(Editors' Note: This article covers a micro-cap stock. Please be aware of the risks associated with these stocks.)
In a frothy market filled with excesses, it is very difficult to find value. It is extremely unlikely that one can find that value, coupled with exponential upside. And it is almost unimaginable that one could find value, coupled with that upside, primarily owned and controlled by a billionaire renowned for his deal making skills, surrounded by some of the smartest money on Wall Street. All this in a $2 stock trading on the bulletin boards, unknown and not followed.
Par Petroleum (OTCQB:PARR) (formerly Delta Petroleum) emerged from bankruptcy approximately a year ago. It emerged with a $1.3 billion net operating loss carryforward ("NOL"), and a 30% stake in 40,000 acres of Piceance oil and gas properties with significant proven reserves. Quickly after emergence, it acquired a company called Seacor Energy (now renamed Texadian) which owns a railcar fleet and a pipeline out of Canada.
As of the most recent filings, Sam Zell beneficially owns 32.5% of Par. Whitebox Advisors, a very savvy hedge fund (known for calling the crash of 2008 and profiting greatly from it), are the second largest holder, with 23.8%. Investors in the last $200 million financing round included Leon Cooperman, Highbridge Capital, and Marty Whitman's Third Avenue Funds. It is worth noting that these investors made the investment before the first large acquisition was closed, thus knowing what the strategy would be, and having intricate knowledge of that deal before financing it (the acquisition of a Hawaii refinery previously shut down by Tesoro - we'll get to that later).
Sam Zell has a very strong track record of creating value in such vehicles. His last vehicle structured similarly was Danielson Holding Corporation (DHC), which was a bankrupt insurance company that emerged with cash and a large NOL. That company ultimately acquired a waste to energy processor out of bankruptcy, which became Covanta (NYSE:CVA). All one need do is look at the ten year chart on Covanta to appreciate the value creation. And shareholders were offered the right to participate in this acquisition via a rights offering as well, further turbocharging the returns of those that elected to do so.
Let's start with the existing business: the 30% ownership of a joint venture in the Piceance Basin, one of the hottest spots for oil and gas discovery in the country. What is it worth? When the company emerged from bankruptcy, they announced proven reserves "in the range of $80 million to $250 million," but developments in adjacent areas by companies such as WPX, and historical transactions in this area, would indicate the value could be far greater than this. Shareholders have not been updated on this venture, but on the conference call management alluded to the fact that as minority owners, they are restricted from discussing it, but that they are "looking forward to discussing developments there." That doesn't sound like negative news to me. And based on the activity in that region, the odds are that things are better than we expect, not worse. Regardless, this asset alone could be worth as much as half of Par's current market cap, if not the entire market cap.
So onto their first acquisition after Seacor Energy, the shuttered Hawaiian refinery of Tesoro. The first question is why buy a refinery? Refineries are historically difficult businesses, relying on many moving parts to achieve profitability. They require significant maintenance capex to keep them running, and are at the mercy of the "crack spread," which is basically the net profit derived from buying oil, refining it into gas, and then selling that gas, plus the value of any byproducts created during the refining process. The short answer is that they basically got this refinery, and associated chain of gas stations and convenience stores, for free. They paid $75 million (plus up to a $40 million profit share in the event certain milestones are met) and for that received a company doing almost $3 BILLION in revenues, and based on pro-forma numbers provided by the company in an 8k, generating a net profit of over $40 million over the past 12 month period. These numbers were generating during a very difficult period for the refining business, during which crack spreads contracted significantly, dropping from $40 to, at one point, zero. As importantly, this refinery was effectively orphaned by Tesoro long before it was shut down. Employees at the plant tell stories of a complete disregard of the business from the parent company. A focused, smart buyer, buying this asset at the likely bottom of the business cycle from a neglectful parent, is likely to have made a very good deal.
Since those pro-forma financials were recorded, however, there is reason to believe those numbers have improved, possibly dramatically. For starters, those numbers include a period of time that the refinery was either completely shut down, or in the process of being shut down. Crack spreads have risen from approximately zero at the time the deal was made, to approximately $14/barrel as of the time of this article. The price of oil (the largest input cost for this oil-powered refinery) has been dropping.
Lastly, this refinery is not just a refinery. They provide over 5 million barrels of storage. They have a retail gasoline business, and the associated real estate.
The company also just completed construction on a new logistics facility in Illinois, as part of the company's plan to capitalize on the business of shipping oil from Canada to the South, and capitalizing on that price differential.
As part of their last financing, Par paid down $46 million in debt, reducing their parent company debt to almost nothing. They installed a new management team at the refinery level, who are likely to improve operations from the predecessor management at Tesoro, who had written the value of this refinery down to zero and had clearly abandoned efforts to improve its operations, especially in the latter months of its operations. They even filed for a liquor license, purportedly to be able to sell liquor at the various gas station convenience store locations they acquired as part of the deal. They also recently announced a veteran CFO joining the ranks of the parent company.
