Summary
- ERN has had a fantastic run-up leaving the company's shares grossly overvalued.
- ERN's colorful management and past related party transactions raise many questions about its governance and assets.
- ERN is likely to return to its history of destroying shareholder capital and faces potential liquidity risk.
Erin Energy Corporation ("ERN", formerly known as Camac Energy, Inc.) is the best-performing U.S. listed Oil & Gas stock in 2015 with a year to date performance of ~295%. The market capitalization is $1.85 Billion. Comparatively, over the same period, the Bloomberg Intelligence Global Independent E&Ps and Integrated Oils index (Bloomberg ticker BRNGEPVA) declined by nearly 6%. This outperformance flies in the face of a long history at ERN of shareholder destruction, a revolving door of senior executives, a series of questionable related party transactions, arguably gross overvaluation, and steadily increasing debt levels. We believe the shares could be worthless, or close to such.
ERN "went public" in 2010 through a reverse merger with pink sheet-listed Pacific Asia Petroleum ("PAP") through which PAP acquired approximately 60% of Camac Energy Holdings Limited's ("CEHL") "production sharing contract rights" in the Oyo Field offshore Nigeria for approximately $32 Million in cash and 99 million in shares and warrants. This transaction gave CEHL ~70% ownership of the listed company. By the end of the year ERN had a market cap of about $230 Million.
A few months after the deal closed, ERN's CEO, CFO, and a board member of the Audit Committee resigned. Between August 2010 and April 2011, ERN went through two CEOs until Kase Lawal became CEO and Chairman, which he has remained since. Since August 2010, ERN has had four different CFOs with the fourth joining just this month. Today, ERN is ~57% owned by CEHL. According to CEHL's website Kase Lawal is also the Chairman of CEHL and his brother, Kamoru Lawal, is the President and CEO of CEHL. According to ERN's public filings, Kase Lawal is a 27.7% "indirect owner" of CEHL, and "his family owns 69.3%" and "may be deemed to control CEHL."
Since the reverse, ERN has focused on a (now) failed Chinese joint venture, prospecting in countries like Gambia and Ghana, and additional transactions related to the Oyo offshore field in Nigeria. These operations have contributed to an accumulated shareholder deficit of -$478 Million. Shares outstanding have risen 264% from 58 Million in December 2010 to 211 Million today. After shifting focus from one area to another since inception, the present focus of the company has returned to where it began - the offshore Nigeria Oyo field in the OML 120/121 lease block (the "OML").
CEHL is the "original indigenous operator" of the OML, having discovered oil here along with Eni SPA (NYSE:E) ("ENI") in 1995. In June 2012, CEHL acquired all of ENI's participating interest in the OML and its remaining stake in the production sharing contract rights for $250 Million. A little more than a year later, in November 2013, CEHL successfully sold to ERN these participating interests and the portion of the production sharing rights ERN did not own for consideration worth approximately $500 Million (based on 11/30/2013 closing share price). This deal was structured as a $170 Million cash payment to CEHL, issuance of a $50 Million convertible note and issuance of shares such that CEHL would own roughly 57% of ERN after the close. The cash consideration for this purchase was primarily funded from a large investment into ERN by The Public Investment Corporation of South Africa ("PIC"). In November 2013, PIC invested ~$270 Million for ~30% of ERN at a meaningful discount to the prevailing market price.
The cash infusion from PIC was a lifesaver for ERN. Allegedly, CEHL had been operating the OML assets at a loss and ERN's own liquidity situation was increasingly critical. In its own Form 10-Q for the Q3 2013 period, ERN stated that "factors raise substantial doubt about the company's ability to continue as a going concern." Ironically, in the same quarter ERN had to take a $186 Million non-cash impairment charge due to "a downward revision of proved reserves at the Oyo Field." Nonetheless, ERN proceeded to offer to buy the remaining production sharing rights and total economic interests in the OML from CEHL. Based on ERN's share price today, the total value of the consideration paid was approximately $940 Million.
