Torchlight Energy: We Believe Its Orogrande Project Is Worthless, Management Has A Questionable Past - 90% Downside

Apr. 29, 2019 10:00 AM ETMeta Materials Inc. (MMAT)53 Comments6 Likes
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Summary

  • Torchlight Energy has an enterprise value of over $130M. The company's entire perceived value is based on possible oil in its Orogrande Project.
  • TRCH only paid $3.35M in cash and stock for 75% of the Orogrande in August 2014 when oil prices were much higher than today.
  • TRCH has little cash with increasing debt, and if it cannot sell the Orogrande, we believe the company is finished.
  • In April 2018, TRCH said it would sell its Hazel Project, but never did, and raised equity instead.
  • In April 2019, TRCH said it will sell its Orogrande Project, but we don’t believe that will ever happen.

Introduction

We are short Torchlight Energy Resources, Inc. (TRCH) because we believe it is a classic pump-and-dump run by a questionable management team in our opinion, with some of the leadership having previous run-ins with securities regulators.

Since commencing operations in 2013, the company has generated only $10.7 million in revenue while incurring $52.8 million in operating expenses and paying $14.4 million in interest expense, for a cumulative net loss of $83.9 million. Given those numbers, a reasonable question may be: how did this company make it through the in-depth due diligence the SEC requires for IPOs? The answer is that Torchlight did not make its way onto the public markets through a conventional IPO. Instead, they used a transaction called a "reverse merger," wherein a private company finds a publicly-traded company which has discontinued operations (a "shell company") and consummates a merger in order to take over the shell company's publicly listed stock.

Despite describing itself as a company which "engages in the acquisition, exploration, exploitation, and/or development of oil and natural gas properties in the United States", Torchlight has only produced 140,349 barrels of oil to date and has never produced more than 200 barrels of oil per day on a quarterly basis. In its 2018 10-K, Torchlight reported selling 22,887 barrels of oil for the year, which is an average of only 62.7 barrels per day. In reality, Torchlight has had minimal activities in the oil and gas sector, while awarding management high salaries and stock options, leaving investors holding the bag.

Management and Related Parties

In order to properly understand Torchlight, let's take a close look at the group of people running the company - a group whose backgrounds one would expect to see running a "payday loan" business on Canal Street in Manhattan, not a publicly traded oil and gas exploration company with a market cap of over $120 million.

Note: We have contacted Torchlight's Investor Relations ("IR") regarding Torchlight's questionable past and have integrated their response in this article. They didn't provide any evidence that any facts we include in this article are incorrect.

John Brda, President and CEO

According to Torchlight's website:

"Mr. Brda has been our President and Secretary and a member of the Board of Director since January 2012. He was promoted to CEO in December of 2014 with the exit of our co-founder Tom Lapinski. Mr. Brda, who also co- founded the Company, has been the Managing Member of Brda & Company, LLC since 2002, which provides consulting services to public companies - with a focus in the oil and gas sector. Core competencies include capital formation, equity and debt financings, strategic business development and securities regulation matters. With over 20 years of investment banking experience, including 5 years as a fund manager, prior to becoming a consultant, Mr. Brda has the knowledge and experience to execute and ensure success for his client companies. Over that time period, Mr. Brda, either originated, invested in, or placed over $70 million in financings. He graduated college in 1988 with a B.S. in Finance from Southern Illinois University, Carbondale, IL."

However, according to Mr. Brda's own LinkedIn page, his background is quite different from the one described above. While he did graduate with a B.S. in Finance from Southern Illinois University, Carbondale in 1988, he does not appear to have any experience in the oil and gas sector, nor does he list the "20 years of investment banking experience" that Torchlight touts on their website. He does, however, list the following experience:

Source: LinkedIn

While Mr. Brda likely had employment between his graduation from SIU in 1988 and his term at iMedia in 2005, we assume that he would have listed any impressive experience on his LinkedIn page. Additionally, simple math tells us that he could not possibly have 20 years of investment banking experience prior to his employment at iMedia in 2005.

