SEFE, balloons and other spark attracting bubbles

I am a collector of peculiar stock market press releases. I cannot read this release (by far this year's best) without tears of laughter welling in my eyes...

No further comment but I expect comment from my readers.

John

Disclosure: short - but the borrow is so tight that being short is hardly worthwhile...

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SEFE, Inc. (OTCBB/OTCQB: SEFE), a sustainability company engaged in offering innovative, pioneering solutions for the world’s energy needs, today provides the following letter to its stockholders and the investment community from its CEO, Don Johnston.

To our valued Shareholders:

I’d like to update you on the status of the company’s technological developments and operational changes. We’ve made much progress in the last four years, taking a seemingly impossible concept and developing it into a solution with many applications in different industries. We call our system the Harmony III.

Briefly, the Harmony III utilizes the phenomena of atmospheric corona discharge by a proprietary collection element held in the air by a balloon. The earth’s natural electrical field drives the discharge, and ions in the lower atmosphere provide a sink for the current. The solution is a high voltage and relatively low current technique by nature and requires a careful approach to handling the power.

Our engineering team has been extremely busy, and we’ve filed for patents on many of the aspects of this unique energy gathering system. The last 90 days have been very productive, and we’d like to share the results with you.

We’ve filed for a patent on our strain reduction system that uses an elastic bungee between a balloon and the tether attached to the balloon. As wind pushes on the balloon, the immediate pressure is absorbed by the elastic bungee rather than the balloon or the tether. This reduces the immediate force and tension, protecting critical components from damage.

Additionally, we’ve filed for patent protection on our tether contact system. The tether contact system is designed to minimize the electrical path length on the power tether. The system uses a proprietary mechanism to complete the power circuit, removing the unused power tether from the path. This system functions in tandem with the dynamic electrical converter and the electrostatic motor-generator as an efficiency booster. This allows for the same hardware to be used no matter what the flight elevation of the aerostat (the technical name for the balloon) may be.

We’ve also filed for patent protection on our system for detecting the concentration of atmospheric ions in the lower atmosphere at varying elevations. The charge detection system will play a critical role in broadening SEFE’s client base, allowing us to quickly determine how to best deliver the required amount of power to the client.

As our research and methodologies have progressed, we’ve realized we need a better balloon launch and retrieval system. So our engineers came up with the “Balloon Launch Assist” system, which uses a secondary stabilizing balloon on top of the primary lift balloon. This invention allows the balloon to be launched and retrieved in a simple manner, without a need for the extra manpower usually associated with the initial launch of a balloon. The secondary balloon provides upward lift and prevents the primary balloon from tipping over, ensuring stability during the critical stages of initial balloon deployment as well as during retrieval. The invention is currently in the patent application process with the U.S. Patent and Trademark Office. A patent-pending number has not yet been issued.

We’re also in the process of designing an electrostatic motor that operates as a generator when supplied with a high voltage-low current power source. This motor will be a key piece of the electrical generation hardware for our Harmony III system. It is designed to work side-by-side with our electrical converter to produce usable AC power directly for immediate consumption, delivery to an electrical grid, or stored for later use.

Our engineers have modified the original ion detector design for a more flight suited geometry which we are calling our “Cubic Wire Detector.” The IP for this technology has been categorized as a "continuation-in-part" application, adding a variation to SEFE's patent-pending application for Collection of Atmospheric Ions while claiming priority based on the original patent, which was filed with the U.S. Patent and Trademark Office on May 12, 2011. The variation employs an open-frame cubic box with alternating wires rather than parallel plates to collect atmospheric ions. The Cubic Wire Detector provides valuable insight into where the most abundant source of atmospheric charge is located.

We believe the cubic wire geometry is more suited to the flight environment and in its second iteration will also be able to capture directionality, depletion, and charge mobility measurements. The alternating wires are held at a high voltage and the ions that pass between the wires are accelerated by the high voltage and measured as a current. The team has developed a custom software routine to automate the data collection and allow for the test operator to adjust test parameters in flight. The software has gone through several iterations over the past year and is currently performing as expected in laboratory tests utilizing an ion source.

As you can see, our engineers are very busy developing Harmony III so it can become a huge success. Our operational staff has adeptly kept pace with several important developments, as well.

While we continue our efforts to advance the capabilities of the Harmony III system, we are working the marketing side at the same time. We’ve launched Revmodo to keep investors and the public up to date on developments in clean energy and the clean energy business. Revmodo has created an online presence that is geared toward driving potential new business to SEFE through community outreach initiatives and education of the public about the growing clean technology space.

Shea Gunther and Michael d’Estries, two award-winning green marketing veterans whose experience ranges from Glamour to Forbes, and from the Huffington Post to the Mother Nature Network and GE’s ecomagination.com, built the site for us and we are very pleased with their efforts. We feel that Revmodo will provide us with unique opportunities to foster new clean energy concepts, and believe it will also enable access to a wide variety of potential business partners that will bolster our company’s commercial opportunities. If you have not yet viewed the Revmodo site, I encourage you to do so.

