as well throw 90% of their Neptune investment away. It doesn't trade publicly, so the only way they can exit at a profit is by colluding with another buyer to purchase at an even higher valuation. That's going to be an extremely difficult sales pitch.

Your theory is that they'll have so much more to gain in OMEX that they can afford to eat this loss. So, let's look at the math. This investment has created $90mn in fictitious asset value to OMEX (Neptune at $300mn * Odyssey's 33% stake (roughly) = $100mn * .90 = $90mn (since 10% of the value may be real). We take that $90mn and divide it by the roughly 78mn shares outstanding at the time and we get $1.15 incremental value to OMEX shareholders from Neptune. The stock was close to $3, so $1.15 would have represented a 38% gain. To offset the 90% loss in Neptune and just break-even, an investor would have to make a commitment of $2.37 in OMEX for every dollar committed to Neptune (0.38x = 0.90). This means that just to recoup the lost investment and break-even, in aggregate Neptune investors (who invested at least $20.5mn at $300mn) would have had to own almost $49mn worth of OMEX stock.

Of course these wily investors are accepting great risk in your complex fraud, so they're not going to be satisfied with breaking-even. They would want to own at least $100mn in OMEX stock to make this scheme even remotely worthwhile. It takes a fairly vivid imagination to assume investors behind $100mn worth of shareholdings could quietly execute this scam given the distributed ownership of this stock. Further, they would want to be able to liquidate that stock pretty quickly once the news hit - before an analyst such as yourself clued into the scam. In other words, the selling pressure instigated in the fraud would assure these investors of losing a great deal of money.

Oceanica is much the same. Mako has invested a total of $25mn in Oceanica at valuations ranging from $100mn to $125mn. It simply wasn't in the gameplan of the investors to voluntarily lose this money while pumping up the value of OMEX by $45mn or $0.56/share. The math here is just as absurd as in the case of Neptune. The vast majority of Mako investors are passive, high-net-worth investors. We have zero reason to believe they have colluded to defraud, nor do we even know that they are OMEX shareholders.

Running Out of Cash?

In a number of places in your report you claim that "OMEX management has publicly stated they don't have enough cash to make it through 2014." Yet you don't cite one single example where management states this. Instead, you quote CEO, Greg Stemm, saying that the company will have enough cash to fund operations through most of 2014.

You must understand the distinction between the two statements, right? It's not unusual in the least for a company not to have enough cash at the end of the year to fund all of its operational budget the following year. Yet not all of these companies are compelled to raise money. Where does the rest of the funding come from? Operations.

Of course you would point to the past operational deficits as rationale for concluding that OMEX will need financing. You may be correct in your assessment, but the truth is that we don't know. Thus, communicating to investors that management has announced they will run out of cash is highly deceptive. Odyssey has plans to generate cashflow next year, and my model has them burning only a small amount this year. Odyssey will harvest additional commodity wrecks, perform service work on a contract basis, and perhaps monetize more mining assets. While OMEX may need to raise cash (I have no idea whether or not they will), nothing management has said indicates they won't have enough cash to make it through 2014. Can you produce evidence to the contrary?

Neptune and Oceanica Financings

You state that on August 14, 2012, Neptune Minerals, Inc., "announced that it would receive $35,000,000 in investment but could only close $3.5mn from one investor." But you direct readers to an SEC filing that merely indicates $3.5mn in securities were placed out of $35mn which were available had the company chosen to offer them. It's not unusual for companies to secure shelf filings for securities in larger amounts than they are trying to raise. You later claim that on March 7, 2013 Neptune announced it would receive $5mn in funding, but was only able to raise $800,000 from six investors. In both of the cases you cite, Neptune was doing small bridge deals. They accomplished exactly what they intended to accomplish in these deals. You deceived investors when you claimed that Neptune had announced it was trying to raise larger amounts.

You insinuate that very small investments were made in Neptune and Oceanica to artificially inflate the value of those assets. This is patently false. As shown here, Neptune's second round of financing was a $17mn deal with a $300mn valuation. The small, $3.5mn placement to which you refer, was also done at the $300mn price. Mako invested $15mn in Oceanica at $100mn valuation and subsequently exercised options to purchase $10mn worth of stock at a $125mn valuation. These amounts represent significant investments in these assets.

Commodity Wreck Economics

On Page 17 you produce two tables that purport to demonstrate the economics behind the Gairsoppa project. The problem is that you didn't dig any further than the filings, therefore you overstated costs, and you failed to take into account the positive inflows from Galt Resources. Again, you seem to willfully avoid the truth.

You cite $17.8mn in Gairsoppa salvage operation costs in 2012, and simply double that number to reflect an estimated cost in 2013. Since you didn't speak with management, you had no way of knowing that the 2012 number expensed several years of work that had gone into research, search and reconnaissance, as well as salvage. Management estimates that the 2013 costs related to the Gairsoppa were just half of the amount expensed in 2012. This means that you overestimated costs by approximately $8.9mn. Further, while you reflected the correct costs associated with the Galt Resources investment, you didn't include Galt's inflow in your return calculation. Since Galt contributed $7.5mn, we would at least want to include half this amount toward the Gairsoppa recovery (leaving the other half in case Victory ever materializes). Once these changes are made, the total net return to OMEX increases from $18.6mn in your calculation to a more realistic $31.25mn.

