If There Is Such A Thing As A Free Lunch In The Markets, Stans Energy's Favorable Settlement Comes Close

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 |  About: Stans Energy Corp. (HREEF), Includes: CAGDF, MCPIQ
by: Edward Vranic, CFA

Summary

Stans Energy was awarded $118M in a settlement by the Arbitration Court at the Moscow Chamber of Commerce and Industry.

The market cap sits at just a fraction of the settlement amount, so the market doesn't think the company can collect, but presents significant upside potential for investors.

The Government of Ontario backs the legal claim so Stans should be able to collect on liquid assets worth the $118M.

Stans's situation leads to it becoming a buyout target.

Management needs to act quickly if the company doesn't want to be a target of a hostile takeover and wants its choice of assets as compensation.

Stans Energy (OTCQB:HREEF) is a company focused on the development of Heavy Rare Earth properties in areas of the former Soviet Union. Its main focus is the Kutessay II mine for which it owns a 20-year mining licence. Kutessay II is the only place in the world outside of China to have produced Heavy Rare Earth Elements in its past and it produced 80% of the Soviet Union's rare earth metals while it was being mined.

In 2012, the Kyrgyz State Geological Agency ordered work to be stopped on the property, as the state wanted a percentage of ownership without any established law requiring Stans Energy to give up any such portion. The resulting legal battle between the Government of the Kyrgyz Republic and Stans Energy came to a conclusion last week as the Arbitration Court at the Moscow Chamber of Commerce and Industry handed down a final binding ruling in favor of Stans. The Kyrgyz Republic is required to pay Stans Energy a total of USD $118,206,056.80, equivalent to 75 cents per share.

At 18 cents for HREEF, Stans has a market cap of $27.5 million, only 23% of the settlement amount that is owed to the company. Clearly, the market has its doubts over the company's ability to obtain the settlement amount from a country that is one of the poorest in the region with about a third of its population below the poverty line.

Despite the uncertainty and potential moral dilemma around collection of the funds, I believe that HREEF's stock price is far too discounted and represents a great risk-to-reward dynamic. The upside potential can be two to five times the current stock price but the long-term downside risk is extremely limited. If there is such a thing as a "free lunch" or at least the $1.99 all-you-can-eat filet mignon special in the stock market, Stans Energy's favorable settlement at more than four times its stock price, which is backed by international tribunals appears to be a good bet.

The easiest course of action is for Stans to seize assets belonging to the Kyrgyz State that reside outside of the country. The most obvious choice would be the seizure of shares of Centerra Gold Inc. (OTCPK:CAGDF), of which the Kyrgyz State holds a 32.7% interest. The precedent for seizure of Centerra shares has already been set in Ontario, where it trades on the Toronto Stock Exchange, as a Turkish company recently won a similar ruling over the Kyrgyz Republic in the Ontario Court of Appeal. Stans may also seize other capital flows and assets such as gold, but may prefer to negotiate a settlement so it can continue to work on the project.

While Stans has several choices it may act upon to favorably impact the stock price, it is prudent that management acts quickly. The most pressing issue in the possible seizure of Centerra shares is a proposed deal in progress where the State receives a direct interest in Centerra's Kumtor mine in exchange for the stake in its shares. Should Stans decide to enforce the settlement and seize assets, the Centerra shares may no longer be an option by that time.

I believe another significant near-term risk (or opportunity from an investor perspective) is the possibility that Stans Energy will be the target of a hostile takeover due to:

  • Stans' market cap being at a disproportionately large discount to the settlement amount, thus it should attract the attention of investment funds specializing in distressed or discounted assets
  • Stans' ability to seize Centerra shares may be of interest to any investor looking to acquire the profitable, dividend-paying gold company. The $118M settlement would result in 18 million shares being seized. That position would be difficult to obtain without pushing up the stock price as Centerra's Canadian listing CG.TO trades about a million shares a day.
  • One of the reasons cited behind the suspicious activities of the Kyrgyz State with respect to Kutessay II is that the previous owner of the licence wanted it back to try to sell it to another entity. That entity may be interested in going directly to Stans to obtain that licence.

One fund sticks out in my mind when I think of a potential suitor for Stans, and that is Pala Investments. Pala has a history of hands-on, aggressive and activist roles in the companies for which it holds an interest. Led by Russian billionaire Vladimir Iorich, the company unsuccessfully tried to take over Neo Material Technologies, another company which produces rare earth metals and has since been bought out by Molycorp (MCP).

Pala's Russian roots and familiarity with the old Eastern Bloc, interest in mining in general and in particular rare earths and its history of aggressive pursuits of discounted companies during bearish times should mean that Stans would be on its radar screen. Based on Pala's hands-on investing style of the past, I believe that the firm would be an ideal suitor for Stans' assets while pushing the Kyrgyz Government for a favorable solution.

A buyout would likely come at a discount to the 75 cents per share owed to Stans from the ruling, but it could potentially come soon thus making it a great short-term flip for speculative traders or investors who agree to my assessment. But I am not basing my investment decision solely on the idea that a buyout is in the works. I hold my Stans Energy shares expecting that a buyout is a good possibility. However, even if it wasn't to be bought out I view the seizure of $118M of Centerra shares or the court ruling over Kutessay II providing Stans with negotiating leverage to continue on with the project both to be choices of the management team that will result in stock price appreciation.

Disclosure: The author is long HREEF. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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