Wednesday, May 23, 2012

Gulfport Energy and Wexford Capital Part V: Parsing Gulfport's cash flow statement

From the last 10Q here are Gulfport Energy's revenue numbers for the past three months:



  
Three Months Ended March 31, 
   2012  2011 
Revenues:
   
Oil and condensate sales
  $64,004,000   $45,196,000  
Gas sales
   613,000    720,000  
Natural gas liquids sales
   806,000    659,000  
Other income
   38,000    63,000  
  


  


 
   65,461,000    46,638,000 


They had $65 million in revenue.

Net income was $26.7 million dollars.

Here is the cash flow statement for operating cash flows:


   Three Months Ended March 31, 
   2012  2011 
Cash flows from operating activities:
   
Net income
  $26,869,000   $21,174,000  
Adjustments to reconcile net income to net cash provided by operating activities:
   
Accretion of discount - Asset Retirement Obligation
   176,000    159,000  
Depletion, depreciation and amortization
   21,395,000    12,158,000  
Stock-based compensation expense
   681,000    77,000  
Loss from equity investments
   268,000    316,000  
Interest income - note receivable
   —      (36,000
Unrealized loss on derivative instruments
   266,000    —    
Amortization of loan commitment fees
   112,000    110,000  
Changes in operating assets and liabilities:
   
Increase in accounts receivable
   (1,718,000  (5,419,000
Increase in accounts receivable - related party
   (463,000  (160,000
(Increase) decrease in prepaid expenses
   (57,000  618,000  
Increase (decrease) in accounts payable and accrued liabilities
   22,431,000    (709,000
Settlement of asset retirement obligation
   (531,000  —    
  


  


 
Net cash provided by operating activities
   69,429,000    28,288,000  
  


  


 


The cash generated was - believe it or not - slightly larger than the revenue - and over 40 million higher than profits. Part of that was depletion (depreciation adds to cash flow). Most the rest was simply an increase in accounts payable of 22 million.

Here is the cash flow from investing for that three months:


Cash flows from investing activities:
   
Additions to other property, plant and equipment
   (82,000  (13,000
Additions to oil and gas properties
   (84,778,000  (33,285,000
Proceeds from sale of other property, plant and equipment
   140,000    —    
Proceeds from sale of oil and gas properties
   —      1,384,000  
Advances on note receivable to related party
   —      (1,319,000
Contributions to investment in Grizzly Oil Sands ULC
   (67,063,000  (4,878,000
Distributions from investment in Tatex Thailand II, LLC
   200,000    —    
Contributions to investment in Tatex Thailand III, LLC
   (483,000  (895,000
Contributions to investment in Muskie Holdings LLC
   (312,000  —    
Contributions to investment in Timber Wolf Terminals LLC
   (1,000,000  —    
Contributions to investment in Windsor Midstream LLC
   (7,021,000  —    
  


  


 
Net cash used in investing activities
   (160,399,000  (39,006,000
  


  


 


In those three months they invested $160 million but only had cash flows of $69 million and earnings of $26.7 million.

How did they finance this?

As noted the company had to finance $160 million of investing activities from only $26.7 million in operating earnings. This presents financing issues.

Firstly the company (as noted) ran up its accrued liabilities.

Then the company borrowed $10 million dollars.

But mostly the company ran down its cash holdings from $93 million to $13 million.

Where did those cash holdings come from?

The cash holdings did not represent past profits. What they were was proceeds from equity issuance. The company cash flow statement in 2011 shows $307 million in equity issuance - much of which has gone into investing in various quarters. The cash is now heavily depleted (note only $13 million is left).

If they intend on investing at these rates they will need to raise more capital.

What were the investments?

In the last quarter they invested $67 million in Grizzly Oil Sands. That is controlled by Wexford.

They also invested in Tatex, Muskie, Timberwolf and Windsor. All of these are Wexford entities.

Indeed they invested more than their entire revenue in Wexford Entities.