Earlier this year, we moved our headquarters to Boulder, Colorado. We believe our Boulder facility provides us with an optimal setting for continued testing and perfection of our Harmony III system. We’re also pursuing a partnership with the University of Colorado’s Department of Electrical and Computer Engineering. We plan to work with both the Colorado Center for Power Electronics and the Center for Environmental Technology to perform research and development related to the physics and engineering of the Harmony III system. We believe the University will be a valuable partner in our efforts to further advance the development of our atmospheric energy technology.

Finally, we have set the following milestones on the path toward commercializing the Harmony III:

• Completing the data collection to determine how much electricity can be generated and stored by each unit over a period of time based on location, altitude, weather, and other factors;
• Securing contracts with mining organizations and/or utility companies;
• Implementation of the communications, monitoring methodologies, and security for each unit through our Network Operations Center (NOC) where applicable.

Please feel free to contact us with any questions you may have. We very much appreciate the continued support of our investors and are committed to delivering long-term shareholder value to all of you.

Sincerely,

Donald C. Johnston, CEO
SEFE, Inc.
4700 Sterling Drive
Boulder, CO 80301
T: (303) 444-0584
F: (303) 444-0571

About SEFE, Inc.

SEFE focuses on pushing the boundaries of what’s possible, embracing innovation and employing the cutting-edge to solve problems, and offering sustainable solutions to a world hungry for invention, direction and leadership. SEFE is technology- and solutions-driven, focusing on developing inventions that provide a real-world impact and true profitability. So, success is measured by both a sustainable return on investment, as well as a project’s sustainability from an environmental perspective.  

How business decisions are made in a boom: Fortescue Metals edition

The Australian boom - the one that leaves foreigners gobsmacked when see our housing prices, debt levels and general economic cheeriness - has been powered by iron ore and (to a lesser extent) coal.

These are the components of steel - and steel is the foundation metal of infrastructure - bridges, skyscrapers, gas pipelines and rail. Coal and (especially) iron ore are the raw material for the great Chinese construction and infrastructure build-out.

Below I demonstrate just how extreme the iron ore boom is by extracting BHP revenue and EBIT margin by commodity from BHP's last annual report:

I want to draw attention to the critical lines. Iron ore revenue (in millions of USD) progresses from 10,048 to 11,139 to 20,412 in 2009 to 2011 inclusive.

Underlying EBIT from iron ore was 13,328 million in 2011.

That is a 65.3 percent EBIT margin. These margins would make a luxury goods maker salivate. LVMH (the iconic luxury goods powerhouse) had an EBIT margin of about 23 percent. To make the margin for LVMH equal the margin from BHP's iron ore operation you need to exclude all selling costs (by far the bulk of costs) from LVMH's accounts.

You get the idea this is profitable. Breathtakingly profitable.

But it has not always been. Back in 2000 BHP made 2.5 billion EBIT on 21 billion of revenue. BHP only made that because its operations were about the lowest cost in the world.

The numbers above (almost 32 billion of EBIT) reflect the powerful commodities cycle.

For an Australian investor (or an investor in the large Australian mining stocks) the (literally) sixty four billion dollar question is what is the normalized profit of iron ore companies? At the moment (in what might be the tail-end of a wild boom) the profit situation reflects two things (i) an historically very high iron ore price and (ii) historically high costs (especially labour) incurred to get the stuff out of the ground.

The end price of iron ore is going to depend on global cost curves. Some very dicey mines are getting funding (for example Alderon financed by Liberty Mutual who are going to waste their policy-holder funds)*. I do not know the shape of cost curves but it seems unlikely to me that iron ore will remain as profitable on a cost-of-goods-sold basis (and three times as profitable all up) as selling luxury goods.

Whatever happens - BHP's mines will remain operational though. They are very high grade (mostly over 60 percent iron content and with acceptable impurities) and with good transport infrastructure in place. The only iron ore operation that is competitive is RIO - where the grades are a little higher still.

Fortescue - an aggressive miner somewhere in the middle of the cost curve

BHP and RIO are the very best iron ore operations in the world. Vale is clearly pretty good too (but further from China where the demand is strongest).

There are some very marginal iron ore operations getting funding (see Alderon as linked above). Also there newly developed large mixed-quality operations (particularly on the West Coast of Africa). The competition is rising.

I don't know (nor does anyone else really) where the cost curve will be - but it is likely that Fortescue Metals Group will be somewhere in the middle. At the moment it is certainly a better-than-average mining operation - it is hemetite (rather than a low-grade iron ore that needs extensive pre-processing before shipping) but the grades are typically about 57 percent. Fortescue exports some mildly processed ore (fines etc) with higher grades for higher prices.

These are good iron ore properties. They are just not as good as the BHP and RIO ones.

You can see this in the accounts too. Here are the last half:

Gross profit is 1426 million on 3357 million in sales - an eye-watering 42 percent margin. After administration costs margins are little thinner.

These margins are still salivating-good - but they are twenty percentage points worse than BHP. This is a modestly inferior mining operation that is stupendously profitable because iron ore prices are very high.

