Project Poseidon Part II
Pantheon Resources (PANR) - 2nd Prong in the Trident
As mentioned in the introductory post to this series, the second leg of the Trident Trade will be an oil exploration play. Junior resource companies in general have a very option like payoff profile. Most of them will never actually extract any commodity but are instead in the business of raising capital and selling a story to (retail) shareholders. If not declaring bankruptcy these companies can tread along for quite some time with the occasional run up in share price whenever their respective commodity is being hyped or management releases imaginative projections. In the rare case that a company goes from explorer and developer to producer (without being acquired along the way) one is most likely looking at a serious multi-bagger.
The company in question is Pantheon Resources (PANR), an Alaska-based oil and gas exploration company. It sits on one of the largest conventional (not shale) oil discoveries in North America in recent years at low breakevens, has no debt and looks cheaply valued vs comps. As with the vast majority of my investments, credit for the idea belongs to someone else. In this case it is Twitter follow contrarian8888 who unveiled the trade in mid July in a thread (see here for a more stylised version - I encourage you to look at it prior to reading the rest of this post). After having hit homeruns on Antero Resources (AR) and Peabody Energy (BTU), contrarian8888 has built up a sizeable following that could help PANR gain momentum. Before examining the company in greater detail, a few notes on due diligence in the junior resources space.
Avoiding getting screwed
Crux Investor and Twitter follow Trader Ferg did a good video on this back in March. I divide a checklist into asset-specific characteristics, governance, and macro.
Asset
Cost of production: Where is the asset on the cost curve? What kind of price in the underlying commodity makes the project viable?
Proximity to critical infrastructure: One can have the greatest deposit on the planet. If it is located in the middle of nowhere, it will be nigh impossible to ever extract anything.
Cost of developing the asset: a junior resource company will not have access to debt in most cases meaning the costs for developing an asset will have to be borne by shareholders through dilutive equity raises.
Time to develop: if your idea horizon is two years and the asset will start producing in ten years plus, then it’s maybe not the right play.
Jurisdiction: often jurisdictions will either be safe (North America) or quick to grant licenses (Africa), rarely both at once. Be aware of what kind of jurisdiction your asset lies in and how it impacts your thesis.
Governance
Management’s incentive: are they being paid generously in cash or is their financial wellbeing tied to that of shareholders?
Track record: what have management done prior? Have they generated shareholder returns?
Dilution: if management are in the business of raising capital, this will show in significant historic dilution
Macro
Commodity trend: Is the underlying commodity trending up/down or going nowhere? As disheartening as it might sound to someone doing detailed single stock analysis but a rising tide will lift (almost) all boats. While dispersion occurs, the commodity beta will often be the most powerful driver of share prices in trending markets.
While this is far from exhaustive, I have found the checklist a good base for due diligence in the past. Given the financials of junior resource companies are most useful to analyse executive compensation and possible dilution, a lot of the research process will have to be devoted to items such as the above.
Pantheon - ticking boxes
While still doing analysis on the name, it struck me early on that PANR is ticking a lot of boxes.
As seen below in Fig 1, estimated breakeven for the field is somewhere in the 30$/b area, making the project highly economical at current levels.
Fig 1: Pantheon break-even levels vs peers
Pantheon acreage is adjacent to America’s largest pipeline (Trans-Alaska-Pipeline) and the Dalton highway (see Fig 2), exactly how you want a project to be located.
Fig 2: Pantheon acreage
Furthermore, Pantheon’s leases are on state land, not Federal. Therefore, Federal moratoriums on leasing and drilling do not impact Pantheon as the Alaskan State is reliant on the Alaskan oil industry for its tax revenues.
In order to start drilling wells the company will have to raise money in Q4 if not accomplished via farm out. Estimates for an equity raise range between 30-50m USD meaning impending dilution of less than 10% vs current market cap of ~520m USD (for now).
Thalita A# is supposed to be tested in Q1 22 (assuming successful financing).
With the exception of 2018/19, when Pantheon acquired Great Bear, dilution remained around 10% since 2015/16 as shown on Fig 3.
Fig 3: Pantheon dilution history
CEO Jay Cheatham’s salary seemed not excessive (and was lowered in 2020/19 vs prior year) at ~430k USD, and with roughly four to five times that amount in warrants, commercial interest seems reasonably well aligned with shareholders. Industry insiders I spoke to only criticised management’s poor job on promotion (half jokingly).
