Miller Energy is an independent exploration and production company that is mostly involved in breathing new life into old oil and gas assets. It has many of the characteristics of an ideal short:
- The company has been very unprofitable over the past several years. In most years the company was GAAP unprofitable.
- The company likely will not make money in the future.
- The company has debt (some at 18%) so the short thesis will play out faster.
- Insiders are overpaid.
- The company trades at a large premium to the market value of its assets.
Unfortunately, I am not the only person in the world that thinks this stock is a great short. Roughly 29.2% of the float is sold short and the interest on the borrow is roughly 5%.
What they do
Oil and gas wells are depleting assets. As the well ages, it will flow less and less oil/gas and eventually become uneconomic. However, it is possible to ‘work over’ the well and apply various techniques to improve the flow of hydrocarbons and therefore the well’s economics. Hopefully there is a healthy return on the money used to improve the well.
I believe that the vast majority of the company’s assets are oil/gas wells that are close to depletion. Many of them are shut-in/non-producing. I believe that these wells are pretty well understood and that the previous owner has tried hard to make as much as possible from the wells. The former owners has probably tried to work over the old well I believe that it is unlikely that the wells will suddenly start producing huge amounts of cash, unless there is some major technological advance in oil/gas recovery or a massive increase in commodity prices. (However, keep in mind that I am not an oil/gas expert. I could be wrong.)
Obviously, the company paints a different picture. It bought its flagship oil and gas properties for roughly $4.5M in cash plus a few million dollars worth of warrants. From the 8-K:
The owners of membership interests in CIE were David M. Hall, Walter J. Wilcox, II and Troy Stafford (collectively the “Sellers”). As consideration for this company Miller issued the Sellers, who were unrelated third parties, stock warrants to purchase three million five hundred thousand (3,500,000) shares of Miller’s common stock. The warrants were priced and vested as follows: Tranche 1 – 1,000,000 warrants with an exercise price of one cent ($0.01) immediately vested as of the date of closing; Tranche 2 – 1,500,000 warrants with an exercise price of one dollar ($1.00) vesting one year after closing; Tranche 3 – 1,000,000 warrants with an exercise price of two dollars ($2.00) vesting two years after closing.
At closing, Miller paid Pacific Energy a purchase price of $2.25 million and provided $2.22 million for bonds, contract cure payments and other federal and State of Alaska requirements to operate the facilities.
The closing price of the stock at the time was around $0.69 to $1.20. I would guess that the warrants are worth somewhere between one to two million. I will make the assumption that the company paid $6.5M for the assets.
The same 8-K also states the net present value of these assets:
The discounted net present value of the Alaska reserves that Miller acquired is over $327 million dollars, including $119 million dollars of proven reserves, $185 million of probable reserves and $23 million of possible reserves, as stated in its most recent reserve report as of January 1, 2009.
Did Miller get the deal of the century? Did they pay $6.5M for $327M? I don’t think so. This is simply inflated reserve reporting at work. Yes, there are reserve engineers out there willing to sell out their professional integrity.
When the company bought the assets, they booked a massive one-time gain. From the 2010 10-K:
During fiscal 2010, we recorded a gain on acquisitions of $461,111,924. This was primarily due from the Alaskan acquisition as previously discussed. As a result of this non-cash gain, for fiscal 2010 we recorded net income of $249,453,180, an increase of $241,096,807 over fiscal 2009.
The company’s book value went from $7.2M in fiscal 2009 to $275M in fiscal 2010. I disagree with recording a gain on acquisition.
If you look at the company’s operating income (which excludes such one-time gains), the company has had operating losses every year since 2005 (see Gurufocus’ 10-Y financial summary). The company’s operating margin in 2013 was an incredible -93%. The company isn’t anywhere close to being profitable.
Debt and cost of capital
The company’s most expensive debt is its credit facility with Apollo Investment Corporation. It is currently borrowing $55M at 18%/year. On top of that interest, the company paid a variety of fees (see the 2013 10-K):
On the Closing Date, we paid Apollo a non-refundable structuring fee of $2,750, payable to the account of the lenders, and we have agreed to pay an additional 5% fee to Apollo for the benefit of the lenders on the amount of every additional borrowing over and above the $55,000 amount of the borrowing base at the date of closing. In addition, we paid Apollo a supplemental fee of $500 on the Closing Date, and have agreed to pay another $500 fee on each anniversary of the Closing Date so long as the Loan Agreement remains in effect.
The $3.25M upfront ($2.75M + $0.5M) is roughly 5.9% upfront on the $55M borrowed. The $500 fee on each anniversary amounts to another 0.9% to the interest rate.
The Closing Date was June 29, 2012. The company was almost immediately in trouble of breaching one of the loan covenants:
As previously reported by the Company, the financial and production covenants in the Apollo Credit Facility were amended in the September Amendment, to delay the date on which compliance with those covenants would be measured from October 31, 2012 to January 31, 2013, and to adjust the covenant levels to be met on that date.
The company more or less breached one of its covenants just one quarter after the loan closed (!). This is not a good sign for the company.
Miller is definitely distressed and it is extremely unlikely that it will meet its >19% cost of capital. Heck, the company would have a hard time meeting a 1% cost of capital.
Key executive compensation (see Morningstar) is as follows:
To be fair, most of this compensation is in the form of options. The true cost of these options may be overstated as Miller is using a volatility assumption that is higher than what it should be. Regardless, it doesn’t make too much sense for insider compensation to have skyrocketed over the past several years.
This company is trash.
But be careful shorting it because the short interest is extremely high. I’m only comfortable taking very, very small positions when shorting common stock.
*Disclosure: I shorted the common stock at $5.22.
VIC writeup (long?!?!) – I have no idea.
The Street Sweeper’s analysis of MILL – I take The Street Sweeper with a grain of salt because its articles tend to be extremely one-sided and negative. There is plenty of character assassination that is pretty irrelevant or off the mark. However, they do make some good points (which I have re-hashed in this blog post).