Fortescue tell us their vision:

They want to be the "lowest cost, most profitable iron ore producer". And whilst they are frighteningly profitable they are a long way from being the lowest cost producer and given the difference in grades it is unlikely they can ever close that gap.

Some calculation of profit versus iron ore price

The average price realized during the last half (the half with the P&L above) was USD139 per tonne.

If I take $20 per tonne off that price Fortescue is a darn good business. Better than the P&L above indicates because they have mega-large reserves and the volumes are expanding very fast.

But if the iron ore price drops by $50 this is very difficult and if it drops by $60 this is disastrous.

If you take $60 off the iron ore price from last half levels then BHP remains profitable (albeit much less profitable than it is now).

I note that iron ore briefly touched prices in the 60s during the GFC - but prices ramped up with Chinese infrastructure spend almost immediately.

One observation though: at a price in the 110 to 120 range BHP and RIO remain more profitable than Louis Vuitton. This just remains an outrageously attractive business.

Just how big are the expansion plans of Fortescue

Fortescue might lack 20 points of margin against BHP. But they want to make that up in volume. Seldom have I seen a company that keen on capital expenditure. They do so much of it that they have wiped their liabilities under Australia's resource rent tax (at least for next few years).

The capital expenditure is well illustrated in this video from the company:





It can also be seen in the balance sheet - where the company has come through this enormously powerful iron ore boom with ever increasing volume and ever increasing debt.

Yes - you do see that balance sheet right. Exploration, evaluation and development assets of USD5 billion (give or take a little) and debt of USD6 billion.

And it can all be paid if the iron ore price remains high.

But if the commodity cycle goes back to the dark days when BHP's margin was around 10 percent this one is pushing up daisies. They have 20 percentage points less margin than BHP and with a commodity crunch like their margin will go negative and the debt will not be able to be serviced.

Jim Chanos (the noted shortseller best-known for picking on Enron) has publicly stated as much.

Of course the management don't see it that way. They have a view of iron ore prices consistent with their business. Indeed I can't imagine how long anyone bearish on iron ore prices would remain around Fortescue. Having a less than sanguine view of iron ore prices would be about as sensible at Fortescue as trying to be a proselytizing moral conservative working at the bar in a swingers club. You are not going to keep your job.

Still iron ore prices were covered in this amazing interview of Nev Power (Fortescue CEO) by Alan Kohler:

ALAN KOHLER: Now, you must be feeling a bit nervous about what's going on in Europe at the moment. About a week ago your chairman Andrew Forrest said it's all a storm in a teacup beaten up by the media. Do you still think that?

NEV POWER: I think the issues in Europe have had a very strong effect around the global economies, and probably far more than what you would expect, so the difficulty there is that yes, they are in trouble over there in those economies, but if you take the sum total of the impact of those economies, say, on China and Australia, they're relatively small.

But the equity markets have been hit very, very hard in comparison to that effect, so what Andrew was talking about was the fact the equity markets have been spooked by Europe far greater than the actual physical impact.

ALAN KOHLER: But what matters to you of course is the iron ore price.

NEV POWER: Yes.

ALAN KOHLER: What price have you got in your forward planning, in your budgeting?

NEV POWER: Well, we see in the short term that it'll trade in that range of $130-$150 a tonne and it has been very resilient over the last 12 months or so trading around that range. But looking forward we've allowed the forecast to drop down to around $110 a tonne and done all our modelling around that, so we see that long term that'll be the sustainable price.

ALAN KOHLER: But in the 2008 crisis it got down to as low as $55 a tonne, so if there's another crisis - this is what I'm talking about you feeling a bit nervous - if there's another crisis, Spain collapsing, Greece or whatever, you could see the price go down to that level again.

NEV POWER: Well, Alan, it did go down to around a little under $60 a tonne but that was for a fleeting moment and it recovered to over $100 a tonne within weeks - and that was a global financial crisis, that was a real global crisis.

ALAN KOHLER: But the reason it recovered so quickly the Chinese economy recovered so quickly and right now it's slowing.

NEV POWER: Well Alan, the Chinese economy is going through a short-term fluctuation, but overall it's growing very strongly. It's growing in that 7 to 8 per cent range which reflects back to a 4 to 5 per cent growth in steel which we see as a really strong growth and something I think a lot of countries would aspire to.

ALAN KOHLER: Thanks very much for joining us, Nev Power.

NEV POWER: Thank you, Alan. It's good to be here.

Get this: they have modelled around a price ($110 per tonne) which is high enough to keep BHP earning far better margins than Louis Vuitton. As if BHP has a god-given right to make Louis Vuitton look marginally profitable.

Those are prices that might even make the Alderon project cited above borderline viable.

Whatever: Nev Power is sure - simply sure - that the price registered in the GFC was an aberration. To view it otherwise means that he could not possibly hold a senior position at Fortescue.

And I am sure Nev Power is a rational man - but I methinks he has succumbed to the capitalist version of rationality. Whatever makes you a dollar (or in this case for the senior people at Fortescue a few billion dollars) is what is rational (and moral too).