But they also added $85 million to oil and gas properties. A fair bit of that was with respect to the Permian Basin properties (they drilled wells and acquired acreage). Those assets are also being sold to a Wexford controlled entity. Other releases have envisaged a sale of that entity which will raise some cash allowing them to continue to invest.

I read many 10K and 10Q filings. Few are this fascinating.






John

Tuesday, May 22, 2012

Gulfport Energy and Wexford Capital (Part IV): What is left after Gulfport sells the Permian Assets to a Wexford Related party?

In the last post I demonstrated that 12.885 million out of 19.367 million barrels of oil equivalent (BOE) in "proved reserves" was being sold by Gulfport to a related party of Wexford. These were the Permian Basin fields as per the table below.



              Proved Reserves
Field
  NRI/WI (1)  Productive
Wells (2)
  Non-Productive
Wells
  Developed
Acreage (3)
  Gas  Oil  Total
  Percentages  Gross  Net  Gross  Net  Gross  Net  MBOE  MBOE  MBOE
West Cote Blanche Bay Field (4)
  80.108/100    95    95    189    189    5,668    5,668    352    3,617    3,969  
E. Hackberry Field (5)
  79.424/100    30    30    93    93    3,291    3,291    226    1,606    1,832  
W. Hackberry Field
  87.5/100    2    2    23    23    592    592    —      76    76  
Permian Basin
  35.4/46.87    121    57    —      —      8,880    4,119    2,008    10,877    12,885  
Niobrara Formation
  39.7/47.9    6    3    2    1    3,954    1,977    26    500    526  
Williston Basin (6)
  2.8/3.3    6    .2    —      —      1,708    132    7    67    74  
Overrides/Royalty Non-operated
  Various    133    .2    —      —      —      —      3  2    5  
    


  


  


  


  


  


  


  


  


Total
    393    187.4    307    306    24,093    15,779    2,622    16,745    19,367  
    


  


  


  


  


  


  


  


  



The table is from the 10K.

Given that most the reserves and most the cash flows of Gulfport are being sold to a related party it is worth considering the quality of the assets left. After all - if you are a Gulfport shareholder that is what you are buying.

Lets just take the Niobrara acreage.

The claim of half a million barrels of oil in the Niobrara raised my eyebrows because I thought most that acreage was locked up. Indeed it was this claim that attracted me (as a short) to Gulfport in the first place. I wanted to see what they based their claim of half a million barrels of proved oil on.

Here is what the 10K says about the Niobrara acreage:

Location and Land 
Effective as of April 1, 2010, we acquired leasehold interests in the Niobrara Formation in northwestern Colorado, and held leases for 14,993 acres as of December 31, 2011. We are the operator on the acreage. 
Area History 
The Niobrara Formation is a shale oil rock formation located in Colorado, Northwest Kansas, Southwest Nebraska, and Southeast Wyoming. Oil and natural gas can be found at depths of 3,000 to 14,000 feet and is drilled both vertically and horizontally. The Upper Cretaceous Niobrara formation has emerged as another potential crude oil resource play in various basins throughout the northern Rocky Mountain region. As with most resource plays, the Niobrara has a history of producing through conventional technology with some of the earliest production dating back to the early 1900s. Natural fracturing has played a key role in producing the Niobrara historically due to the low porosity and low permeability of the formation. Because of this, conventional production has been very localized and limited in area extent. We believe the Niobrara can be produced on a more widespread basis using today’s horizontal multi-stage fracture stimulation technology where the Niobrara is thermally mature. 
Geology 
The Niobrara Formation oil play in northwestern Colorado is located between the Piceance Basin to the south and the Sand Wash Basin to the north. Rocks mainly consist of interbedded organic-rich shales, calcareous shales and marlstones. It is the fractured marlstone intervals locally known as the Buck Peak, Tow Creek and Wolf Mountain benches that account for the majority of the areas production. These fractured carbonate reservoirs are associated with anticlinal, synclinal and monoclinal folds, and fault zones. This proven oil accumulation is considered to be continuous in nature and lightly explored. Source rocks are predominantly oil prone and thermally mature with respect oil generation. The producing intervals are geologically equivalent to the Niobrara reservoirs of the DJ and Powder River Basins which are currently emerging as a major crude resource play. 
Production Status 
In the fourth quarter of 2011, our net production from our Niobrara acreage was 3,390 BOE, or an average of 37 BOE per day, 100% of which was from oil. From January 1, 2012 through January 31, 2012, our average daily net production from our Niobrara acreage was 41 BOE, 100% of which was from oil. 
Facilities 
There are typical land oil and gas processing facilities in the Niobrara Formation. Our facilities located at well locations include storage tank batteries, oil/gas/water separation equipment and pumping units. 
Recent and Future Activity 
We drilled three gross (1.5 net) wells at Niobrara during 2011. We have completed a 60 square mile 3-D seismic survey over our Craig Dome prospect, have received a processed version of the seismic and are selecting future drilling locations. We currently intend to drill five to seven gross wells at Niobrara during 2012.
Production - net - was 37 barrels of oil per day during the fourth quarter of 2011. In January they raised this to 41 barrels of oil per day.