Torchlight's IR replied to this concern:

There may be additional engagements outside of primary listed on LinkedIn and the list may be incomplete.

Mr. Brda also has a checkered past. In 2007, Mr. Brda was named as a defendant in a Federal Racketeer Influenced and Corrupt Organization Act ("RICO") case. According to Torchlight's 2012 10-K (and not mentioned in the other 10-Ks):

Involvement in certain legal proceedings. In November 2007, Mr. Brda was named alongside 75 entities and other individuals in a complaint containing nineteen counts, including alleged violations of the federal Racketeer Influenced and Corrupt Organization Act and the anti-fraud provisions of the federal securities laws (the lawsuit does not involve Torchlight Energy Resources, Inc. in any way). Several months later, Mr. Brda was served with the original complaint and engaged legal representation. …the court entered a default judgment against him in September 2012.

Mr. Brda's motion to vacate was accepted by the court, contingent upon Mr. Brda's compliance with his settlement. This required Mr. Brda to file an affidavit describing his involvement in the American Pallet Leasing ("APL") scheme:

Source: John Brda Affidavit, accessed via PACER

The two individuals Mr. Brda did business with at APL were Craig Medoff and Curt Kramer. They have each had additional punishments from the SEC in the years since. Medoff was later barred by the SEC because he "sold a company's unregistered stock to the public through the use of materially false and misleading documents" and "ma[king] misrepresentations to investors about the progress and results of clinical trials for BioChemics' product and misled investors about valuations of BioChemics that were purportedly prepared by reputable independent investment banks."

Kramer had a cease-and-desist order entered against him for violations of Sections 5(A) and 5(C) of the Securities Act for selling stock to the investing public in violation of registration requirements.

Although Mr. Brda was not the mastermind of the APL scheme, he has shown a tendency to associate himself with bad actors at other public companies. Is this someone you would want to invest your capital with?

Roger N. Wurtele, CFO

Mr. Wurtele has been Torchlight's CFO since September 2013. Prior to his time at Torchlight, Mr. Wurtele served as the CFO of Xtreme Oil & Gas, Inc. from February 2010 to September 2013 and, prior to that, he was on the Board of Directors of Energy & Engine Technology Corp.

Interestingly enough, Energy & Engine Corp. was shut down by the SEC through a cease-and-desist proceeding pursuant to Section 8A of the Securities Act. From the administrative proceeding:

a common abuse found among certain small publicly held companies. In recent years, many such companies have hired stock promoters to tout their shares on stock-picking websites and through mass-mailed e-mail messages (commonly known as "spam"). The promoter is often compensated in the form of purportedly unrestricted shares of the company's common stock, which the promoter sells after its touting has attracted investor interest in the company.

In other words, the SEC charged Mr. Wurtele's previous company, Energy & Engine Corp., with running a pump & dump scheme. It appears that he has employed a similar strategy at Torchlight.

Torchlight's IR replied to this concern:

It is my understanding that this is misinformation.

Following his time at Energy & Engine, Mr. Wurtele served as the CFO of Xtreme Oil & Gas, Inc. Xtreme Oil & Gas, Inc. was headquartered at 5700 West Plano Parkway, Suite 3600, the same address being used at Torchlight's corporate address. It appears that shortly before Mr. Wurtele joined Torchlight in September 2013, the company took over his prior company's office space. Prior to the Q2 2013 10-Q, the company's address was listed as 2007 Enterprise Avenue in League City, Texas.

Regarding the change in address, IR replied:

Torchlight purchased some assets from the mentioned company in 2012 following which they hired Roger (Wurtele) and began to occupy the address in Plano.

Umbrella Research

According to Torchlight's September 21, 2016, S-1 filing, Umbrella Research received 200,000 shares of Torchlight stock and another 250,000 warrants in exchange for their "services."