Oscar Schaefer, a renowned value investor, was asked by Barron's in their October 28, 2013 issue to provide two stock picks. His picks were Norway based Orkla, and PARR, stating "When you buy stocks, you basically bet on the jockey -- the person who runs the company. Over the years, Zell has made money by investing in companies with big net-operating-loss carry forwards, or NOLs, which allow you to shield future profits from taxes. He bought Par Petroleum debt and exchanged it for equity. The company sells for $2 a share, and the market capitalization is a bit over $600 million. Par has $1.50 a share of NOLs. You're paying very little for the chance to see what Sam acquires with this company. He owns $200 million of the stock." Can you imagine being a famous investor, sitting at the Roundtable, asked by Barron's to tell the world your top picks, and you pick an unknown bulletin board stock that just emerged from bankruptcy as your pick? You'd have to have a very high level of conviction to do so. One somewhat ironic thing to note: at this roundtable discussion, sitting across the table from Oscar was Leon Cooperman. At this point, Leon was already an investor in the last round of financing. I'd love to have been a fly on the way in that elevator ride downstairs.
So what is most likely to happen?
We should expect to see further acquisitions (as confirmed by management on the last conference call), funding by rights offerings backstopped by Zell et al. Rights offerings allow current shareholders to participate on a pari-passu basis, retaining their % ownership, and thus maintaining the validity of the NOL. As they pursue these acquisitions, they have the rare "ace in the hole" of being able to make deals with assured financing, because when Zell makes a deal and commits to funding it, there is no grey area he will get it done, even if he has to fund it himself (as he did with the refinery acquisition). And they will usually be able to be the most likely buyer, capable of paying the highest price, because of the benefits of the NOL.
How many acquisitions can they do? They will do whatever they can to first tap the $1.3 billion NOL, and from there, we can expect organic growth of the businesses and continued strategic acquisitions. Most likely, future acquisitions will be complementary to the company's current business lines, either utilizing their pipeline access, refining abilities, or logistics business.
What are the risks?
To put it simply: doing multiple bad deals. Because even one bad deal can be undone by a good one later. In the case of DHC, the first acquisition Zell made was a shipping company called American Commercial Lines, which soon went bankrupt due to an economic recession. But then he did Covanta. So even if everything goes horribly wrong with the refinery and it goes to zero, how many deals will have been done since to offset it? We don't know yet. But maybe a giant discovery in the Piceance basin is the answer. Or maybe the answer lies in the next deal. The point is, this isn't an all or nothing bet on one deal. The NOL will not go away until 2035. So there is no failure that will stop this group from continuing to funnel every good deal they can find into this vehicle. People sometimes cite Tribune as an example of a disastrous deal Zell did. What if he does something like that here? Well there are a couple of built-in protections against that happening. First and foremost, acquisitions will be made that will utilize the NOL. That typically excludes buying money-losing companies. By more importantly, there is another major shareholder involved who will provide a second set of eyes, and another reasoned point of view, and has a vote that could block a deal. So any deals getting done are effectively vetted by multiple very smart groups, and are beings sourced by the highest level bankers and deal makers in the business today.
Recently, the stock spiked as high as $2.50, and then dropped on large volume, and has been stalled in the $2.05 range. It has come to light in a recent filing that Waterstone Capital, the third largest holder with approximately 29 million shares, has been the seller. It is my estimate that there are less than 5 million shares left in their coffers, and if they intend to complete their liquidation entirely, those shares will be snapped up soon. Once this overhang and artificial pressure that has had its foot on the stock's neck for months is gone, it would not surprise me to see the stock closer to $3.50.
What is it worth today? With 300 million shares outstanding, I estimate the oil and gas reserves to be worth $1.00 - $1.50/share. I estimate the refinery to be worth $1.50/share. The net present value of the NOL is approximately $1.50/share. What is the pipeline and logistics business worth? I guesstimate .25/share. That's $4.25-$4.75 in value today for a stock trading at $2.05. And those numbers are likely conservative. And there will be plenty more deals to come to add to these numbers, of that we can be sure. And the real value from this play will probably come from those future deals, because the bigger this market cap gets, the bigger the deals that can be done.
In summary, there is simply too much value already in this deal, and too much smart money surrounding it for it not to work. The deal sourcing, the financing options, and managerial contributions from this group are priceless. This entity is very likely to be the recipient of major focus by Zell, as his significant stake and the exponential upside that would be achieved by successfully utilizing the $1.3 billion NOL make this an important part of his portfolio.
Disclosure: I am long OTCQB:PARR. 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. I know that Seeking Alpha does not usually publish articles on stocks trading on the OTC Bulletin Board. This stock has a market cap of over $600M and I believe that this article should be published.