The most recent 10Q filing contains this text.
Niobrara Formation. Effective as of April 1, 2010, we acquired leasehold interests in the Niobrara formation in Colorado and held leases for approximately 14,993 acres as of March 31, 2012. Aggregate net production from the Niobrara play during the three months ended March 31, 2012 was approximately 2,638 BOE, or 29 BOE per day. During April 2012, average daily net production in Niobrara was approximately 66 BOE due to completion of our 2011 drilling activity.
So for the first quarter the production fell to average only 29 BOE per day after averaging 41 BOE per day in January.

41 BOE per day in January implies production of 1271 barrels (approx) in January (being 41 BOE per day times 31 days).

We are told that production in the quarter was 2638 barrels. Simple arithmetic implies that production in February and March was 1367 BOE. Assuming 60 days in those months (29 in February, 31 in March) we get production of 22.8 barrels per day. A fairly sharp drop from 41 BOE per day in January. This may be a decline rate or it may be weather or other shut-in (we do not know). However shut-ins are more likely in January so decline is a reasonable guess.

After completing drilling activity for 2011 the production rose to 66 BOE per day.

These are not big numbers and production drops seem large. Indeed flow rates almost halved within the first quarter.

However the company states that 500 thousand barrels of oil in reserves are proven in this field.

It is a cliché that you only know what the reserves of an oil field were when the last barrel is produced. There are many fields that have surprised to the downside and some that have surprised to the upside.

I will leave it to my readers to judge - whether on the basis of the relatively small production and high decline rates demonstrated - they regard the 500 thousand barrels of proved reserves listed here as a solid number.





John

Gulfport Energy and Wexford Capital: Part 3

Gulfport Energy - as I have shown in Part 1 and Part 2 - is intertwined with Connecticut based hedge fund group Wexford Capital. All their substantial assets are either jointly owned or operated or both by Wexford entities. The Chairman of the board of Gulfport is - at least in part - a Wexford man.

However Wexford have over the past few years dramatically reduced their holding in Gulfport. In the 30 April 2009 proxy Charles E Davidson (the principal of Wexford) spoke for 15,235,786 shares or just over 35 percent of the company.

After years of sustained selling by Wexford and sustained issuance by Gulfport, Wexford's ownership position is about two thirds lower.

Despite Wexford's reduced holding Gulfport remains tied to Wexford.

Wexford and Gulfport are still doing related party transactions. On 7 May (ie this month) they announced a transaction whereby they are selling their Permian assets in exchange for a stake in a soon-to-be-listed entity called Diamond Back.