Source: SEC filings

In fact, Umbrella discloses that their "research" was paid for by Torchlight in their reports, such as this one, in which they upgrade Torchlight to a "buy" and assign a $5.00 price target. This disclosure, as well as the names of the analysts behind the report, is shown below:

Source: Umbrella report

In later TRCH filings, Umbrella shows up as "Catalytic Capital Partners". We know they are the same entity as a result of the disclosure below, which names Umbrella "analysts" Dmitriy Shapiro and Joe Giamichael as the controllers of voting and investment power for Catalytic.

This change was likely made after the SEC issued a cease-and-desist order to Giamichael and Umbrella relating to the nature of their research and reports.

Source: TRCH 424b3, filed 2/8/17

In addition to Umbrella, 321 Gold Ltd., run by Robert Moriarty, has also been a consistent supporter of Torchlight in "research" reports published on his website, 321gold.com. This report is a good example. Mr. Moriarty's articles occasionally appear on Streetwisereports.com, as well - here is another "research" report Moriarty wrote on TRCH.

The Orogrande Project: Drilling For Suckers

As explained in the recent 10-K, Torchlight acquired the Orogrande Project on 8/7/14. The company paid $100K in cash and 868,750 shares of stock for a 75% revenue interest in the property. Using TRCH's stock price of $3.74 on 8/7/14, that equates to a total of $3.35M, or $19.47 per acre. A tiny sum, also considering that oil prices were much higher back then.

Said former Torchlight COO Will McAndrew on the deal:

"This new asset gives us the opportunity to prove up and develop the western most section of the Permian Basin".

Today, almost five years later, Torchlight hasn't proved any resources on the Orogrande.

Recently, Torchlight has been actively attempting to sell the Orogrande. Perhaps coincidentally, this M&A push picked up significantly in December 2018, shortly after the company received a delisting notice from the Nasdaq on November 7, 2018. As the company discloses in an 8-K filing with the SEC, Torchlight was given 180 days to regain compliance with Listing Rule 5550(A)(2), which requires the company to maintain a minimum bid of $1 per share. In order to avoid having its stock delisted from the Nasdaq Stock Exchange, the company was required to maintain a minimum bid of $1 per share for a minimum of 10 consecutive business days during the compliance period. Torchlight's stock closed at $0.80 on November 7, 2018, and reached its low of $0.53 on December 31, 2018.

Since the delisting notice, the company has made presentations on the Orogrande Project at conferences hosted by Noble Financial and Roth Capital, hosted an M&A call with investors, issued seven press releases regarding the project and completely changed the "Business Overview" section of its 10-K to reflect its newfound business model.

The Business Overview section of Torchlight's 2017 10-K, filed on 3/16/18, states:

We anticipate acquiring exploration and development projects both as a non-operating working interest partner, participating in drilling activities primarily on a basis proportionate to the working interest, and acquiring properties we can operate.

The same section of the company's 2018 10-K, filed on 3/18/19, states:

We are primarily focused on the acquisition of early stage projects, the development and delineation of these projects, and then the monetization of those assets once these activities are completed.

Before, Torchlight was looking to participate in drilling activities. Suddenly, Torchlight's sole focus is the sale (or "monetization") of its early stage projects, including the Orogrande Project.

And, the Orogrande is all that Torchlight has. From a PR on 4/9/18, Torchlight states:

Our mission on the Hazel Project was to prove the overall concept of the Wolfcamp horizontal development, increase the value of the acreage and exit at a higher value. We have achieved all goals and are now ready to focus all efforts and capital into the Orogrande.

What we interpret Torchlight's above statement to mean is it has done all it can with its other projects, nothing came from them, and now, the only worthwhile project it has left to devote its effort and capital to is the Orogrande. Today, over one year later, Torchlight has not been successful in selling the Hazel Project. From the 2018 10-K, it says:

In April 2018, we announced that we have commenced a process that could result in the monetization of the Hazel Project. As of this filing, we continue to maintain the leases in good standing and continue to market the acreage in an effort to focus on the Orogrande Project.

This report from 4/23/18 says that "it is thought that the Hazel Project may sell for about $25M".