If I were not short this I would wish them good luck with that. As it is I have a small bet against Mr Power and Fortescue. (But then maybe I am just hedging my Australia risk...)


John

*Disclosure: I am short less than 10 thousand dollars worth of Alderon Iron Ore. The project is silly - but the stock is too illiquid and the borrow is too tight to stay short. But it would be a much better short than Fortescue if you could borrow and sell it in quantity. I am also short other marginal iron ore properties. They too are - I think - better shorts than Fortescue.

Weekend diversions (which I think you may need after a Friday in the markets like that...)

You know you are getting old when the librarian at your child's school (Amanda Brown) was in a band you idolized when young.

I give you the Go Betweens (still my all time favourite Australian band with the Triffids a close second).






And for something more recent (Lissie and one of the best covers of a Bob Dylan song done on a single guitar I have ever seen):









John

Gulfport Energy and Wexford Capital Part VII: The independence of reserve assessment

Having got into a spat with everyone and their dog (including more than one client) about the ethics and conflicts of interest in investment banking I thought I would go back to just old-fashioned hot-chair-job-swapping conflicts.

And my old flame - Gulfport Energy and the many conflict-ridden relationships they have entered.

This is a conflict as old as industry: who do you get to assess your reserves and are they truly independent?

Oil and gas companies are meant to have independent and competent parties assess their reserves. This is critical because what you as a shareholder are buying is future production and reserves are the basis for future production.

In this light I want to explore who is involved in assessing the reserves of Gulfport Energy.

To quote the 10K:

There are numerous uncertainties associated with estimating quantities of proved reserves and in projecting future rates of production and timing of expenditures. The reserve information herein represents estimates prepared by Netherland, Sewell & Associates, Inc., or NSAI, with respect to our WCBB, Hackberry and Niobrara fields at December 31, 2011, with respect to our WCBB and Niobrara fields at December 31, 2010, and with respect to our WCBB field at December 31, 2009; by Ryder Scott Company L.P., or Ryder Scott, at December 31, 2011, and by Pinnacle Energy Services, LLC, or Pinnacle, at December 31, 2010 and 2009, with respect to our assets in the Permian Basin in West Texas; and by our personnel with respect to our overriding royalty and non-operated interests at December 31, 2011 and with respect to our Hackberry fields, overriding royalty and non-operated interests at December 31, 2010 and 2009.

I have highlighted the critical bit. The reserves with respect to the Permian Basin are assessed by Pinnacle Energy Services LLC. This has been the case for many years - dating back at least to the 2008 annual report. Specifically the reserves were last assessed in 2010 and were assessed in 2009.

These reserves are over half the stated reserves of Gulfport in the last 10K.

In the first post I quoted the Gulfport's proxy stating that Windsor Energy (which is controlled by Wexford) is the operator all Gulfport's assets in the Permian basin.

Who are Windsor Energy?

Well apart from being controlled by Wexford we know very little about them. They have a website - but it is dead. More precisely the site is "under construction". Corporation Wiki gives a list of officers. But our best clue comes from archive.org - and the "way-back machine". On archive.org we can find how the WindsorEnergy.com website looked a few years ago. The site isn't "under construction" as described - it has been removed and replaced with an "under construction" page.

Anyway the old site contains some CVs and I have pulled one which you can find here (click the world "impatient" at the bottom right hand corner of the linked page).

Lance Galvin
Vice President and Chief Operating Officer 

Mr. Galvin was appointed Chief Operating Officer in July 2008. Prior to this appointment he served as Vice President, Operations and Engineering for Windsor Energy since February 2008. Mr. Galvin worked as a consulting petroleum engineer for Pinnacle Energy Services, LLC from 2003 to 2008. Mr. Galvin started his career in the oil and gas industry in 1980 with Marathon Oil Company serving in various locations and capacities. He served as Engineering Manager for Marathon Oil Company’s Oklahoma City business unit from 1996 to 2001. Prior to this 1996, Mr. Galvin served in various engineering and operations roles for Marathon in Houston, Wyoming and Alaska. Mr. Galvin graduated from Colorado School of Mines in 1980 with a bachelor's degree in Petroleum Engineering and is a Professional Engineer in the state of Oklahoma.

This CV was valid in 2009. I do not think the CV is currently valid because Lance Galvin no longer appears on their dial-by-name phone directory of Windsor. Thus I presume he no longer works there. He did work there during the period that Pinnacle assessed Windsor's reserves. Remember Windsor's reserves were assessed by Pinnacle in 2009.

And that is notable. According to the above CV, Lance Gavin, the former Chief Operating Officer and VP of Windsor Energy used to work as a "consulting engineer" for Pinnacle Energy Services LLC immediately prior to working Windsor Energy.

When accountants do that - going from audit firm to their clients - it raises eyebrows because it raises issues of independence. But it is not illegal. Its the sort of soft-conflict you get used to on Wall Street - surprising, but not very surprising.

