Cheap Point Loma Resources Passes 1,000 BOED While Overcoming Extra Startup Challenges

| About: Point Loma (FMTNF)

Summary

Point Loma Resources was a combination of privately held Point Loma, cash strapped Madalena properties, and First Mountain Exploration.

This company management redefined lean and mean by not raising cash at the onset. That caused some initial accounting alarms but production should top 1,000 BOED in the first quarter.

Management is unusually deep with several senior managers co-founding other companies and having experience raising capital or debt.

Low risk production restarts are the first priority. Then comes low risk side-tracks and new drilling.

Madalena is still a major shareholder, but acquisitions and fund raising have cut its stake to a little over 10% while increasing stock trading liquidity.

Madalena Energy Inc. (OTCQX:MDLNF) had some very serious cash problems. In fact the latest quarterly press release has a "going concern" statement along with a discussion about a financial advisor. So things are pretty serious for this company. Evidently with an announcement of lower oil sales prices in the future of the company there could be more serious problems. Once a financial advisor gets involved, then usually these problems get resolved promptly. This company has needed cash for some time. To get that cash, Madalena has done several things, one of those steps gave birth to a new company Point Loma Resources Ltd. (OTC:FMTNF). Point Loma Resources is in far better shape now than the parent company and as a result could be a much better bargain. This is an unusual situation.

Back in June, Madalena Energy had some non-core Canadian assets that could be sold for cash. Point Loma Resources Ltd. (a private company) acquired those noncore assets, combined them with its own, and then did a reverse merger with First Mountain Exploration Inc. at the same time. Point Loma used the public company First Mountain to go public a little more cheaply than the usual way. The new company produced a little more than 100 BOED, had some cash, and a lot of hopes and dreams. First Mountain, the public company survived but changed its name to Point Loma Resources Ltd. The new management and board of directors also came from the Point Loma team.

Source: Point Loma Corporate Presentation, January, 2017

Readers will recognize some familiar names such as Surge Energy (OTCPK:ZPTAF) and Painted Pony Petroleum (OTCPK:PDPYF) as fairly successful companies. This management has a remarkable history of successfully growing oil and gas companies. So even though this company definitely had a very rough start, there is some very experienced management at the helm to guide the company.

Madalena had cash problems that were going to take some Point Loma management time in addition to all the usual startup challenges. So this management was going to need all that experience. A financially weak major shareholder can cause stock trading disruptions and change of control issues. In fact, at one point Madalena could have owned more than one-third of the Point Loma outstanding shares (in theory). To its credit, Point Loma management managed to defuse many of the related issues by the following actions.

Madalena Energy received some cash, a Point Loma debenture, and shares of Point Loma from this deal. The debenture was subsequently sold. Point Loma converted the debenture into two debentures whose combined value was C$2.5 million or C$500,000 less than the originally issued value. So shareholders benefited from the distress sale of Madalena corporation.

This series of transactions may cause some observers to question the sales value of the leases received in the merger by the new Point Loma company. Madalena cut the debt amount significantly, and sold the debentures (admittedly in a distress sale) for much less than the face value of the convertible debentures or the market value of the underlying shares of stock. However, the relatively low cost startup of significant production combined with the projected profitability of new drilling on the various leases may ease some of those concerns.

One could wonder why Madalena did not just distress sell the leases directly and avoid all the steps shown above. Madalena subsequently received C$10 million in another transaction plus a line of credit. These steps should ease the fears of Point Loma shareholders that Madalena Energy would have to dump its remaining ownership interest on the market. But these kinds of problems divert the attention of Point Loma management from the current operational management issues. Thank goodness the shareholder stake of Madalena has declined from a potential 40% (including the debenture conversions) to a little more than 10% currently. Plus the convertible debentures are now in financially stronger hands.

In fact, Point Loma has much of the remaining ownership interest in escrow and is releasing pieces of the ownership interest every six months to prevent such an occurrence. Madalena did sell about937,000 shares in the latest transaction without seriously disrupting the market. So while Madalena still has financial difficulties, the immediate crisis appear to have abated somewhat. Still though it bears watching by Point Loma shareholders until the whole situation is resolved.

Madalena may at some point be required to raise cash by selling the rest of its stake. Madalena has roughly 4 million shares of Point Loma remaining to potentially sell. So an unsupervised dump onto the market could really depress Point Loma share prices temporarily. Point Loma management may have to deal with that issue. If it happens, that event will probably happen within the next few months. The low long term debt levels and increasing production increase the chances that Point Loma will qualify for a bank line to deal with the issue. So there could be a buying opportunity currently for potential Point Loma investors. This management distraction should be resolved by fiscal year end (probably a lot sooner).