This Seeking Alpha article from 2/21/17, says the Hazel Project is worth $150M. It states:

Assigning zero value to the Orogrande Project acreage; Torchlight equity should be assigned $2.50-3.00 in immediate-term value.

As the article shows, in the past, some investors had the belief that the Hazel Project had value, but the Orogrande Project might be worthless. Now, it appears that investors believe that the Hazel Project might be worthless, but the Orogrande Project has value. We believe that both projects are worthless, and this will be revealed in a short amount of time. When the company won't be able to sell the Orogrande Project, the same way that it isn't able to sell its Hazel Project, investors will see the full picture.

Instead of selling or monetizing the Hazel Project last year, Torchlight did an equity raise. Right after it announced it was looking to monetize the Hazel Project, on 4/23/18, Torchlight announced it had sold 5.75M shares of common stock at $1.15 per share.

Torchlight is currently running low on cash and living off credit. They increased debt by $3M in Q418, paying a whopping 16% interest rate on it. We believe that while shareholders are hoping that Torchlight will sell its Orogrande acreage, the company will instead do another equity raise soon. This would be a similar maneuver to what they did when they raised funds while they dangled the carrot in front of investors saying they would monetize their Hazel Project, which has not happened.

Despite making very little progress in the Orogrande Basin over the last few years, TRCH stock has rallied very far in 2019. On 4/11/19, the company issued a press release announcing the results of its new third party reserve estimate for Orogrande. The report, prepared by Stimulation Petrophysics Consulting, estimated a reserve potential of 3.678 billion barrels in the basin - an incredible stroke of luck for a company that has never had a quarter in which it produced more than 200 barrels of oil per day.

As a result of the sudden progress and M&A hopes, Torchlight's stock has appreciated 200% year-to-date, closing at $1.59 per share on April 23, 2019. Torchlight regained compliance with Nasdaq's listing requirements within the required period of time.

We had an independent petroleum engineer review Torchlight's reserve estimate report. He has a B.S. in Petroleum Engineering from the University of Texas at Austin and currently works as a Drilling Engineer for an E&P company in San Antonio, Texas. Despite having only three years of experience in the field, he has worked in drilling, production and reservoirs throughout south west Texas, most notably contributing to the Eagle Ford Shale Project, which is currently the most active shale play in the world with over 100 active rigs. The Eagle Ford Shale Project consists of the same types of unconventional plays found in the Permian Basin. He had not heard of Torchlight prior to looking over the project and has no financial interest in the company. He noted that the 3.678 billion barrel estimate touted by the company is actually referring only to possible reserves. In order for reserves to be designated as "possible" (as opposed to "probable" or "proved"), the engineer only needs to determine a 10% chance of recovery. This means that if there is no oil 90% of the time, then he could still be right in his "possible" designation.

Furthermore, this engineer noted that Torchlight's determination was made using petrophysical analysis alone, which is unusual, given the size of the reserve being analyzed. Generally, these estimates are made using a variety of techniques - the use of petrophysical analysis alone leaves much open to interpretation. As stated on PetroWiki:

Petrophysical data take many forms and, for many reservoirs, may not be as comprehensive as desired.

In our independent engineer's own words:

They are a public company looking for investors. There are laws that keep them from lying, that's why they call them 'possible', but when it comes to rocks a mile under the ground, it's easy to say you see things that are promising.

Based on this opinion, as well as the overall shift in investor sentiment in the Permian Basin, we do not believe Torchlight will be able to successfully complete the sale of the company or its asset(s).

The Orogrande Rig Shown On Torchlight's Website Is Not There Anymore

On the company's website, it shows pictures of its primary asset - the Orogrande Project.

This is under the "Current Projects" tab. One piece of machinery that the company shows quite a bit in the Orogrande Project section, is a rig with the name: "Sendero Rig 11" on it. It shows a video of an aerial view of the rig:

Source: torchlightenergy.com

And here is a picture of a side view of the rig with the name and number of it:

Source: torchlightenergy.com

These are nice pictures, but we believe they give the impression to shareholders that there is activity going on right now on the Orogrande. We did our due diligence on this rig. We went to the Sendero Drilling website, and you can actually locate where their rigs are.

