Jeremy Raper on his Serica engagement campaign (SQZ) (podcast #148)

Jeremy Raper returns to the podcast to discuss his latest "engagement campaign" at London listed Serica Energy (SQZ). In particular, he focuses on why Serica is trying to rush through their most recent deal and why shareholders should consider voting against the share issuance at the meeting next week.

---

This podcast is brought to you by Daloopa.

Daloopa was founded by a former hedge fund analyst. He didn’t have a tool that he trusted to be 99.9% accurate, allowed him to pull updates directly into his existing models, and had the granularity in KPIs, Guidance, and non-GAAP adjustments that he needed. So, he built Daloopa. Daloopa is the fastest growing source for public company data, with data available for over 3,000 companies. Hundreds of AI algorithms collect and organize customized company historicals with an accuracy level and depth of data that is higher than anything achievable by other modeling tools. Each datapoint is auditable to the source. Daloopa’s Excel plugin is the first to allow you to update your models in your existing format. It’s simple and non-invasive—Daloopa will never #REF out your models. Daloopa clients are able to cover more opportunities and generate more ideas. No more data errors, no more Excel monkeying, just the fundamentals. See why equity investors are switching to Daloopa by checking them out at Daloopa.com/YAVP.

---

Please follow the podcast on Spotify, iTunes, or most other podcast players, as well as on YouTube if you prefer video! And please be sure to rate / review the podcast if you enjoy it, or share it with someone else who would enjoy it (more listeners is a critical part of the flywheel that keeps this Substack and podcast going!).

Disclaimer: Nothing on this podcast or on this blog is investing or financial advice; please see our full disclaimer here. The transcript below is from a third party transcription service; it’s entirely possible there are some errors in the transcript

Transcript begins below

Andrew Alright! Hello and welcome to Yet Another Value Podcast. I'm your host Andrew Walker. If you like this podcast, it'll mean a lot if you could rate, subscribe, review it wherever you're listening or watching it to it.

With me today, I'm happy to have one of the most popular guests of the Yet Another Value Podcast. My first guest, the people's, maybe, the people's favorite guest based on the response on Twitter the one I said you're coming on. My friend Jeremy Raper. Jeremy, how's it going?

Jeremy Raper: It's going great Andrew, nice to see you again. The People's Champ. That's what I go by these days. That's what his champion.

Andrew That's what I was thinking in my head when I see all the response and [inaudible] came through. Let's start this podcast, just with a quick disclaimer. Remind everyone nothing on this podcast is investing advice. We're going to talk about, Jeremy's busted out the poison pen again and he's going activist on a company.

It's a small-cap, London-listed company, energy-focused going through what I think, what Jeremy thinks is a pretty bad merger. We're trying to stop that but there's obviously lots of risk. Everyone should consult a financial advisor, do their own work. This isn't investing advice, and I'll add on top of that.

I think we're going to start by talking about that and then at the end, we're going to go and maybe bounce through just other situations we've been looking at but, let's start with Jeremy.

You busted out the poison pen, Serica Energy. The ticker is SQZ, trades in London. They've got to vote next week trying to rush until through pretty quickly. I'm going to toss it over to you, what's going on there?

Jeremy: I said in the preamble, I'd try to maintain a dispassionate position because this really got me fired up. Actually, a lot of people who read the letter thought I was a little too aggressive but in response to that, I kind of said look, it accurately reflects the outrage that I feel of this transaction.

I mean, we've talked in the past about UK corporate governance and the propensity for bad transactions to get pushed through. This is definitely up there if not the worst, one of the worst transactions rush jobs, that I've seen in recent times.

Basically, Serica Energy today is an oil, you're asking me, gassy very gassy 85% production is gas that ENP, entirely North Sea focused. They supply about 5% of the UK's natural gas and its very cash-rich.

So, it's got 65%, 63% of its market cap in cash today. So, if you look at the stock, it's 272 pence. It's got about 160, 165 pence per share in net cash.

They're exchanging the vast bulk of that net cash to buy another ENP, also in the North Sea, called Tailwind Energy. In addition to taking on Tailwind's debt, so, they're going from a £460 million, net cash position to a £124 million net cash position.

So, they are taking on effectively £337 million of net debt. In addition, they're giving 29% of the pro forma capital, the company, to the selling company, that is to Tailwind shareholders - Mercurio a Swiss trading house.

So, they're buying another operating asset. They're changing the balance sheet completely. They're changing the capital structure completely and they're creating a defect, as we'll discuss, a de facto controlling shareholder on the register because pro forma Mercurio will earn 25% of the company.