I was however very surprised when I googled Mr Galvin's name. You see the first hit was his CV at Pinnacle Energy Services. I note that Lance Galvin is the second most senior listed employee at Pinnacle. The following was downloaded in May 2012 and is still on the web at the time of posting.

Lance J. Galvin began working part-time for Pinnacle Energy Services, LLC as a consulting petroleum engineer in 2003 and joined the company full-time in 2005. 

In 2001 Lance purchased a small manufacturing business in Oklahoma City and continues to be involved in that business. 

From 1996 to 2001, Lance was Engineering Manager for Marathon Oil Company’s Oklahoma City business unit. His duties included managing a multi-disciplined Business Development Team responsible for identifying, evaluating and completing acquisitions and divestitures, managing several multi-disciplined Asset Teams responsible for development and exploitation of the business unit’s reserve base. These responsibilities included properties located in Michigan, Wyoming, and Oklahoma. Lance was also responsible for engineering personnel development, reserve reporting and budget compilation. 

From 1992 to 1996, Lance held the position of Operations Engineering Manager reporting to the Vice President of onshore operations for Marathon Oil Company in Houston, Texas. He was responsible for overseeing all engineering functions in business units located in Midland, Texas; Oklahoma City, Oklahoma and Cody, Wyoming. Lance managed development of asset optimization strategies, implementing corporate change agendas, engineering personnel development, SEC reserve reporting, and corporate financial planning. 

From 1990 to 1992, Lance was Operations Manager for Marathon Oil International’s Damascus, Syria operation. His responsibilities included evaluating well performance, developing economics, preparing a Plan of Development, managing drilling and completion operations, government negotiations and facility design oversight.
From 1988 to 1990, Lance held the position of Reservoir Engineering Supervisor for Marathon Oil International in Houston, Texas. He was responsible for managing all reservoir engineering activities for properties in Ireland, Norway, The Netherlands, Tunisia, Egypt, Indonesia, and Australia. These duties included detailed technical well analysis, reservoir simulation, preparing drilling proposals, economic evaluations, preparing Development Plans, interfacing with government officials and reserve reporting.
From 1980 to 1988, Lance held various production and reservoir engineering assignments with Marathon Oil Company in Casper, Wyoming and Anchorage, Alaska. His responsibilities included field operations supervision, well completion and facility design for oil and gas fields in New Mexico, Utah, Colorado, and Wyoming. He prepared economic evaluations, reservoir simulations, field-wide reservoir studies and reserve reports for fields and reservoirs in Utah, Colorado, New Mexico, Nebraska, Wyoming and the Cook Inlet. 

Lance graduated from Colorado School of Mines in 1980 with a bachelor's degree in Petroleum Engineering.

There are several issues with this CV vis the CV on Windsor Energy's site. For a start Lance is described as a full time employee of Pinnacle since 2005 - somewhat more involvement than a "consulting engineer". The CV's don't match.

But again I suspect the CV is temporarily incorrect. I rang Pinnacle and despite the current web page stating that Lance is a full time employee his name does not appear in the Pinnacle phone directory. It is also possible to find other entities which Lance has been an employee of during this time - so the page stating he is a full time employee of Pinnacle may be old or not updated.

Still Gulfport Energy is laced with conflicts of interest: conflicts have been the point of this series. And conflicts of interest are not often illegal but the law generally requires disclosure. Moreover as my Facebook series shows reasonable people often argue about the ethics of conflicts.

Moreover, the disclosure at Gulfport is generally pretty good - but I had to work a little harder to find this conflict.

And I thought the process amusing.



John

Diversions: Greetings to the New Brunette

Complete diversion here...

Brad Delong complained recently that Siri was interpreting "surely" as "Shirley". He doesn't even know anyone called Shirley.

And in the perverse way my brain works I was thinking back to a 1987 show by Billy Bragg at the Coogee Bay Hotel and him singing Greetings to the New Brunette. (It is a song about a relationship with "Shirley".)

Due to the magic of YouTube I could find a live recording of the same song from the same tour (this time in Wellington New Zealand).

There is no video - but headphones make it worthwhile:

The Epicurean Dealmaker replies to my Facebook post

The Epicurean Dealmaker (TED) has replied to my Facebook post. As usual TED is worth reading.

The Epicurean Dealmaker: As Long as the Right People Get Shot

His argument comes down to the IPO discount being a cost of doing business.

However I would like to turn this into a real estate deal. I go to a real estate agent and ask her to sell my property at the best price.

I enter into a contract which obliges the real estate agent to sell at the best price.

She sells it at less than the best price - as she always does.

She has a queue of buyers willing to buy because she always sells at the best price.

In this case I would think she is a shonk more concerned with her own franchise (her queue of buyers) than my best price and her legal and moral obligations.

I think precisely that of investment bankers. Always have.

My view of the morality of this trade differs from TED's view. And I would like to explain how I think that TED has got to his strange position.

To do that I need to look at this transaction from Morgan Stanley's viewpoint

Morgan Stanley (at least on this deal) appear to have broken the cardinal rule of investment banking. The cardinal rule of investment banking is to look after the investment bank (in the hope that at bonus time they will look after you).