So the Gairsoppa salvage, which you declare "barely profitable" in 2012, "entirely unviable"(pg 23.), and incapable of funding OMEX "for even one year" is in fact 68% more profitable than you estimate. The $31.25mn represents a return of 117% on OMEX's $26.7mn in costs over a period of several years (remember that the $31.25mn is net of the operational costs). As a shareholder, I'm happy with those returns. They represent a strong endorsement of the company's new focus on this business.

Salvage Competition

Why do you contradict yourself in assessing the competitiveness of OMEX's salvage business? On page 22 of your report you explain why "OMEX Lacks Serious Competition in the Deep Sea Treaure Hunting Business." You go on to proclaim "all you need is a few million dollars and access to a ship and crew, which are readily available for hire." Since anyone can do it and few are trying, you reason that this must be a bad business. A few pages later (page 25) you have changed your tune, and declare the salvage business to be "highly competitive." You cite an article about an emergency salvage company (Titan) demonstrating, once again, your lack of real comprehension of Odyssey's business.

Odyssey isn't in the emergency salvage business. They didn't get a phone call when the Costa Concordia went down. Odyssey seeks older, deep-water commodity wrecks that were lost at sea within the last 100 years, carrying valuable cargo. Once they've found a wreck, they negotiate terms with the owner/insurer and usually contract to receive 80-90% of the value of the recovered cargo. The economics are dramatically different from emergency salvage, which targets current wrecks that aren't hard to find, and is more akin to time & materials work. Again, one can understand how someone whose only exposure to this business is through the financial statements would make this mistake.

Do you honestly think that you and a buddy could grab a six pack, rent a boat, and go locate and salvage 100 tons of silver buried in a complex maze of steel at a depth of three miles? Perhaps an operation like this requires a measure of expertise as well as sophisticated equipment? After all, OMEX is the only operator to successfully complete an operation at this depth. This might explain why this business is capable of producing attractive returns (see Gairsoppa analysis).

The truth is that OMEX has good reason to believe that the commodity salvage business can be a financially rewarding business. This is why the company has chosen to focus on this business going forward. The company has contracted to salvage six wrecks representing value in excess of $200mn where they are set to receive 80-90% of the economics after covering costs. These wrecks are relatively low risk recoveries with relatively high reward. These recoveries should be even more profitable than the Gairsoppa as their commodity payloads are easier/less-costly to locate (they generally make up greater than 50 percent (see page 8) of the tonnage by weight in the wrecks (Gairsoppa's silver was two percent), and the company has taken measures to buy rather than lease certain key equipment, and secure less expensive recovery vessels.

Foreign Subsidiaries and Oceanica

You point to the creation of five offshore subsidiaries around the mining business as a reason for concern, comparing the structure to that used by Enron (page 43). In reality, there is nothing unusual with this organizational structure. Many countries require that mining rights be held in legal entities which are locally domiciled. Further, OMEX's latin legal representation is in Panama. Panama has a tax treaty with the country where the Oceanica resource resides, making Panama a logical location for two subsidiaries.

On page 44 you state "Given our confusion over ownership claims and the fact Oceanica was apparently started by two people (listed below) with just Mex$50,000, we question how Oceanica could be a private company with a valuation in excess of $100 million?" I'm not sure why you would find this unusual. You've worked with at least one mining firm in your career, therefore you should understand that often mining rights in previously unexplored geographies are fairly inexpensive. Yet, if these licenses prove to hold high quantities of resource that can be economically mined, the entity's value can increase dramatically.

DNA Ltd Inc.

You write extensively about criminal activities tied to directors at DNA Ltd Inc (Private:DNA). Yet you don't seem to know the purpose of DNA, who controls the entity, or what role the directors you've "investigated" play.

DNA is an entity managed by Daniel de Narvaez, a Columbian mining expert and shipwreck enthusiast. De Narvaez has worked closely with Odyssey in connection with the Oceanica project. DNA was set up by De Narvaez to secure the license for Oceanica. The entity was organized with the help of a Panamanian law firm, which provided statutory or nominee directors for the organization. This is a customary service provided by law firms engaged in forming businesses for foreign nationals. Sometimes local statutes require local directors, other times having local directors helps reduce logistical burdens and saves money.

Statutory directors are often employees of the acting law firm. They may serve on many different boards. Safeguards are normally enacted such that these directors have no operational control, they don't manage, and are not otherwise involved in the organizations.

The individuals you name are not involved in Oceanica - they play no role in the operations of the company. They likely serve as directors on hundreds of boards, and it's not all that surprising that some of the companies which they serve are corrupt. Their nominee status explains why the particular individuals that you reference weren't named as active participants in the corruption in each of the cases you cite. Rather, they were named only on the legal documents.

Once again, if you were after the truth you would have found it by talking with the principals involved. Roberto Guardia's law firm is just a phone call away. Instead, you seem content with the idea of spinning a story of intrigue, international money laundering, and pump-and-dump, to confuse and intimidate shareholders so that you might profit. This biased and incomplete account was reprehensible and irresponsible in the extreme.