Now, in isolation, those kinds of transactions would require examination. But what's the real kicker is, they're doing it on wildly disadvantageous financial terms. So, exchanging their own equity, which is trading at about $6 a barrel on an EV/2P basis, meaning the enterprise value of the proven reserves. So, when we look at oil and gas, we don't really look at current annualized earnings, whatever. We basically look at the value of what's proven to be under the ocean. So, the value of the oil that's proven to be there extracted over time.

So, on a dollars per barrel basis of what they've proven exists, which is two-peas pretty conservative to generally over time, you spend money, you can find more resources and convert to sea. So, contingent resources to proven or probable resource. But anyway, on a 2P basis, their own equity is currently trading around $6 a barrel.

The implied multiple they're paying on the Tailwind assets is $20 a barrel. So, they won my main contention is, your just incinerating value because you're paying for something three and a half times where your own iniquity trades, and you're paying for it in stock.

Fifty-two percent of the total consideration for the deal is in stock, meaning even if you believe the management's arguments that this deal was strategic and accretive, we'll come to that. But even if you gave them credit for all those strategic arguments, that doesn't matter because the vast majority of that supposed accretion will go to the new shareholders, not the existing shareholders.

And so, look, there's tons of problems with the transaction but at a very high level, you have another example of kind of corporate Britain gone mad. You have a board of directors where, X the chairman, to be fair the chairman does have a substantial stake in the company but X the chairman, none of the other executives of the company. And that includes the operating executive, the chief executive, own meaningful shares in the company.

Mr. Flagg owns 180,000 shares. He does have some options. He has 185,000 shares. It's a tiny piece of the company and it's largely irrelevant related to his ongoing tenure at the company.

You have a history where another strategic bidder actually bid to acquire this company, at a huge premium. A huge premium for 25 pence per share, five months ago. That was rejected at the time with Serica saying, said deal, massive, excuse me. They didn't use the term massively. It said, I think they use some other adjectives but they said it strongly undervalues Serica's equity.

And now, in this current transaction, barely five months later Serica is underwriting selling 30% of their equity at 278 pence a share. So, my contention is, sole reason they're doing this transaction and they're rushing through at the very last minute using a couple of loopholes unique to the UK market and also to them being an AIM-listed issuer rather than a premium-listed London issue is because they simply don't want to give up control.

The management core at Serica did not want to give up their management control of the company, which would have happened if they'd merged with Kistos, the prior acquirer, that made a reasonable offer.

And now they're rushing through a transaction, which [inaudible] it for all intents and purposes, it has the same strategic merit as the Kistos deal. It increases your production; it gives you more scale. It allows you to create a platform for further acquisitions. The only difference being shareholders would have received 45% more, and Serica management would no longer be in control of the merged entity.

So, they're choosing the wildly inferior deal solely to entrench current management and allow them to maintain their tenures and operating control. Even though it's wildly, we're a [inaudible] for every other shareholder. So that's at a very high-level kind of my take on why I think it's a bad transaction. We could we can dive into some more of the details. I'm sure there's areas you'd like to focus on and maybe some of the pushback from people who are less aggressively against it then I...

Andrew No, look, I think you hit the main things. The thing that jumped out to me, when looking at this situation and I mainly heard about it from you, but there have been some really bad deals in the UK in the past couple of months. And there there's like almost an email threat at this point. People just emailing around like, "hey another awful deal in the UK energy space" like does anybody have bandwidth to go look at this one?

But, the two things that jumped out to me just of, how bad a deal this is, as you said, you had an offer £450 pence, 45 percent, 50 percent above the, what their prices right now. Just six months ago, same strategic rationale, you rejected it as undervalued and now you're doing this deal, diluting yourself for this deal. It's just, it's crazy to me. And it shows, I mean, not I'm not even putting your words in your mouth, but it shows to me, management entrenchment, they wanted to be in control, they don't have a shareholder mindset, all they care about is getting bigger, staying in control, so they keep building these.

And then, the second thing that jumps out to me and again, you highlight it. But I've never, I've literally felt like I heard about this deal two days ago. They announced, it basically Christmas, they announced it December 20th. Somehow, they get a circular published early January, and somehow, they've got the vote. We're talking, what, it's January 18th today. We're talking January 18th somehow; they have the vote next month. I've never seen $100 millions of dollar deal done within a month like this, with a shareholder vote. It's absolute insanity. And I think it speaks to how hard they're just trying to jab this thing through.

Jeremy: Absolutely. Okay. So, a couple of points of detail on those points you just mentioned, it's very important. Serica, you mentioned in the intro, this is a small cap. It's actually not that small. It's a £750 million pound market cap. So, it's, call it what, $11.1 billion dollar market cap with a huge amount of excess cash. As I said, 60-plus percent of the companies in cash.