Morgan Stanley's interests are clearly damaged by the Facebook IPO. Their ability to do more IPOs of scale is somewhat limited. Their ability to do future deals is contingent on a reasonably predictable IPO discount.

In my post I defended Michael Grimes (the Morgan Stanley investment banker) as he did what the law and ethics required of him. He looked after the client. I stand by that moral assessment.

Michael Grimes should most certainly NOT be investigated by the SEC for this.

But here my deeply cynical side comes out: Michael Grimes should be fired by Morgan Stanley for this deal. He broke the cardinal rule of investment banking which is the investment bank's interests come before the client interests. By selling too much Facebook at too high a price he has damaged the franchise of the investment bank. That is untenable.

People get fired in investment banking for lesser infractions.

So where does the Epicurean Dealmaker's moral position come from

TED is an investment banker. His background is M&A.

Morality for him is defined by the cardinal rule of investment banking. After all that is what you have to do. It is the moral pact of everyone who works in investment banking.

Indeed it is a moral pact that almost all humans make. What feeds you becomes (in your eyes at least) moral.

This was the very point of my post. People's morality is defined not around what is right and just but what they need to do to make a buck. We are human. Even TED.

Investment bankers learn to rip of clients. That is what they need to do to get by.

And the Epicurean Dealmaker - and everyone else in the industry - has accepted that as the new fair and just.

Its not the Epicurean Dealmaker is a bad man. (I like and respect his blog. I think I would like and respect the man.) It is just that circumstances make the morals.




John

Facebook and the sad case of ethical investment bankers

In an IPO an investment bank takes a fee from a business to place that stock in financial markets.

Or, more precisely, they take a fee from a business to sell part of that business.

Their customer is the company doing an IPO and they have a legal and moral obligation to get the highest price for the company they are selling. No more. No less.

However investment bankers have, as a practical matter, a desire to expand and improve their franchise. Their franchise consists of a huge number of buy-side investors (some retail, some institutional) who will buy from them whatever they sell so long as it comes in a prospectus.

Investment bankers expand that franchise by making sure the things sold in a prospectus have excess demand. If they can sell for $38 they chose to sell for $33 to guarantee a stag. Every time they do so they build their own franchise as an investment bank at a cost to the client to whom they owe a legal and moral duty and who is paying them fees.

The buy-side customers of investment banks have got used to playing in this little game of theft. We – as buy-siders – like to be able to buy IPOs and have instant stag profits. Indeed in the 1990s the game of giving favours to investment banks in exchange for instant stag profits became the way business was done on Wall Street.

The moral corruption of investment banks not only became accepted but we redefined morality around what investment banks did rather than what they should do. We though the process of systematically ripping off the sellers of IPOs in order to build the buy-side franchise of the investment bank was right-and-proper.

It is not right-and-proper and it never was right-and-proper.

The investment bank owes a duty to the seller of the IPO and that is all. Whining fools who complain otherwise have allowed their own greed to distort their morality until they have become gebbeths. Jeff Matthews argues it was their foolishness that cost them money. I disagree. The idea that Wall Street has an obligation to them (thus guaranteeing stag profits) cost them money. And that idea came from their complacent immorality - a complacent immorality pervasive on Wall Street.

But not only have people with hurt hip-pockets complained about the Facebook IPO their supplicants in the press have been sucked into supporting the buyers same self-interested immorality. The Wall Street Journal (a magazine captured by Wall Street not Silicon Valley) derides Michael Grimes (the Morgan Stanley Banker) for not standing up to David Ebersman (Facebook's CFO) and allowing Facebook to sell too many shares at too high a price. This is tits-up-backward. David Ebersman in this context is the client. He paid the fees. Michael Grimes had a duty to act in Ebersman's interest. Ebersman wanted to sell more shares at a higher price. Michael Grimes and Morgan Stanley obliged even at the cost to their own franchise.

And for that he is being pilloried in the press.

What we have here is an investment banker acting ethically. And the whole financial press is a twitter about it.

And the SEC is investigating.

No ethical behaviour goes unpunished in America.




John


PS. Joe Nocera seems one of the few people in the financial press who sees this the right way. My respect for Joe rises every year.

Santander: The lady doth protest too much...

One blog reader - a Sovereign customers - sends me the following:

Across the top of my Sovereign home equity statement for June, I read: "The Safety of Santander—Benefit from the security of one of the world's safest banks." 

Santander Preferreds: Are North American Grandmothers brave, ignorant or insane?

There is - at least amongst North American grandmothers who are the natural buyers of American listed bank preferred securities - a love of yield.

Santander (the Spanish mega-bank) has preferred securities issued in America - they mostly replaced the preferred securities of Sovereign Bank - a Santander-owned US regional bank. 

But they are equity securities of Santander - taking full equity risk for a high (but limited) yield. 

Linked (here) is the Google Finance page for one such security. Par value is $25 and the last trade is $25.65 - a small premium to par.

What could possibly go wrong?