The macro has been discussed ad nauseam here.
Potential upside and valuation
For estimates on PANR valuation and upside, a couple of sources below:
Canaccord update from July 21 with 170p price target and fully financed, risked share price of 560GBp, using of 7.6$/b resource value.
Reddit-user valuations from Aug 21 using 9$/b valuation estimate, and 3.1$/b valuation (same as Pikka acquisition) from May 21.
Comparables analysis vs 88Energy (88E) and Reconaissance Africa (RECAF) dated June 21.
Comparison to Pikka
Oil Search‘s acquisition of Pikka from Armstrong Energy for $3.1/b in November 2017 has been mentioned as the best comparison. WTI was trading in the low 60s back then vs low 70s today. In addition, Pantheon‘s acreage appears to be better located.
With estimates of contingent resources of ~1.95b bbl (2.4b including pre-drill estimates), a 3.1$/b valuation implies market cap of ~5.85b USD or upside of >11x from current levels.
On the other hand, Pikka was smaller, meaning the total price way below what Pantheon‘s acreage would command in USD terms, and more appraised (ie further developed). Lastly, this transaction occurred almost four years ago and oil and gas companies have not exactly risen in institutional investors‘ favour since. Meaning a potential acquisition could be harder to finance today, weighing negatively on a sale price.
Lack of sufficient comparables, time elapsed since last transaction, and change of industry landscape since then make for greater variance of outcomes. But if I were to boil it down into one sentence I would put it like this: there appears to be a lot of oil on Pantheon‘s acreage, and it is currently being valued at somewhere closer to ~0.25$/b.
Additional resources
Resource upgrade from WHIreland from July 21
Baker Hughes VAS executive summary dated April 21
Oilsearch presentation discussing Pikka acquisition
Risks
An exploratory play always carries a lot of risk and PANR is no different. Besides the obvious macro risk a lot of idiosyncratic factors have to be considered. And given the existence of more mature, cash flow producing alternatives, this is definitely not an investment that will suit everyone. As Josh Young of Bison Interests put it:
Buying exploratory assets in a high service cost area in a geography with extremely limited commercial exploration success in the past decade + seems unnecessarily risky in the current market context.
Personnel
With only a dozen or so of employees, mission success critically depends on the team. With most of them in their 70s already, there is a risk of them looking to cash out and selling the asset at a very low valuation to get a deal done.
Related to this, mission fatigue could delay or impede execution as the project has been running for ten years plus.
Lastly, one or more key players might be unable to complete this project due age/illness/death - this risk is obviously higher than with management in their 40s.
Asset
The most obvious risk is the oil being harder to extract, or less of it than currently assumed. Exploration companies often use the most aggressive available resource estimate for promotion. So far, estimates have only been revised up in the case of PANR.
If the asset is more costly or takes longer to develop than currently anticipated, this will also hurt returns in the form of dilution.
Low takeover price
Going down the rabbit hole on PANR, I always came back to the same question: why has nobody bought the company yet if it is that cheap? Why wait until the market realises the potential of this asset when it can be scooped up for a fraction of that now? The company even markets itself as a takeover target, yet has not received any bids. Why is that?
Reasons for this include declining capex into upstream by majors, the acceleration of this trend during covid, the fact that the resource has only very recently been upgraded to current estimates and prior to current appraisal status may have simply been too underdeveloped to be acquired by a bigger player. Management’s lack of success in marketing the asset may have played a role too.
This makes me think that the biggest risk to a blue-sky scenario is one in which a potential buyer pays significantly more than current implied value (maybe 3-4x), yet still way below what would have been possible as the gap between current implied value and NAV is simply too large. A similar thing happened to me in GT Gold earlier this year. While far from a bust, an outcome like this still leaves a bitter taste as the upside scenario receives confirmation in form of someone willing to acquire the asset.
Conclusion
Same as the first leg of the Trident Trade, PANR exhibits many option like features and there is a non-zero chance of total loss of principal. There is an even bigger chance of perhaps making some money, yet way less than possible, resulting in poor risk/reward. Then again, goal of Project Poseidon is to capture maximum upside in the bull case and PANR has lots of it. The company scores well on a host of metrics, both quantitative and qualitative. The upside in a blue-sky scenario coupled with the differing risk factors vs the first leg of the Trident Trade made me choose PANR as its second component.
Thank you for reading,
LazCap
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What do you make of the latest developments at Pantheon? Do you still have this trade on?