There was no specific press release for this transaction - but it was announced via a long 8K. On May 8 they announced their quarterly results which briefly described this transaction. To quote the earnings release:


As previously announced, on May 7, 2012, Gulfport entered into a contribution agreement with Diamondback Energy, Inc. ("Diamondback Energy"), in which Gulfport agreed to contribute, prior to the closing of Diamondback Energy's initial public offering, all of Gulfport's oil and natural gas interests in the Permian Basin in exchange for (i) common stock representing 35% of Diamondback Energy's outstanding common stock immediately prior to the closing of its initial public offering and (ii) approximately $63.6 million to be paid to Gulfport upon closing of such offering, subject to adjustment. Gulfport's obligation to complete the proposed contribution is subject to various closing conditions, including Gulfport's satisfaction with the terms of the Diamondback offering.

The earnings release however does not include the observation that this is a related party transaction. You had to go to the 8K for that. Here is what the 8K says:

On May 7, 2012, Gulfport Energy Corporation (“Gulfport”) entered into a Contribution Agreement (the “Contribution Agreement”) with Diamondback Energy, Inc. (“Diamondback”). Diamondback was incorporated on December 30, 2011 for purposes of undertaking an initial public offering (“Diamondback IPO”) of its common stock, par value $0.01 per share (the “Common Stock”), pursuant to a Registration Statement on Form S-1 (Registration No. 333-179502) initially filed with the Securities and Exchange Commission on February 13, 2012. Diamondback has not conducted and will not conduct any material operations prior to the transactions described below. Prior to the completion of the Diamondback IPO, Diamondback will acquire all the outstanding equity interests in Windsor Permian LLC (“Windsor Permian”), which as of March 31, 2012, owned and operated approximately 30,025 net acres of oil and gas interests in the Permian Basin in West Texas. 
Under the terms of the Contribution Agreement, Gulfport agreed to contribute to Diamondback, prior to the closing of the Diamondback IPO, all of its oil and gas interests in the Permian Basin in exchange for (i) shares of Common Stock representing 35% of Diamondback’s outstanding Common Stock immediately prior to the closing of the Diamondback IPO and (ii) $63,590,050.00 in the form of a non-interest bearing promissory note, which will be repaid in full upon the closing of the Diamondback IPO with a portion of the net proceeds from that offering. The aggregate consideration payable to Gulfport is subject to a post-closing cash adjustment based on changes in Windsor Permian’s working capital, long-term debt and other items referred to in the Contribution Agreement as of the date of the contribution. Windsor Permian is the operator of the acreage to be contributed by Gulfport. Gulfport’s obligation to make this contribution is contingent upon, among other things, the contribution to Diamondback of all the outstanding equity interests in Windsor Permian by DB Energy Holdings LLC (“DB Holdings”), Gulfport’s satisfaction with the terms of the Diamondback IPO and customary closing conditions. Under the contribution agreement, Gulfport is generally responsible for all liabilities and obligations with respect to the contributed properties arising prior to the contribution and Diamondback is responsible for such liabilities and obligations arising after the contribution. 
In connection with the contribution, Gulfport and Diamondback will enter into an Investor Rights Agreement in which Gulfport will have the right, for so long as Gulfport beneficially owns more than 10% of Diamondback’s outstanding Common Stock, to designate one individual as a nominee to serve on Diamondback’s board of directors. Such nominee, if elected to Diamondback’s board, will also serve on each committee of the board so long as he or she satisfies the independence and other requirements for service on the applicable committee of the board. So long as Gulfport has the right to designate a nominee to Diamondback’s board and there is no Gulfport nominee actually serving as a Diamondback director, Gulfport shall have the right to appoint one individual as an advisor to the board who shall be entitled to attend board and committee meetings. Gulfport will also be entitled to certain information rights and Diamondback will grant Gulfport certain demand and “piggyback” registration rights obligating Diamondback to register with the SEC any shares of Common Stock owned by Gulfport. 
The preceding descriptions of the Contribution Agreement and the Investor Rights Agreement are qualified in their entirety by reference to the full text of such agreements, copies of which are attached as Exhibits 10.1 and 10.2, respectively, to this Current Report on Form 8-K and are incorporated herein by reference. 
Diamondback, Windsor Permian and DB Holdings are entities controlled by Wexford Capital LP (“Wexford”). Charles E. Davidson, the Chairman and Chief Investment Officer of Wexford, beneficially owned approximately 9.5% of Gulfport’s outstanding common stock as of March 13, 2012. Mike Liddell, Gulfport’s Chairman of the Board and a director of Gulfport, currently serves as the operating member and chairman of Windsor Permian and has an interest in DB Holdings. A special committee of the Board of Directors consisting solely of independent directors negotiated and approved this transaction on behalf of Gulfport.