OK: plenty could go wrong - but we don't need to analyse whether the Spanish mega-banks will succeed or fail - all we need to do is observe how bizarre the pricing is. Why would you own this preferred when you could own the common? The ADR is trading at $5.66 - and good earnings (2009 would you believe) were $2.24 per ADR. The common is two and a bit times normalized earnings. The no-failure earnings yield on the common is 40 percent (and if it does not blow up you will get capital appreciation). The prefs are at 10 percent yield.

There is a good chance that Santander never again earns "normalized earnings". There is a crisis going on... 

But go tell that to the preferred holders who are happy to take a very similar risk to the common for a 10 percent yield and no chance of capital appreciation. They must envisage a world where Santander is saved by equity dilution that somehow leaves them intact. After all they are presuming (through their holdings) that the preferred is more attractive than the common.

And they believe that just as the Spanish Government injects 24 billion euro into Bankia.

Brave. Or is it ignorant? 

Or do the holders expect the Spanish government to bail out banks at no cost to the preferred holders as per much of North America? That does not seem likely to me. Or even possible.

John

PS. I lost good money on Washington Mutual preferred stock. But I purchased them at 25 cents in the dollar. This one is going to trade there very soon in my estimation. 

Disclosure: trading short on the preferred. Covered the common a few dollars up from here. But you guessed that.

PPS. In the interests of disclosure I should note that the borrow has become tight on this security (which  from my perspective is a pity).

Gulfport Energy and Wexford Capital (Part VI): The independent directors

As the previous posts have shown Gulfport Energy and Wexford Capital are related parties on many levels. All the major projects of Gulfport are essentially joint operations with Wexford or will be after proposed transactions.

Wexford holds this privileged position despite having sold down most of its shares.

On major transactions though (such as the sale of the bulk of the proven oil reserves to a Wexford entity) you find statements that are reassuring. This was - for their latest major related party transaction - the form of words:

A special committee of the Board of Directors consisting solely of independent directors negotiated and approved this transaction on behalf of Gulfport.

With all these related party transactions an independent director of Gulfport would really have their work cut out. The Chairman of Gulfport is - as shown - in many respects a Wexford man. Most the operations are on a day-to-day basis run by Wexford controlled entities. Gulfport has issued hundreds of millions of dollars in shares and invested the vast bulk of this money in Wexford controlled entities. Being an "independent director" of Gulfport would have to rank as one of the most involved directorships in corporate America.

So who are the independent directors. Lets crib this from Gulfport's website except that I am going to do it in reverse order because the directors start more colourful that way:

Craig Groeschel: Director

Mr. Groeschel has served as a director of our company since August 2011. Since 1996, Mr. Groeschel has served as a founding pastor of LifeChurch.tv, one of the largest churches in the United States, reaching over 30,000 people each weekend. Since founding LifeChurch, Mr. Groeschel has served on its Board of Directors. Under Mr. Groeschel’s leadership, LifeChurch has grown to 15 locations in the United States. Mr. Groeschel received a Bachelors in Business Marketing from the Oklahoma City University and a Masters of Divinity from the Phillips Graduate Seminary. Mr. Groeschel is a frequent speaker at various domestic and international forums and an author of a number of books.

Craig Groeschel is a very high profile pastor - running a church reaching over 30 thousand people each weekend. He hangs around with Brian Houston from the Hillsong Church in my home town (Sydney Australia). Hillsong was founded by (now deceased) paedophile priest Frank Houston. Frank was sacked by his Brian who now runs the show. [OK - I am a self-described godless liberal from Sydney. I have learned to loathe Hillsong and all that it stands for. My intense dislike of Hillsong might colour my judgement...]

Whatever: Craig Groeschel's church is nowhere near as controversial as Hillsong but it is easier to find tithing demands than charitable works on the internet. Here is one:



There are suggestions on the web that Craig Groeschel is one of the most financially successful pastors in the world however the church has stated that Pastor Groeschel does not even have access to the church check book.

As a godless liberal I will leave the estimate of spiritual success to other people.

It is also easy enough to find Craig promoting financial advisers who seem to get 12 percent annually from mutual funds without telling you which funds they are picking.

Independence is an issue with Pastor Groeschel. In a 2007 prospectus (withdrawn) for Diamond Back Energy Services Pastor Groeschel agreed to be a director. Do I need to say that Gulfport was a Wexford entity?

This Pastor is an independent director of Gulfport who negotiated a sale of the majority of Gulfport's oil reserves to a Wexford controlled entity called Diamondback. He was once slated as a director of a Wexford controlled entity called Diamondback.

Still he is independent now...

The next director is Donald L. Dillingham. Here is his CV cribbed from the website.