Here is a snapshot from the website regarding Sendero Rig 11:

Source: senderodrilling.com

As shown in the snapshot above, there is a picture of the same rig that was on the torchlight.com website. Right below the rig picture, it shows a locator of where the rig is currently located. As shown, #11 is nearby Midland and Odessa, TX. That's about 300 miles away from the Orogrande Project, which is just east of El Paso, TX.

We spoke to a representative of Sendero Drilling. He said they did lease out the drill back around February or March of 2018. But they didn't work with Torchlight directly. They leased the drill to Founders. Right now, the drill isn't being used, he said. That rig was there on the Orogrande in early 2018. Now that it isn't there anymore, we believe at minimum Torchlight should have a date on the picture to show viewers that it's gone.

Torchlight's Auditors

Until recently, Torchlight's auditor was Calvetti Ferguson P.C. Calvetti Ferguson has also had legal troubles in the past. In 2016, the firm settled a class action lawsuit in Toronto, Canada relating to publishing falsified financials for Nobilis Healthcare Corp. Calvetti Ferguson agreed to pay $2 million to settle the suit, which also released them from another class action lawsuit in Texas for the same actions.

Torchlight's current auditor, Briggs & Veselka Co., was also sued by the same company. On June 12, 2018, Nobilis Health Corp. filed a malpractice lawsuit in Houston, Texas against Briggs & Veselka. Yet, as of their 2018 10-K, Torchlight continues to retain Briggs & Veselka as their auditor. What is the point of paying auditors who have a concerning history? Can we trust Torchlights financial reporting?

Remaining Oil In Texas Is In Doubt

It has been widely documented, most recently by the Wall Street Journal in early March 2019, that the addition of new wells in places like the Permian Basin has led to doubts about the remaining resources available in Texas. The Journal states:

Newer shale wells drilled close to older wells are generally pumping less oil and gas than the older wells, according to early corporate results. Engineers warn the new wells could produce as much as 50% less in some circumstances.

The newer shale wells often interfere with the output of older wells, because blasting too many holes in dense rock formations can damage nearby wells and lower the overall pressure, making it harder for oil to seep out. The moves could potentially cause permanent damage and lower the overall amount recovered from a reservoir.

Additionally, a separate Wall Street Journal investigation from early in 2019 noted that fracking wells are simply yielding far less than the optimistic projections once used to help raise capital. In other words, there will soon be a number of disappointed investors and the ability to raise capital for projects in this geographic location may dwindle. It states:

Two-thirds of projections made by the fracking companies between 2014 and 2017 in America's four hottest drilling regions appear to have been overly optimistic, according to the analysis of some 16,000 wells operated by 29 of the biggest producers in oil basins in Texas and North Dakota.

Collectively, the companies that made projections are on track to pump nearly 10% less oil and gas than they forecast for those areas, according to the analysis of data from Rystad Energy AS, an energy consulting firm. That is the equivalent of almost one billion barrels of oil and gas over 30 years, worth more than $30 billion at current prices. Some companies are off track by more than 50% in certain regions.

Little to Be Optimistic About Torchlight

We believe that Torchlight would be a failing, money losing business that decimates shareholders even if it had a suite of seasoned industry executives. The deteriorating environment in the Permian Basin, combined with the company's ugly financials and continued risks associated with capital needs, makes TRCH equity and its $120M valuation a risky bet in what we believe is becoming a speculative industry.

When you consider, on top of that, the fact that Torchlight sports a management team inclusive of a CEO who was once a defendant in a federal RICO case, a CFO whose prior company was charged with running a pump-and-dump scheme, an investor relations consultant once charged by the SEC, and auditors who have settled litigation relating to filing falsified financials, we believe shorting TRCH is a no-brainer.

This article was written by

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Disclosure: I am/we are short TRCH. 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.

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