The Manual of Ideas'  Instablog

Victor Fasciani, Managing Partner of Praetorian Value Fund, made a compelling case for Contango Oil & Gas (MCF) during his presentation at the Value Investing Seminar in Molfetta, Italy today. Our notes from his speech follow:

Praetorian Value Fund -- Investment Philosophy

• Wants to understand every detail of the business (financials, management, industry, competition) --> "leave nothing to chance"
• Thinks current market volatility and irrationality presents opportunities across all market cap segments (although traditional small/mid-cap focus)
• Diversification is not risk management

Praetorian Value Fund -- Selected Investments

Long (as of 4/30/09):

• Alliance Grain Traders (AGT.UN-V.TSX): company in commodity business without commodity-like characteristics
• American Express (AXP)
• Contango Oil & Gas (MCF)
• Cresud (CRESY)
• Gigamedia (GIGM)
• Transocean (RIG)
• Vulcan Materials (VMC)

Recent Short:

• Dollar Thrifty (DTG) - over-levered year-to-date outperformer that should come crashing down

Investment Idea: Contango Oil & Gas (MCF)

• Company focuses on highest ROI part of the value chain: exploration
• Founded by CEO Ken Peak in 1999 with $30M of capital (at $43/share current market cap approx. $670M with stable share count since 2001)
• Buffet-like company philosophy: give smart people capital, give them large incentives for doing well, and then let them do their thing
• Leanest operation in the Gulf of Mexico: 7 employees in small Houston office (everything except planning and idea generation is outsourced)
• Underfollowed by sell-side: no analyst coverage
• Robust balance sheet: no long-term debt
• Motivated and incentivized management: CEO owns 20% of company

Compelling valuation:

• $1.3B or $78/share intrinsic value of proved reserves only (based on net present value of after-tax income assuming $7 per Mmbtu natural gas price and $70 per barrel of oil)
• Reserves in place for last ~50 million years and not going away
• Other assets and free options add up to an additional $30-40/share (MCF bought more than 70 lease blocks in the Gulf at $35M cost basis; Victor thinks this is worth $100M today because of seismic data and the company's successful drill track record of 67%)

Catalysts:

• Continue drilling in the Gulf potentially converting probable into proved reserves
• Company was for sale in summer 2008 - received offers in the $70-80 range but CEO would not sell as these prices viewed as fire-sale
• Assets remain in play and CEO is 65 years of age
• Company has $100M stock buyback in place

Reasons for mispricing:  

• Natural gas stocks trade partly based on spot or front-month natural gas futures price movements --> as 12 month forward curve significantly higher than spot prices (around $5.50 vs. $3.50 per Mmbtu) market seems to ignore the implied increase in prices  
• Market won't pay for optionality value of assets in oil & gas, especially in current environment 
• Market doesn't give enough credit to good management teams in this industry

Why Natural Gas Stocks Present Opportunities

• Assets can be easily converted into cash and non-perishable inventory
• Currently reserves are cheaper on Wall Street (--> M&A) than in the ground
• Ratio of oil to natural gas prices at 16:1 currently vs. 10:1 historically --> Victor convinced of reversion to mean and thinks this will happen by natural gas prices rising from their recent lows in the $3.50 range (thinks long term floor  for natural gas prices is around $6 for companies to achieve 10% ROE --> if prices fall below that for long, higher cost onshore wells are shut reducing supply and eventually leading to higher prices again, as happened in fall of 2006)

About Victor Fasciani

Mr. Fasciani is the Managing Partner of Praetorian Value Fund. Praetorian Value Fund utilizes a bottom-up, research driven value approach focusing much attention on small- and mid-cap value opportunties.  Mr. Fasciani was a Senior Analyst and Co-Portfolio Manager with Sellers Capital from 2007 through 2009.

Disclosure: Long MCF, no other positions.