The business they're buying, Tailwind, the pro forma, excuse me, acquisition enterprise value they're paying is £703 million. So, it's, a market cap, £770 million, £700 million acquisition. It's a transformational deal. Like, there's no debate about, it's a large transaction.

However, given the structure of the deal is, they're funding it partially with cash, mostly with the share exchange. What they're seeking approval for shareholders is not a vote on a merger. There are simply seeking approval for an extra share issuance. So, when you issue over 25% of the equity of the pro forma share capital, you need shareholder approval but it's an ordinary resolution. Meaning 50 plus percent of the votes cast at an extraordinary general meeting.

You don't need, it's not a scheme of arrangement where you need two-thirds or 75% of approval. Though if Serica was being acquired, always acquiring another company. Well, actually, Serica was being acquired, you'd need a much higher voting threshold. Whereas now, they've decided on this deal which is essentially a merger transaction and obviously a transformational transaction, but because it's only needing, they've structured in such a way they're only issuing a certain amount of shares, it's a much lower threshold to push it through. That's point one, point two is you're right.

This was announced just basically before Christmas. They put out the circular which was 23 pages long, 23 pages of which 10 pages were definitions and repetitions of documents. There is almost no historical financial information provided on the assets being acquired. This is extremely important because said assets were producing, 11-12 thousand barrels of oil equivalent per day in January, February 2022. And now, according to all company presentations, they're exiting December 2022 at 24-25 thousand barrels a day.

So, that's not to say Tailwind energy assets are bad, that's not what I'm saying. I'm saying, they've been highly volatile in terms of their production. There is very little historical, zero historical information given, there was no CPR, CPR being a Competent Persons Report. There was no CPR given with the acquisition certifying that the 2P reserves of Tailwind were actually there. This is, again, not required because they're not technically doing a merger or takeover the assets, they're just asking for approval for the share issuance, right?

If they were a premium-listed company and actually doing a merger, they would have to do like the UK version of a proxy, where they would give you, background on the discussions and also some kind of CPR or competent persons report certifying the actual geological basis of the assets.

They're not doing that. I mean, it's maximum absolute rush job. So even if you thought this acquisition had merit or you thought the idea of merging Serica with Tailwind has merit. Forget the price for a second, which you cannot do, but forget it. Even then you don't have enough evidence. You don't have enough information to make a valid judgment in such a short period of time. Well, we're going to spend 70% of our net cash on this business and fundamentally change our course going forward. Why? We don't have enough information to make that judgement at the very least, and then, when you add the context around this. So, you then ask yourself, why would they rush it through? That's where it gets interesting because the Kistos deal was mid-late July, right?

And in the UK, there's what's known as six-month cooling-off period. Meaning, if you have an intention to make a formal offer to acquire, which Kistos did, then you cannot make another formal offer for six months, that's the cooling-off period. Said, cooling-off period expires when, February 6th. Guess when the vote for this deal is, January 27th. Coincidence? Me thinks not.

So, when you add the terms of the transaction, the structure of the transaction, the timeline of the transaction. Altogether with the prior context in which this transaction has been promulgated, it all adds up to a rush job. It's a put-up job to like, avoid the elephant in the room, which is when this is the real key that I want to try and communicate.

Whenever you make a transformational deal or contemplate meeting a transformational deal, it's not enough to say, well it's accretive, well it's strategic. You have to consider, is this the best available alternative? The status quo or any other viable course of strategic action. So, I want to ask management, why was no strategic alternatives process conducted? T

his is not the US where you have a proxy that explains exactly what happened during the negotiation of a merger. I believe, very strongly, there was no full process run, because if there was, there's no way they would be selling a third of their equity at 1 times PX cash, 1.5 times PX cash, right?

And so, as I tried to lay it in a letter, either of two options merger, with Kistos at similar terms, even with a reduced consideration, because Kistos stock has come down, or just a simple recapitalisation of the balance sheet would be so far in a way better than the current deal being pushed through, being shoved down our throats as to question whether or not all of alternatives were considered and it's my contention. They had no intention to consider what's best for shareholders.

Andrew Just to jump in on some point you said, like the accretive thing, it's one of the things that used to drive me crazy. In 2014-2015, if you were a company with net cash on your balance sheet, you see tons of companies, they denounce deals and they say it's an accretive deal and be like, of course an accretive deal, you're taking cash that's earning nothing and you're buying an earnings company.

You could pay 80 times earnings for any business in the world and it's going to be accretive. The question is, the opportunity cost of it. You could buy back your own shares. You could dividend it out, you could go buy a company that for a lower multiple. Of course, it's an accretive deal.