This company started out very lean. In fact no initial cash was raised. The only cash was the money that the original company, First Mountain and the private company Point Loma had. Management targeted a fair number of suspended wells to jump start production. This was fairly successful as management reported an exit production rate in December of 570 BOED. Two wells were down plus management thinks there is another 120 BOED or so to restart which will increase the overall rate significantly in the new fiscal year.

"The Company has a net loss for the nine months ended September 30, 2016 of $1.9 million (2015 - $2.9 million). As at September 30, 2016, the Company has an accumulated deficit of $5.7 million (December 31, 2015 - $3.8 million) in addition to negative cash flow from operations and a working capital deficit. These conditions along with any further losses in the development of its business indicate the existence of a material uncertainty that may cast significant doubt upon the Company's ability to continue as a going concern."

The reverse merger closed near the end of June, 2016. So the new company really was responsible for the latest quarter of losses. Most of those losses were the result of the merger charges and beginning production costs. Those will decline significantly in the next few quarters. The company used about C$650,000 in cash during the third quarter but increased production by more than 400 BOED. The new company may be able to make use of the tax losses and other accumulated credits that First Mountain had before the reverse merger. Those tax losses (and other credits) are assets and part of the value acquired in the merger. Some will be lost due to the change in control.

The accountants were justifiably alarmed when the cash balance dipped to about C$100 as the cash spending rate was very high to restart the production. However, in October, the company raised about C$2 million (before expenses) to erase the roughly C$600K working capital deficit and provide funds to continue to increase production cheaply.

Another company InPlay Oil Corporation (OTCQX:IPOOF) raised a significant amount of cash initially when completing a reverse merger. So the expenditure of cash did not alarm the accountants. The initial startup was completed with far less mandatory warnings along the way. Plus the company had a much easier time obtaining a bank line of credit. Point Loma will probably have to establish a production and cash flow history. None of the founding entities appear to be in a position to aid the company in establishing an initial bank line of credit.

So Point Loma is managing its startup with proportionately far less cash than InPlay Oil, even including the latest cash raise. The production level is also lower and the enterprise value far lower. Even though the startup process appears to be a success, the relatively (or proportionately) low cash balance history could still be affecting the market price even after the latest cash raise.

Point Loma now has more than 30 million shares outstanding. Plus the company announced another acquisition for stock that should push production near the 1,000 BOED mark and significantly aid cash flow. The latest acquisition for 4 million shares will add about 410 BOED (95% gas) and will continue to increase liquidity. All of the cash flow will be available for capital and maintenance expenditures as well as decreasing the working capital deficit. Plus the increasing number of shares will make it easier to dispose of large blocks of shares should that be necessary. The total market value after the acquisition closes should approximate C$20 million.

With the latest January acquisition announcement, production should exceed 1,000 BOED when the shut-in wells and the behind pipe potential production is included. In fact production could easily approach 1,300 BOED as production is optimized and startup issues fade. So significant cash flow going forward to stabilize operations will happen immediately. It would take only a few new wells to exceed 1,500 BOED even when natural production decline rates are included.

The company has about C$3.2 million in long term debt, all of that is convertible. The conversion of those debentures would roughly 15% more shares. In exchange for some dilution, the liquidity of the stock will increase materially. The current stock price is above the conversion feature so the chances of conversion are currently very good. In any event the company now has the cash to pay the debenture due in 2018 (convertible at C$.40 per share) if it is not converted. The remaining debt is not due for several years. The rising production should keep the working capital strong enough to allay any maturity concerns.

Source: Point Loma Corporate Presentation, January, 2017

The first slide summarizes much of the discussion up until now plus provides the current netback. This production may not have the cheapest costs, but there are plenty of drilling opportunities plus a possible water flood project may lower future costs. That cash flow can be somewhat protected with hedging and management can easily hedge the production. Plus this small company can change its average costs relatively quickly because of the initial low production levels. At the current production levels, every new well will materially affect costs.

In the meantime, the second slide shows the relative low valuation of the company. This is caused by the financial problems of a major shareholder, a lack of financial track record, and the new company name. Much of this will resolve itself fairly promptly, providing new investors with a chance to profit as the market recognizes the accomplishments of the new management. The netback above at the production rate shown could be worth about C$1 million per quarter. With two wells down, an acquisition in process, and another supposedly easy hookup ahead, that amount will grow significantly. Cash flow from operations of C$1 million should be very easy to achieve. Management appears to present as though that C$1 million per quarter cash flow from operations should be exceeded by the end of the year (they have not yet clearly stated a goal). Long term debt is relatively low, so expanding production should easily begin to service the debt.

