Spartan Delta Corp T.SDE

Scotia's Note TODAY on Makarov: Just Smoke - No Fire!

[Bamsmba]

Our Thoughts on the Russian Issue: Some Media Smoke but No Actual Fire

OUR TAKE: Neutral. The sanctions and financial penalties launched against Russia and certain Russian nationals in the wake of Russia’s invasion of Ukraine have roiled markets and led to a spate of asset and equity divestiture announcements in the energy sector. They have also spawned a number of news articles about SDE (e.g., CBC, Bloomberg, Politico) because of the company’s largest shareholder – ARETI International Group Ltd. (“ARETI”).

WHAT WE KNOW

Based in Geneva, Switzerland, ARETI is described by FactSet as follows:

“The Group was established in 1992. Since 1994 the Holding has been engaged in natural gas deliveries. From 1998 to 2013 the Group was the biggest private oil and gas company in Russia and participated in hydrocarbons extraction. From 1998 to 2007, ITERA developed and operated nine gas fields in Northern and Eastern Siberia of Russia with annual production of about 80 billion cubic meters of natural gas.”

ARETI is controlled by Igor Makarov, a Russian national who has been described in media reports as an oligarch. Mr. Makarov appeared in the U.S. Treasury Department’s 2018 “Putin list,” but has not been sanctioned by the Canadian or U.S. governments. When contacted by the CBC, a spokesperson for ARETI stated that “Neither ARETI nor Mr. Makarov are or have ever been the subject of any governmental sanctions” and “Mr. Makarov has never been ‘close to Putin.’”

ARETI acquired its position in SDE in Q1/21 through SDE’s all-share acquisition of Inception Exploration Inc. Pursuant to the deal, Steven Lowden and Elliot S. Weissbluth from the Inception board joined SDE’s board. We noted ARETI’s ownership position in SDE in our March 8, 2021, note and the Financial Post highlighted Mr. Makarov’s interest in a March 24, 2021, article.

To summarize:

• ARETI is a Swiss-headquartered corporation.

• ARETI came to own its position in SDE (20%) through SDE’s acquisition of Inception Exploration Inc. in Q1/21.

• Neither of the two former Inception directors who joined the SDE board is a Russian national.

• Igor Makarov controls ARETI. Mr. Makarov appeared on the U.S. Treasury Department’s “Putin List”, which was compiled from a Forbes article. He has been described as a “billionaire Russian oligarch” in media reports.
• Mr. Makarov has not at this time been sanctioned by the Canadian or U.S. governments. However, we note that Mr. Makarov has in the past been a board member of several Russian state-owned enterprises, and in 2005 he was appointed Honorary Consul of Belarus in Moscow. Given the rapidly evolving geopolitical environment and our lack of first-hand knowledge of Mr. Makarov’s dealings, we have no view on the potential for future sanctions.

WHAT DOES THIS MEAN FOR SDE?

 

In our view, not much. While we recognize that the recent media attention given to ARETI’s position is hitting SDE’s shares, at this point we do not see much reason for concern. SDE does not have Russian assets or interests. The company is not being funded by Russian interests. ARETI is simply a shareholder of SDE that acquired its position in exchange for Canadian oil and gas assets previously owned by ARETI. We believe the negativity around SDE’s shares is being stoked by the publication of numerous media reports, some of which seem unduly sensational. For example, a March 1, 2022, National Observer article argued that ARETI’s position in SDE (among other things) was part of a body evidence calling into question Alberta premier Jason Kenney’s ethics.

 

WHAT ARE THE RISKS FOR SDE?

 

Given that SDE does not have Russian assets, interests, or majority ownership, we see little potential for sanctions to hit the company directly. Moreover, neither ARETI nor Mr. Makarov has been sanctioned at this point.

If Mr. Makarov or ARETI were to be sanctioned, the company’s position in SDE could potentially be frozen or confiscated. Alternatively, ARETI could look to voluntarily liquidate its SDE shares. (Note that both of these scenarios are purely hypothetical). In the latter case, a significant block of SDE shares (~30M per current SEDI ownership data) could hit the market. In our view, this could be a negative short-term event for SDE if the shares hit the market in a chaotic manner. Nevertheless, we would not expect this to be a long-term problem given that: (1) increased liquidity in SDE’s stock would actually be a positive development given the relatively low trading volumes; (2) SDE should be a very desirable holding for investors, and (3) SDE is rapidly deleveraging (i.e., debt free in Q1/23E on current strip) and amply free cash flow positive, which should put the company in a position to potentially start buying back stock later this year.

 

BOTTOM LINE

 

We believe SDE has lagged over the last week due to market fears about all things Russia. Moreover, the equity appears to be collateral damage in a heated Alberta political environment. At this point we are not overly concerned about the composition of the company’s shareholder base and do not see any realistic risks to SDE’s operations or the ultimate realization of value from the company’s asset base. While the media noise around ARETI and, in our view, low probability of the shares being pushed into the market could generate short-term risks, we see weakness in the stock as a buying opportunity for long-term minded investors.