ERN's Board of Director's Special Committee retained Canaccord Genuity ("Canaccord") to provide a fairness opinion on the purchase of the OML and surrounding transactions. According to ERN's deal proxy, Canaccord told ERN on November 13, 2013 that it would be "unable to conclude that the terms set forth in the draft term sheet of October 31, 2013 were fair, from a financial point of view." Two weeks later, ERN's Special Committee obtained its fairness opinion by making modest tweaks to the deal, notably by lowering CEHL's pro-forma ownership stake to ~57% from ~61% and lowering the amount of convertible bonds to be issued to CEHL from $100 Million to $50 Million.
In its calculation of comparable offshore transactions, Canaccord came up with an implied enterprise value range for the deal of $107 Million to $196 Million, far below the price actually paid by ERN:
(click to enlarge)
Cannacord further examined the appropriate implied enterprise value range based on comparable company trading metrics and established a range of $172 Million to $422 Million.
(click to enlarge)
Why would PIC, an organization entrusted with managing the South African Government Employees Pension Fund, among other assets, make such a questionable investment decision? In a series of articles, South Africa's The Mail & Guardianrevealed that Kase Lawal is a personal friend of South Africa's president Jacob Zuma: "in 2010, the Lawals' holding company signed a memorandum with Zuma's charity, the Jacob G Zuma RDP Education Trust, pledging R1-million annually for five years. The following year, Lawal accompanied Zuma to his alma mater, the Texas Southern University, to get an honorary doctorate." According to The Financial Times, the PIC is no stranger to allegations of politically motivated investments, reporting that "the PIC at times struggles to shed the perception that political considerations as much as financial ones guide its investment decisions." Furthermore, The Business Times of South Africareported on June 1, 2014 that the CEO of PIC, Elias Masilelas, resigned suddenly and unexpectedly after clashes with the Chief Investment Officer noting that the ERN deal "in particular sparked clashes between the two."
Kase Lawal's personal history is concerning. According to a U.N. Security Council report, in February 2011 Mr. Lawal, along with former NBA basketball star Dikembe Mutombo, attempted to smuggle gold out of Congo. The gold was to be purchased from the Congolese warlord, and "most wanted" human rights violator, General Bosco Ntaganda. The plan allegedly backfired, when instead of selling Lawal and Mutumbo the gold, Ntaganda and his men turned the tables and robbed Lawal's henchmen and held the crew of a Gulfstream jet (leased by a CEHL subsidiary) against their will. The U.N. report recounts an allegation that Lawal later paid more than $30 Million, including a portion for "bribes," to get out of the mess and that the deal was financed using funds from the Camac Group. (The U.N Security Council report can be read online here). A flight attendant, Kelly Shannon, brought suit against Camac International after she was "interrogated and held for six weeks" in Congo as a result of the gold fiasco. The owner of the jet, David Disiere, was awarded$32 Million after the Gulfstream V jet was "lost" in Congo.
Other fun Kase Lawal adventures include:
1) Alleged forgery: According to a story published by The McClatchy DC news service, "a six-count criminal complaint filed in Nigeria eight years ago [2000] charges Kase Lawal with joining in a plot to forge papers in the name of a local company, win offshore-drilling approvals and illegally pump and sell more than 10 million barrels of crude oil."
Some reporters alleged that Lawal got "off" for this incident because he "bribed both the then Inspector General of Police and the Attorney General of the Federation to intervene by 'killing' the case."
2) Alleged oil piracy: A 2008 McClatchy DC news service article states that "from 2003 to 2005, The Mail & Guardian in Johannesburg, South Africa, reported in several stories that Lawal had engineered a deal between the South African government and Nigeria that ultimately promised to bring South Africa 120,000 barrels of oil a day at wholesale prices. Neither of two companies that CAMAC set up ever provided any oil to South Africa, however. Instead, the oil went to one of them in the Cayman Islands that was 75% owned by CAMAC, the newspaper said. Its minority owners remain secret. The other firm, which apparently got no oil, was the South Africa Oil Co., established in Pretoria. CAMAC owned 49% of its shares. The remaining shareholders were a 'who's who' of relatives of leaders of the country's ruling African National Congress, the newspaper said."