The related party nature of this transaction requires (and is being granted) a committee of the independent directors.


How important are the Permian assets?

The last annual report (10K) contained a table with Gulfport's proved reserves by field:


  
              Proved Reserves
Field
  NRI/WI (1)  Productive
Wells (2)
  Non-Productive
Wells
  Developed
Acreage (3)
  Gas  Oil  Total
  Percentages  Gross  Net  Gross  Net  Gross  Net  MBOE  MBOE  MBOE
West Cote Blanche Bay Field (4)
  80.108/100    95    95    189    189    5,668    5,668    352    3,617    3,969  
E. Hackberry Field (5)
  79.424/100    30    30    93    93    3,291    3,291    226    1,606    1,832  
W. Hackberry Field
  87.5/100    2    2    23    23    592    592    —      76    76  
Permian Basin
  35.4/46.87    121    57    —      —      8,880    4,119    2,008    10,877    12,885  
Niobrara Formation
  39.7/47.9    6    3    2    1    3,954    1,977    26    500    526  
Williston Basin (6)
  2.8/3.3    6    .2    —      —      1,708    132    7    67    74  
Overrides/Royalty Non-operated
  Various    133    .2    —      —      —      —      3  2    5  
    


  


  


  


  


  


  


  


  


Total
    393    187.4    307    306    24,093    15,779    2,622    16,745    19,367  
    


  


  


  


  


  


  


  


  



12.9 million of the 19.4 million barrels of oil equivalent in the proved reserves is in the Permian Basin. On this table Gulfport has sold the bulk of its proved reserves to a related party.

In their defence - after the transaction they own 35 percent of the related party which is lower but not massively lower than their prior ownership of the field. All that has happened is that they have lost control of the assets which they directly owned and are now owned by a Wexford entity. In this I presume the Wexford interests in those assets were also contributed and on similar terms. [I do not know - I am just giving Wexford the benefit of my doubt...]

Whatever: losing control means that they also lose control of the cash flows from these assets. Moreover as they own less than 80 percent of the assets if they get these cash flows out there will be a tax event. The 8K quoted above envisages a sell-down of the assets. This transaction does not make sense from a tax perspective unless that sell-down happens. So I presume a sell-down is expected.

As a shareholder it seems you are swapping productive assets you know for some cash which will (presumably) be used to develop other assets. Some of that cash only arrives when the IPO of Diamondback happens. There is nothing obviously wrong with that - but the related-party nature of the transaction does raise governance risks which make shareholders dependent on the non-executive directors to guard their interests.




John

Monday, May 21, 2012

Astarra Trio: report of the Parliamentary Inquiry

This post is a victory lap on Astarra-Trio. If you are not interested in fraud in the Australian superannuation industry you might skip it.

Long-time readers of the blog will know that I am responsible for reporting to authorities the largest fraud ever conducted in the Australian Superannuation system.

For non-Australians I should note this is important. Australia has a privatised compulsory social security system where individuals are compelled to invest money in funds to fund their own retirement. Choice of fund is important (because returns are dependent on choice) but the investing population is usually unsophisticated in finance and often uninterested. Large pools of unsophisticated investors are - in my experience - always a magnet for scammers.