Mr. Dillingham has served as a director of our company since November 2007.  Since August 2001, Mr. Dillingham has served as the Senior Portfolio Manager for Avondale Investments, LLC and Merit Advisors, Inc., each of which is a registered investment advisor. Mr. Dillingham is currently the Senior Portfolio Manager for two mutual funds, a member of the investment committee of Merit Advisors, Inc. and the Vice-President/Treasurer of the Merit Advisors Investment Trust.  From August 2002 to December 2004, Mr. Dillingham served as an adjunct professor of finance at the University of Oklahoma.  Mr. Dillingham has also served as Senior Vice President, portfolio manager and state director for J.P. Morgan Investment Management, State Director responsible for managing the financial planning services and product sales for the State of Oklahoma for American Express, and Vice-President of Investment Banking for Bank of America.  Mr. Dillingham began his career in the finance industry with Stifel, Nicolaus as a fixed income analyst, risked based market maker and sales manager from August 1984 to May 1994.  Mr. Dillingham received a Bachelors of Business and Administration in Accounting from the University of Oklahoma and his Masters of Business and Administration in Finance from Oklahoma City University.  Mr. Dillingham is a Chartered Financial Analyst, a Certified Public Accountant and a Certified Financial Planner.  Mr. Dillingham is considered an independent director.

I have not checked the veracity of this CV however there are a few things missing. Donald Dillingham is also a director of The Beard Company. This now trades on the pink sheets under the ticker BRCO. The Beard Company had quite good looking assets and "proven" oil reserves but still managed to run out of cash. It never went bust though - it just went quiet. It no longer files with the SEC.

He has also been involved in a tax case with some controversy. The website (with his CV) for what he appears to be his main business is here.


The next director is Scott E. Streller. Here is his CV.

Mr. Streller has served as a director of the company since August 2006. Mr. Streller is the principal and founder of Streller Insurance and Financial Services with the Farmers Insurance Group of companies. Mr. Streller’s agency is consistently recognized as one the top agencies in the nation and is a member of the elite President’s Council. Mr. Streller is a frequent guest lecturer to Oklahoma City based universities and high schools on the topics of finance, risk management and budgeting. Mr. Streller is a member of numerous non-profit boards and recently served as the operations director for the 2006 Senior PGA Championship. Mr. Streller received a bachelor’s degree in business administration from the University of Central Oklahoma and a master’s degree in athletic administration from Oklahoma State University. Mr. Streller is considered an independent director.

A tied insurance agent does not strike me as the obvious choice for such a difficult independent directorship. Whatever my problem is not with him being an insurance agent. It is with the assertion that Mr Streller is an "independent director". Gulfport discloses otherwise in the 2007 proxy. To quote:

Effective September 29, 2006, we entered into an administrative services agreement with Diamondback Energy Services LLC, which we refer to as Diamondback. Under the agreement, our services for Diamondback include accounting, human resources, legal and technical support. The services provided to Diamondback and the fees for such services can be amended by mutual agreement of the parties. The administrative services agreement has a three-year term, and upon expiration of that term the agreement will continue on a month-to-month basis until cancelled by either party with at least 30 days prior written notice. The administrative services agreement is terminable (1) by Diamondback at any time with at least 30 days prior written notice to us and (2) by either party if the other party is in material breach and such breach has not been cured within 30 days of receipt of written notice of such breach. We were reimbursed approximately $823,000 for services provided under this agreement during the year ended December 31, 2006. Our Chairman of the Board, Mike Liddell, is also the Chairman of the Board of Diamondback. One of our directors, Scott Streller, is also a director nominee of Diamondback. In addition, Wexford Capital LLC indirectly controls Diamondback.

I thought the Good Pastor was compromised having once agreed to be a director of Diamondback. But this is kind of special. Scott Streller is an independent director for the purposes of selling the Permian assets (that is the bulk of the proved oil reserves) to a Wexford controlled entity called Diamondback.

But in 2006-2007 he was director of a Wexford backed entity called Diamondback. The Pastor only agreed to be a director of the Diamondback entity.

The last independent director is David L. Houston. Here is his CV:

Mr. Houston has served as a director of the company since July 1998. Since 1991, Mr. Houston has been the principal of Houston & Associates, a firm that offers life and disability insurance, compensation and benefits plans and estate planning. Mr. Houston has served as a director of Bronco Drilling Company since May 2005. Mr. Houston was President and Chief Executive Officer of Equity Bank for Savings, F.A., an Oklahoma-based savings bank. Mr. Houston currently serves on the board of directors and executive committee of Deaconess Hospital, Oklahoma City, Oklahoma, and is the former chair of the Oklahoma State Ethics Commission and the Oklahoma League of Savings Institutions. Mr. Houston received a Bachelor of Science degree in business from Oklahoma State University and a graduate degree in banking from Louisiana State University.  Mr. Houston is considered an independent director.

Mr Houston is a director of Bronco Drilling. Mr Liddell, the Chairman of the board of Gulfport (and a Wexford man) is also the Chairman of the board of Bronco. Oh, and Wexford controls Bronco. Again the issue of independence matters.

So there they are. The four independent directors of a company laced with related party transactions - possibly the four independent directors with the hardest job (assessing all those transactions) of any oil and gas company I know.

Still - and I should repeat this - the company has set up a "special committee of the Board of Directors consisting solely of independent directors" to negotiate and approve the major transactions on behalf of Gulfport. And that is good practice.



John