Headlines
• In Brief:
o Frontera Resources (LON:FRR – 0.21p) – $26mm Management Debt
o Nighthawk Energy (LON:HAWK – 0.71p) – Still Waiting on an Update
o Sound Energy (LON:SOU – 58p) – Badile Update
o Zenith Energy (LON:ZEN /CVE:ZEE – 8p/C$0.14) – Curious Statement
In Brief
• Frontera Resources (LON:FRR – 0.21p) – $26mm Management Debt: Today’s news that $26mm of “management debt” has been accumulated comes at somewhat of a surprise for a company whose paper (in its current format), has been listed since 2011. Those with long memories will remember that at that time, the management converted the $9.2mm of outstanding management notes to shares. This is in addition to the $120mm of debt that was also converted in 2011 and the ~$30mm of convertibles it has sought to eliminate from the balance sheet using Chapter 7 regulations, which quite rightly has faced significant headwinds.
In the context of this, the latest move to convert an illiquid note to tradable paper, irrespective of the fact that it is being conducted at a premium, belies the fact that management appear to have little concern for respect for generating shareholder value. If they did, they would forgo that unpaid salary, especially as it is a reflection of the excess over and above what they could be paid in cash terms; Steve Nicandros paid himself $550,000 in 2011, which obviously hasn’t included any “performance” payments, and the $7mm per annum SG&A hasn’t varied significantly since then.
Irrespective of the fact that they have got these shares converted at a premium, that have now valorised their cash, which means that should they so desire, once the 12-month lock in expires, they can start to realise that cash.
This is all against the fact that they could have surrendered the salary in lieu of the disastrous performance over the life of the companies, (including the predecessor company Frontera Resources Delaware), and rather than wait for cash flow from operations, they have chosen this route. In order to fully understand this, the directors should make known the tax advice they have received in respect of this premium, as under certain circumstances, the US tax code allows the carry forward of losses to be offset against taxable ordinary income; see Section 165. If this is the case, I will let you draw your own conclusions, but management could allay these fears by signing a perpetual lockin, forbidding them for selling or otherwise valorising their ownership until certain criteria are met.
Of course, the number of shares also provides them with effective control, a happy by-product some may say. Management teams should always be rewarded for creating shareholder value, but where there has been wholesale destruction of value on the scale of Frontera Res ources, and it is still not in production, we believe that the shareholders, bond holders and any other provider of credit to the Company should ask serious questions.
• Nighthawk Energy (LON:HAWK – 0.71p) – Still Waiting on an Update: While today’s news that the Company’s senior lender has indicated its willingness to relax some of the loan covenants (providing other parties take some pain too), will provide some relief to the share price, there is still yet to be agreement with those third parties, most notably the royalty holders. We believe what is more pressing for the Company is the need to provide a comprehensive update and forward looking programme, coupled with an honest assessment and reconciliation of expectations and performance to the last issued plan (March 8, 2016) (the “March Presentation”). That way, the investors can assess the Company’s current position and measure the future performance in a meaningful way. While we acknowledge that the details will not be as great as those afforded to the lenders, but there i s still a gulf between where the Company is now with respect to discussing its forward plan with shareholders, and where is needs to be, using the March Presentation as an example.
• Sound Energy (LON:SOU – 58p) – Badile Update: Today’s news, that Badile has failed to intersect commercial hydrocarbons, comes as a blow to the Company, but to be frank, there was little value in the current share price for Badile. However, the share price is likely to trade down, at which point investors should revisit the Company with a view to increasing their interest, which to our mind is supported by the manner in which the Company has progressed since the assumption of the interest in Tendara from Fastnet. While disappointing, and at one time would have been catastrophic, the lack of commercial success at Badile is now just a footnote.
• Zenith Energy (LON:ZEN/CVE:ZEE – 8p/C$0.14) – Curious Statement: Today’s statement reads like a significant success, but the fact that there is oil present in a production well shouldn’t be a surprise. What should be more celebrated is the ultimate result from the installation of the ESP, or more specifically, that the results are inline with pre-workover expectations. We are concerned by this lack of proportionality when in fact, they have lost a tool in the process, so what should have been a simple job (relatively) has become a drama, which in itself is a minor issue, to be frank.
What is of more importance, is the final outcome of the workover, and more specifically, whether it is in accordance with the Company’s expectations. In this context, what is needed, and has been needed since its AIM admission, is a clear outline of the redevelopment plan, its costs a nd benefits, such that performances can be measured, by well preferably, and an assessment of the management team undertaken.
We will be clear, we do not believe in the Board’s ability to deliver this project in a way that generates value for shareholders, and that this is underlined by the fact that the they have failed to be clear as to what their plans are, and will continue to be unclear on the Company’s forward programme. However, we can’t say that the Company will fail to deliver value, as Mike Palmer, the in-country manager, is a skilled operator and has significant experience in Azerbaijan, working on the successful redevelopment and waterflood of Nation Petroleum’s Mishovdag. If the Company succeeds it will be despite the Board, not because of it, and due to the knowledge and understanding brought by Mike Palmer.
We may provide a further update on one, or all, of the stories above later today. However, if there is anything that you would like to discuss, please feel free to contact us.