Source: Point Loma Corporate Presentation, January, 2017

Once the company has restarted production where possible, there are some very attractive drilling opportunities on the leases. These leases appear to be fairly profitable even at considerably lower commodity pricing. Plus the company is experimenting with the latest industry improvements to lower the breakeven point further. The kinds of returns shown above will allow cash flow to grow very fast from a very low starting point. Management has every intention of continuing to specialize in the Central Alberta area. But will continue to look for accretive "bolt-on" acquisitions that complement the existing leases. This company has the advantage of making very small "bolt-on" and accretive acquisitions that are significant. So far those acquisitions have made a very rough start far more pleasant in the future.

Source: Point Loma Corporate Presentation, January, 2017

It was amazing that management managed to bring online a discovery well with all the challenges it faced. Plus for the area, this is a relatively large producer. The well offset two wells that were taken offline to accomplish the final year end record production figure. Management further stated that the oil ratio is a little higher than originally forecasted, so the netback should be favorably impacted in the near future. This is also the area in which there is another 120 BOED that can be easily restarted during the fiscal first quarter.

Summary

Source: Point Loma Corporate Presentation, January, 2017

The top slide shows wells that are relatively cheap to drill and produce. Plus they are profitable to drill at considerably lower commodity pricing than the current strip pricing. It would take a fairly minimal hedging program to keep cash flow robust. Management has plans to significantly increase production. That will require some commodity price cooperation. Plus continuing small accretive acquisitions for stock are a very strong possibility. Those small landowners often have trouble selling their interests to larger companies because of their insignificance. So in a very competitive industry, there is slightly less competition for those very small production interests.

But the low debt levels should ensure that the company would survive a sustained downturn of commodity prices if that occurs. Many of the initial merger and startup expenses are now complete. So management will need to demonstrate the generous netback and the increased cash flow. The third quarter cash flow was approximately C$170,000. But that figure will increase quite a bit in the fiscal fourth quarter. If management achieves its goals, cash flow from operations should exceed C$1 million per quarter within a few months. Plus expenses will drop as routine maintenance becomes the rule and startup expenses become less significant. So this stock could be very cheap as the underlying cash flow quickly builds. Despite all the "could's" and "should's" this speculative stock is less risky than many other speculative situations after the latest cash influx due to the experienced management.

Source: Point Loma Corporate Presentation, January, 2017

This board also has quite a bit of experience. Between the senior management and the board, there are several individuals that have experience raising capital for new ventures. This company currently needs that experience. But despite the going concern language, the company appears to have overcome the initial startup phase and now has a fairly reliable cash flow. Unlike many companies, the going concern language will be removed once operations and cash flow reasonably stabilize (or begin growing). Debt is not a problem here, it was the quick depletion of cash during the startup phase. Shut-in production can have above average downtime when restarted. But this management appears to have the experience to handle those kinds of problems if they appear.

The challenge for this management will be to drill new wells and establish some low cost production to continue to lower the breakeven point of the company. It will not require that many new wells to increase the production about 50 % from current levels. A drilling budget of about C$5 million to C$6 million should do the job. Management is currently adamant about living within the cash flow. But there could be another capital raise if commodity prices drop significantly to raise production to the point where cash flow will fund future growth. The company is located in one of the lower cost geographic areas. So if the acreage is "good enough" the company should be able to survive the downturns and thrive during the better times.

In the meantime, the market appears to approve of the initial steps that management has taken. The stock is trading near its high of C$.60 per share (as of the close of market on February 9, 2017). Management has a very easy comparison in the when the fourth quarter is reported, and the fiscal first quarter should report further progress as a result of the acquisition. Since there is more shut-in production, the financial and operational comparison could be very cheerful all year. That includes comparisons to the previous quarter as well as comparisons to the previous year.

So while the ride may be a little bumpy in the beginning until the financial problems of a major shareholder no longer affect the stock of the company. It is clear that this risky stock, with its experienced management team could be part of a portfolio as one of a basket of several speculative stocks. Some discoveries like the one reported in December, or even the confirmation of oil presumed to be in-place should reward shareholders significantly over the next year. The market usually demands a track record before it places much value on the stock. In this case, the experienced management should be up to that challenge.

Disclaimer: I am not an investment advisor and this is not a recommendation to buy or sell a security. Investors are recommended to read all of the company's filings and press releases as well as do their own research to determine if the company fits their own investment objectives and risk portfolios.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

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