Fossil fuels, i.e, oil, gas, and coal producers are the cheapest sector of the equity market since all institutional and many retail investors will not own carbon producers, because they think they are destroying the planet with climate change. They think it's a sunset industry, but in reality the fundamentals have never been better thanks to politically-caused supply constraints and a long cycle of underinvestment. So oil companies are cheap. But the valuation of Africa Oil is by far the lowest of any listed oil & gas company outside of Russia, and even then I'm not so sure. Why? You could point to Africa jurisdiction risk, but when you check the facts you see Nigeria has an attractive and stable fiscal regime, and the company has cashed $500 million in dividend cheques. So that's not it. The asset quality is top drawer. Great geology and a benign operating environment. Steady flows of premium crude at low opex, all operated by top-tier majors. Modest debt at the JV level, and $170 million in cash at the parent, with no debt. Combining the two, zero net debt. As common for good offshore fields, they keep replacing reserves, and the stock trades at 2x earnings, with several surplus discoveries yet to be monetised. Good assets, strong balance sheet, moderate political risk, and a crazy valuation. What gives?
Governance:
The Lundins control the board with 6 of 7 directors, yet they own zero shares. They are not required to disclose ownership at under 10% of shares outstanding. But the way we know their ownership is virtually nil is that only 3 million shares (less than 1% of outstanding) not held by directors or Helios were voted in favour of the board. Do you think they would vote for their own people? So either they own no shares, or they own through Helios as a front for their ownership, which would be questionable in itself.
Institutional Ownership:
Fewer than 15 million shares, or 3% of shares outstanding, are held by institutions, mostly index funds. Because of ESG? No. Check the Canadian peers: virtually all have 30% or more, up to about 60% institutional ownership. This is an outlier. And the institutions have been selling down AOI lately.
Capital allocation:
It's obvious to every shareholder and every outside observer with any degree of financial sophistication that the only thing the company should be doing right now, and for the past year or so, is buying back stock. They should just tender for masses of shares, just like many peers are doing, including Imperial Oil, Frontera, and International Petroleum, in addition to buybacks in the open market. Algoma Steel is another one with a huge Dutch auction. All these buybacks have been warmly greeted by the market. But what is Africa Oil doing? Hoarding cash. Sitting on $170 million and counting. They also have a $160 million credit line, so plenty of liquidity. They're hunting for a deal so the CEO can grow his empire and build his own mini ExxonMobil. Keith says he can buy oilfields at $60 and share the upside with the buyer. So average that with $100 and that's $80 oil. Meanwhile, AOI is pricing about $45 oil. So even if they got a sweet deal from divesting majors, they could buy the same amount of cash flow and asset value for half the price, or twice as much cash flow or barrels in the ground, for the very same dollar. None of the officers or directors has a meaningful amount of skin in the game, other than Mr Hill, who got all his shares through ESOP. This is his baby to grow at any cost, so he can make more and more ESOP on a bigger and bigger asset base. Who is representing the shareholder here?
“Hedges”:
The company is continuously selling forward almost a year of production despite having very low costs and virtually no debt. Selling into a rising market, in steep backwardation. The “hedges” are highly unorthodox, not standard contracts on a regulated exchange like NYMEX, as virtually every other oil company does. But forward sales they announce with a huge lag, limited disclosure about prices and volumes, and no disclosure about timing or counterparties. They claim their partner is making them do it. Yet AOI has joint control of Prime. Look at the circumstances of the acquisition by the Brazilian bank from the Brazilian oil company, and you might be surprised they both have a sordid history. If you go through the numbers with a fine-toothed comb, it's tough to figure out if they make sense, because of the limited and untimely disclosure about the forward sales, and the complex accounting at Prime, with the PSA underlift and the tax credits, etc. A June Bloomberg article states that Egina is fetching a $13 Brent premium for its light sweet crude. So we can say this much: whoever bought forward Prime's production has made an absolute killing. The hedging is commercially questionable, to say the least, and in Q1 the company reported no more of it, thanks to shareholder pressure.
Value Suppression:
If you compare capital allocation between IPCO and AOI, you immediately see the former is rational, and the latter is negligent. IPCO, a high-cost tar sands producer, is buying all the stock they can get their hands on, while AOI, a low-cost producer and fountain of money, is just hoarding cash and paying a token dividend so small it's laughable, and even that probably only due to caving to shareholder pressure. Given that the Lundins hold 25-30% of IPCO and 0% of Africa Oil, it seems plausible that their puppet board is deliberately suppressing the valuation of AOI so IPCO can make a stock deal with their more expensive paper. In town hall meetings management has talked of keeping AOI's assets within the Lundin empire, and folding in assets. Financial engineering to their benefit, as they've done in previous mergers, e.g., LUN & JOSE.
Stockholm Syndrome:
There is a Discord board where shareholders, mostly in Sweden, chat in Swedish about the company. They are well informed. They mostly think the world of the Lundin family, and that everything they touch turns to gold. So they give the company the benefit of the doubt at just about every turn, and it's frankly a huge circle jerk about how undervalued the stock is, and always has been (and probably always will be!), and how much money they think they're going to make some day in the far distant future. Call it Stockholm Syndrome, because they've all become enamoured of their captors, namely, the D&O who are doing just about everything in their power to minimise the market value of their investment. But these Swedes did not like the hedging. And they now realise that they'll be paying Canadian taxes on dividends, and they see how poor the performance of their shares has been relative to peers doing buybacks, and are losing patience. The vast majority strongly support buybacks. The problem here is this: the Swedish shareholders hold their shares in tax shelters they call “insurance solution accounts” which according to Swedish regulations are not allowed to be voted by the beneficial owner. Therefore, by cultivating support and ownership in Sweden, management is effectively insulated from a proxy battle or other activist attack.
The disclosure on the unorthodox forward sales is wanting, and the auditor really should be looking into this. But PwC and peers, as well as the Ontario Securities Commission, don't seem to take much interest in the integrity of financial statements.
So the answer is for a group of shareholders to get together 5% of shares, or roughly $40 million, not held in Swedish insurance accounts, and present a dissident slate. Replace the board and put in shareholder-friendly directors to do the right thing and tender aggressively for shares. The stock would double in about six to twelve months' time, I am virtually sure of it. The existing board has zero support from shareholders, apart from Helios, who appears to be either sleeping, or cooperating with management's agenda. Helios owns only 14%, so a strategic entity or private equity group could easily get control and/or go hostile. Why haven't they? Who knows. Meanwhile, an activist group could run the proxy battle on the buyback agenda and drop the share count aggressively to maximise the payoff of the final buyout payday.
Who is out there with a significant stake? Or knows someone who could help? Otherwise the poor minority stockholder is flying on a wing and a prayer.
High time for a shareholder mutiny. Voice your opinion, band together, and vote your shares!