EGD Writeup

[Bart]

Fan, maybe I'll have to start agreeing with you on this dilution issue with energold:

 

http://www.marketwire.com/press-release/energold-announces-20-million-bought-deal-financing-tsx-venture-egd-1628119.htm

 

Unbelievable - even though the money will go to rigs that should normally be very accretive, they literally give away about 10% of the company at a price that is probably about 5-7 x PE - there must be better/cheaper ways to raise money...

[finetrader]

What I've noticed on Energold is the constant increase in working capital.

So one can argue that FCF is not as high as it seems to be.

 

 

[shoeless]

Some interesting comments about the industry in this article.

 

Boart sees more growth in global exploration

http://www.reuters.com/article/2012/03/05/canada-mining-pdac-boart-idUSL2E8E506O20120305

 

 

[AAOI]

The bought deal is disappointing. Both because I hoped if a raise was done it would be done with debt and because Fred specifically told me (~2 months back) that an additional equity raise wasn't contemplated and wasn't necessary.

 

Baoxiaodao is right in the sense that this business has large w/c needs in order to grow. That said, issuing equity at a ~20% FCF yield to fund low cost, quick payback rigs with 50%+ ROIC is expensive but still amply accretive. I think that is the more important point.

 

Per the original write-up...

 

Assuming that each new rig consists of $350,000 investment in capital assets and $250,000 in working capital, we estimate that Energold’s investment in new rigs has a strong chance at generating +50% after-tax returns.

 

Cost of a New Rig $600,000

Meters Drilled 6,500

Revenue Per Meter (Frontier Pricing) $215

Annual Revenue $1,397,500

Gross Margin 40%

Gross Profit $559,000

Incremental SG&A 5%

SG&A Load $69,875

Operating Income $489,125

Taxes $161,411

After-Tax Incremental Cash Flow $327,714

After-Tax ROIC 54.6%

[link01]

The bought deal is disappointing. Both because I hoped if a raise was done it would be done with debt and because Fred specifically told me (~2 months back) that an additional equity raise wasn't contemplated and wasn't necessary.

 

 

i dont mind this bought deal at all, not at 2x book. if its accretive, as you excellently show in the table below, then its not dilutive. not in the most meaningful sense of that word, anyway.

 

i prefer a ceo thats financially conservative, eschews debt where prudent, & is willing to trade a little juice (debt issuance) for long term assurred viability. EGD operates in a very volatile industry, after all. and the whole world currently teeters on the knife edge between conflicting deflationary & inflationary forces.

 

i do think the ceo should follow a policy of keeping discreetly mum re any analyst & shareholder questions regarding shorter term financing or other tactical plans, tho

[AAOI]

Link01,

 

All great points, and I generally agree although I think EGD's "optimized" capital structure (all things considered) could support a small/prudent amount of debt. Don't get me wrong here, I love Energold's unlevered balance sheet for all the obvious reasons, but I do think the stability of its cash flows over a full cycle could easily support a prudent level of debt at this point.

 

[bathtime]

Harris Kupperman's latest comments on EGD (http://adventuresincapitalism.com/askkuppy.aspx) on3/12/12:

 

Kuppy,

I believe you have stated that EGD is a fairly large position for you. How do you determine your end game for it? Do you have a specific price target? Do you just ride it as long as you think it has legs? Or until its stock price more accurately represents a fair valuation? Thanks for the great column.

 

I intend to own it until the business has stopped growing. That would only happen if either mining companies replaced all their depleted reserves, or substantial competition shows up. Of course, as a very large position, I have internal position limits and from time to time, I sell a few shares as you have to stay disciplined about position limits.

 

Kuppy- I was reviewing some Energold info and came across their updated presentation that cites having 234 rigs (as of 1/16/12). I believe this certainly includes those that they acquired with Bertram & Dando, but it still seems higher than I expected. I'm just curious if based on the latest you've seen how their trajectory falls within your expectations.

 

In all honesty, I don't really have any expectations for rig count. I track it looking backwards for ease of reference, but I've always found models to give you a false sense of confidence on things. If it doesn't make sense at first glance, and if it doesn't seem cheap on the back of a napkin, I'm just not interested. Once you start building models, you start to justify ideas that just might not be that good. Sorry I cannot help on this one.

 

Kuppy,

 

I see Fred at EGD is addicted to these bought deals.  Love that he throws in an extra 6% cash commission and 6% warrants too.  Must be a struggling enterprise with an overleveraged balance sheet desperate for cash!  Seems Fred would make a great VP of operations.  EGD needs a real CFO, from the outside.  When they promoted from within I knew nothing would change in this respect.

 

Still, they did the deal because business is booming so it’s just a short-term set back.  But you would think that knowing they are on the verge of announcing a strong Q4 they would do the financing after the announcement which would likely get them a better price.

 

Each time they announce one of these deals the stock tanks.  You would think that would get their attention.  Do you think Fred isolates himself from the financial community?  I mean, doesn’t he feel any pressure to improve his financings?

Let's face it, these guys are just awful at the capital markets. For a bunch of guy from Vancouver.....

 

Unfortunately, when you're in a growing business, you need to work with the markets. Not against them!!! The whole point is that you want your shares to be fairly valued so that you do not dilute your shareholders every time you do something. Energold is horribly undervalued--but maybe this is because they keep dumping bought deals on investors and have lost the confidence of the investment community.

 

I think you are right. Fred is a great COO. They need some professional help on the capital markets side.

 

I have no issues with companies issuing shares to raise capital and grow the business. In fact, I would expect Energold to continue raising money in the future. Thus far, all their acquisitions have been brilliant. I just spent two days with Brian Bertram up in Fort McMurray. His company is really well run and in massive demand. My complaint is that the shares trade at a mid-single digit multiple on earnings and they need to do more to fix this valuation gap before just blindly spraying the street with shares. I don't object to financings. I just simply abhor the concept of bought deals. They're about as shareholder friendly as a death spirl convert. ...

 

Hi Harris, what is your opinion on EGD's recent $20MM bought deal financing? I am a little confused why management chooses to raise capital at this moment. It seems that under current pricing and capacity utilization, EGD will have more than enough cash to build a lot of rigs, unless management wants to do acquisitions.

 

I'm guessing that they're either looking at acquisitions or buying some much larger (more expensive) rigs for Bertram. In either case, I'm sure the money will be used well. I have no problem with raising capital. I just hate bought deals. I think if they had waited until Q4 was out, they could have gotten much better prices on this financing.

[premfan]

My take on EGD:

 

- The catalyst that I see is in 1.5 years the Bertram earnings will go straight to the bottom line. 

- The market consensus is one of distrust because of the bought deal and the lack of financing from the juniors causing lack of demand for drilling. This is not top of the cycle behavior.

- The company is insanely cheap based on the earnings power in 2015. The market cap is 90 percent of 2012 revenue. This is a high margin business and its still growing ( even though it has been a horrendous year for drilling demand).

-  Assuming crappy growth like 10 revenue growth which is horrible for energold. I see a base of 0.50 cents a share. This is a very conservative estimate.  Its currently trading at 5x 2015 earnings.

 

Negatives

- The acquisitions have been great but, the dilution is a concern

- Will management learn from their previous errors with the capital markets

 

Increased my position by 200 percent recently.  What is everyone else's take on EGD lately?

 

 

[Liberty]

One of my favorite companies, I own a lot of it and plan to hold it for many years at minimum.

 

Recent interviews with the CEO Fred Davidson about both EGD and IPT:

 

http://classicvalueinvestors.com/i/2013/01/interview-with-fred-davidson-from-energold-drilling-and-impact-silver/