Galt Resources

You criticize OMEX's business relationship with Galt Resources, an extension of John Morris. Your charge is that even when OMEX successfully salvages a wreck it "gives away" a substantial portion of the upside to Galt. You assert that you are uncommon in discovering this secret, that "this is a dynamic missed by most shareholders." Further, you've discovered that the original agreement was altered "to benefit John Morris and Galt Resources, at the expense of OMEX shareholders." And note, "We could not find any shareholder friendly reason for this amendment."

I'm not sure why you find the Galt relationship to be unknown or unfavorable to shareholders. It's presented front-and-center in filings. Management is not shy about walking through the relationship with investors. Galt contributed $7.5mn to OMEX at a time when the company needed the cash to undertake exploration and salvage work. Galt could have lost all of this money.

The returns Galt has earned are not uncommon in higher-risk project finance. Galt sponsored one successful mission. They've earned a 100% return over approximately three years (roughly 26 percent annually). If the second salvage (HMS Victory) is successful, Galt will do even better as it will take home an additional $15mn plus 7.5 percent of the net proceeds. It's worth noting that these terms were substantially better than those offered by a third party project financier, Robert Frasier Marine, so the relationship between John Morris and OMEX appears to have worked to the benefit of shareholders rather than to their detriment as you suggest.

The reason you could not find a shareholder-friendly reason for the amendment in the Galt deal is that you failed to speak with the people in charge of making the amendment and maximizing shareholder value. The deal between Galt and OMEX was structured as an option where Galt had a year to choose a wreck in which to participate. When that year was up, management was able to convince Morris to restructure the deal so that it was bifurcated between two wrecks. Had they not restructured the deal, Galt would have chosen Gairsoppa, which would have created a much larger cash demand on OMEX shareholders ($30mn rather than 15mn, and 7.5% of the remaining net returns).

Accounting for Value of Entities

"OMEX presents $179 million of off balance sheet value in their investments in offshore mining businesses at recent investment conferences despite the fact the investments are carried on the company's balance sheet at $0. Why?"

You can answer your own question by consulting US GAAP accounting rules and by speaking with management. Oceanica is carried on the parent company books under investment assets, but when the accounts are consolidated, this entry is eliminated by an offsetting balance in the shareholder's equity of the subsidiary. The following Wikianswer entry may be helpful: "Investments by a parent in its subsidiary and the corresponding net assets of the subsidiary should be offset and eliminated for consolidation purpose."

As for Neptune, which is not a subsidiary, the investment is consolidated on an equity basis which takes into account losses on a periodic basis. These losses reduce the carried value of the investment until it is eliminated. Thus, because Neptune has experienced only losses to date, its accounting value has been eliminated.


Many of the other points you make in the report relate to the company's historical performance or matters disclosed in various filings. You bring up valid points with respect to the firm's past failures, the rich compensation of its executives, the related party transactions, and the lack of a proper communication program. There is nothing new in any of these gripes, however, and they were all reflected in the share price prior to your report. The reason the stock cratered was the poorly researched, and sensationalist claims you made, which are demonstrably false. Unfortunately, most shareholders weren't in a position to understand how little you knew.

The irony is that OMEX presented an opportunity for you to serve your investors profitably as an honest shareholder advocate. You've spoken publicly about the need to take a constructive approach with management teams. You've also emphasized the need to build communication and connections with the people in a company. Why didn't you practice what you preach? Why did you fail to communicate with management and try to deceive shareholders?

The truth is that OMEX has made substantial changes to its operating model without a big activist push. Management realized that the old model of swinging for the fences with historic wrecks was not something that could support a public company. They've refocused Odyssey's efforts on mining, services, and commodity salvage, and the new strategy is beginning to realize impressive early dividends. Shareholders are tentatively optimistic. These businesses have much further to go, and we expect some excellent returns from them in the not-to-distant future. The balance sheet will be in better shape at year-end than ever before, and this is opening new opportunities to improve the company further.

You've attacked the company at an opportune moment (I would imagine this is by design). OMEX is not able to talk about its mining business in much detail due to restrictions stemming from the SEC's Guide 7 disclosure rules. The salvage business also requires very strategic disclosure at times (eg. HMS Victory). So, while the company has to be somewhat circumspect about its key businesses for now, you have an opportunity to continue your bear raid with additional "investigative research." I would encourage you, however, to vet your research thoroughly with someone who has a greater understanding of this business before you publish again.

You're reportedly a fan of Warren Buffett, as am I. So, I'll close with one of my favorite Buffett quotes as I think it's appropriate. "It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you'll do things differently."

You would be wise to keep this advice in mind.


Scott Vincent

Green River Asset Management

Disclosure: I am long OMEX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The Author has obtained all information herein from sources he believes to be accurate and reliable. However, such information is presented "as is," without warranty of any kind - whether express or implied. The Author makes no representation, express or implied, as to the accuracy, timeliness, or completeness of any such information or with regard to the results obtained from its use. All expressions of opinion are subject to change without notice, and the Author does not undertake to update or supplement this report or any information contained herein.