The fraud I reported was in a fund called Absolute Alpha - but it was only part of a larger network of fraudulent funds.

Spotting it required no genius on my part: I was tipped by a blog reader.

The regulators acted very promptly (within weeks) to my tip and closed the fund. I have described their behaviour as exemplary.

Several prominent people in the funds management market denied fraud - and one publicly argued that I was motivated by (a) greed* and (b) publicity for my fund.

Later one of the main perpetrators admitted guilt and is serving what I thought was as surprisingly short prison sentence.

Eventually there was a Parliamentary inquiry by the Joint Committee** on Corporations and Financial Services. The inquiry reported last week.

It is amusing to find this blog post written into the Hansard (permanent record) or the Australian Parliament. The inquiry was quite nice to me. They essentially accept all my propositions about how the fraud worked and described me as "persistent". I can't complain at any of the comments about me or this blog.

After reading the report (from Parliamentarians who had more resources and more time than me) I  conclude I knew most - but not all - of what was going on. I don't find anything in the recommendations I strongly disagree with - but I can't see why the clients of ARP Growth should be treated any differently to the clients of (say) Tarrants - both were in self-managed super funds established in cookie-cutter fashion by their financial planners.

And I thank the Joint Committee for their observation that whilst the response to my letter was exemplary the persistence with which the regulators followed leads after an admission of guilt leaves a bit to be desired. In particular I have been surprised and disappointed that so little has been done to examine the ARP Growth Fund. The Committee expressed the same surprise.

Astarra-Trio may be a one-off. But somehow I doubt it. There is over a trillion dollars invested in superannuation schemes and almost all of the end-clients are way less sophisticated than the readers of this blog. I hope the Parliamentary Inquiry leads to a closer regulatory focus on ways of preventing theft in Superannuation. A honey-pot like the Aussie Super Pool is too attractive to fraudsters to leave so lightly guarded.



John

*I responded that it was hardly an insult to claim a hedge fund manager is motivated by greed. My clients expect nothing less. Controlled greed is what my clients pay me for.

**Joint Committee simply means that members come from both the Senate and the Lower House.

Saturday, May 19, 2012

That is not a bubble. This is a bubble...

I have just returned from visiting relatives in Vancouver. I mostly stayed in West Vancouver with my retired aunt and uncle but also stayed in outer-suburban areas with my police-officer cousin.

I was looking for a bubble - after all Vancouver is a notorious property bubble - but - speaking as someone from Sydney I could not see one. Everything was so cheap. Houses especially. Cars too.

A Mountie and his drug-rep wife had a material standard of living that would match a partner in a second tier law firm in Sydney. House prices seemed impossibly low.

The only place where my material standard of living was markedly higher than the outer Vancouver middle class was that I have a decent surf beach locally and the local restaurants and coffee shops are much better in Sydney. Also alcohol is cheaper in Sydney - which is in part taxes and in part protection. (Alcohol is much cheaper in parts of the USA.)

To offset the beaches and restaurants, my cousins had a ski resort up the hill. And food (other than dairy) was cheaper. Quality was high. Dairy seemed to be another industry-protection issue.

And housing was much cheaper and much higher quality.

I remember thinking that Sydney was in a bubble when it got as expensive as Vancouver now is. But then housing prices doubled. After that they seemed to drift upwards.

I have given up predicting the end of the Sydney property bubble. It will happen. It feels like it might happen now. But it has felt like that before. And before that. And before that.

I would rather be short Sydney property than long it (though my wife might object). And that stance has cost me money in the past.

There is a scene in Crocodile Dundee where a New Yorker pulls a switch blade on Dundee. He pulls out an Australian bush knife which is far more impressive.




That is how I felt about Vancouver. You call this a bubble? I am an Australian. I can show you a bubble. Vancouver - that is just kids having fun.



John

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