Kase Lawal is a significant donor to American political campaigns. He supported Hillary Clinton in 2008, reportedly helping her campaign to raise more than $100,000. Per public campaign finance disclosures, Lawal raised $35,800 and $28,500 for President Obama's 2008 and 2012 election campaigns, respectively, and raised a further $32,400 for the [Democratic] House and Senate Victory Fund in 2014. Lawal's publicly-disclosed direct contributions to political campaigns total $147,800 since 1998 (Data available via query).
Kase Lawal has been appointed (incredibly, given his background) to public commissions by three different US presidential administrations. According to a profile published by The Economist, Lawal was "a member of the United States Presidential Trade Advisory Committee on Africa during the Bush and Clinton Administrations." The Obama administration appointed Lawal as a member of the Advisory Committee for Trade Policy and Negotiations in 2010. It appears Lawal may have been removed from this committee following the 2011 Congolese warlord gold smuggling fiasco.
Putting questionable deals and accusations of fraudulent behavior aside, we estimate that shares of ERN are worth little to nothing. There are already signs that the company could have liquidity issues: in January 2015 the company's driller, Northern Offshore International ("NOF NO"), attempted to terminate their contract with ERN claiming that ERN was unwilling or unable to meet the terms of their arrangement. NOF NO cited a "failure to provide the required letter of credit" and demanded that ERN be "required to pay Northern all outstanding unpaid invoices, the early termination fee, the demobilization fee and amounts due but not yet invoiced for work performed up to the date of termination." ERN disputes this claim and the parties are in mediation according to ERN's 10-Q filed on May 8, 2015. This quarrel further speaks to the risks inherent in ERN serving as "operator" of the company's offshore assets - a position which, as far as we could find, ERN does not have experience with.
In ERN's 2014 10-K the standardized measure of discounted future net revenues based on the company's reserve report and various operating estimates stood at $237 Million based on oil prices of $100.37 per barrel. The spot price of Brent Crude today is $65.49, 35% lower. As of March 31, 2015, ERN did not have any oil price hedges in place. ERN's debt, inclusive of -$168 Million working capital, stood at -$347 Million at March 31, 2015. This calculation of debt excludes the company's off-balance sheet lease obligations to pay for drilling and production-related equipment. These obligations total $52.9 Million in 2015 and $96.7 Million in 2016-2017.
After being pushed back for close to one year, two quarters of zero revenues, and having spent more than $160 Million on development capex since they began development of the OML, ERN announced on May 18, 2015 that it had successfully completed drilling on the Oyo #8 oil well. Initial production from this well was 7,080 barrels of oil per day, in line with management expectations. ERN expects to show production from the Oyo #7 oil well soon.
Disregarding ERN's liquidity issues, let us assume that ERN can drill the Oyo #7 with capital on-hand and achieve their production goal for this well of 7,000 barrels of oil per day, yielding a combined production total of about 14,000 barrels per day. Even under this fantastical scenario, ERN would still be significantly overvalued on a production basis relative to comparable independent energy & production companies with meaningfully exposure to Africa. A particularly close comparison is Vaalco Energy (NYSE:EGY).
|
Ticker
|
Name
|
Enterprise Value (M $USD)
|
Production Rate (boe/d)
|
EV/Production ($/boe/d)
|
|
ERN US
|
ERIN ENERGY CORP
|
1,978
|
14,000*
|
$141,274
|
|
TLW LN
|
TULLOW OIL
|
5,626
|
74,800
|
$75,219
|
|
MAU FP
|
MAUREL ET PROM
|
1,165
|
21,624
|
$53,862
|
|
MMT CN
|
MART RESOURCES
|
300
|
9,000
|
$33,350
|
|
EGY US
|
VAALCO ENERGY
|
105
|
3,800
|
$27,683
|
|
AFR LN
|
AFREN PLC
|
847
|
35,100
|
$24,138
|
CEHL has "formally committed to provide the company [ERN] with additional funding… sufficient to maintain the company's operations" until March 2016. Given past transactions, we would not be surprised to see significantly dilutive transactions at poor terms to the minority equity holder from these additional financings.
Disclosure: Cannell Capital LLC has been both a buyer and a seller of the common stock of Erin Energy Corporation in the past. The firm is currently 'short' such shares and could potentially short more shares in the future. This report is provided for informational purposes only. Any implied recommendation as to whether these shares should be sold or bought is explicitly withheld. Caveat emptor.