If you're an oil and gas company, like oil and gas are declining assets. They're never going to trade for 20- or 25-times P unless you think oil is going to 400 and we should all just be buying guns and getting some bunkers and stuff. They're not. They're always going to trade for a low-price earnings multiple. So really, any deal you do is probably going to be pretty accretive to your earnings just because of that simple math, especially if you're using some cash forward and some debt, it's not about that. It’s your opportunity cost, it’s your value and like here if I just say, "hey, we're issuing shares to go by someone who's more expensive than us. We're issuing our shares for 300," when we had a deal at, we had offers at 400 to me it just screams the opportunity cost is not there.

And then, the only other thing. I mean, your logic with the July offer the cooling-off period, and everything makes so much sense. The other thing I would add is, you make an announcement Christmas day, let's call it. You've got New Year's, you hold the vote 30 days later. I mean, you've basically got 10 days to become a shareholder of record. That's really great defense against. We can talk about CNA in London; they've tried to get too bad deals through and activists have combat built up a position in are coming out pretty forcefully against some. If you've only got 10 days of trading, activists don't even have time to do the work like, open up an excel sheet. So, they seem to have really structured this well to insulate and entrench management.

Jeremy: Totally, look, you hit on a number of important points. I mean, just on the accretion point, I think this is quite key to understand because, let's kind of put it in the context of management's communications.

As you said, the first announcement of this deal was just before Christmas. Note that this is simply just a press release. A simple presentation on the Tailwind assets. There was no discussion of accretion, there was no discussion. There was a broad discussion of strategic rationale and what would come with the acquisition, the 2P reserves of the acquired business. The run reproduction of the acquired business, diversifying into oil from gas, but there was no discussion on the financial accretion, that only came much later, maybe mid-10 nights or 10th. I'd have to look up the document but January, a week ago or something.

And that was largely in response to push back from people like me or other investors who said what the hell are you in. You're spending your own equity at $6 a barrel to buy something at $20 a barrel. You're selling your own equity at one time zoning. What is wrong with you?

And then they came back with this ply. They put out another press release, an RNS, a regulated news in which they went through describing the "accretion" on a per share basis to your point. If you swap a bunch of cash for an earning asset, if you take on cash for debt, which is essentially what they've done here. Anything is accretive, literary anything you could pay 100 times earnings, it would be accretive versus the status quo, always zero.

But the very fact that they chose to portray the acquisition in those terms, meaning, according 0 value for the extent cash in their view of fair market value or intrinsic value, shows that they're trying to pull the wool over the shareholders' eyes. I mean that is the evidence enough, right? You would not portray if the acquisition was truly accretive to the enterprise giving value to the cash but also on the run rate earnings power of the pro forma, you would not portray that way.

You would have two separate columns, cash per share plus earnings per share pre-acquisition then post-acquisition cash per share plus earnings per share, still accretive, that's not what they did. They simply sent they simply set EPS with, without plus 10% plus 15%.

And so, look, I think the financials are powerful enough that we can speak to them a little bit. If you take management's own numbers, which I think are wrong, but if you just accept management's numbers at face value, they say that standalone Serica next year you would earn £85 pence per share, midpoint.

This is just the operating business, just what they have. Forget the current cash on hand, which as I said is £160-165 pence per share. £85 pence per share and it's going to add about £10-12 pence per share in "accretion." But, the difference in cash per share through the transaction is about £90-95 pence.

In other words, you're going from a net cash position of £160-165 to about £65-70. So, you're swapping £90-95 pence per share for £10-12 pence per share in earnings. You're paying 9 times multiple, but the actual reserves of the business you're buying are only like five years, five-and-a-half years on a 2P basis. Now, there may be upside there, but there could be downside as well. I mean, that's the thing, there's execution risk. So, you're paying 9 times multiple of run rate earnings for something where you only have five and a half, six years of banked, it's just immediately as value destructive.

Andrew And look, just to throw in something, I can't be an expert on Tailwind because they haven't provided a lot of information on them. But look, oil and gas assets, do not trade for 8-9 times price to earnings, especially like, first of all, this would be really simple. They could come out and then say, "Hey, here's our value." Like most people value oil and gas companies PV10 in some way, shape or form. So could just say, “Right now, our valuation is here's our net cash per share, here's Serica's PV10. We're going to take minus 100 or 90 or whatever it is from Serica cash balance. But we're buying 110 of PV10 from Tailwind. And by the way, for this reason and this reason and this reason, there are these things that are excluded from PV10, where we think we have upside."

Like they could do that, they could simply do that. It strikes me as pretty obvious. They have not done anything close to that. It strikes me as pretty obvious what they're doing here. Let me ask one quick question on shareholders. So, Serica Energy, it strikes me like, you know this way better than I do, but one of the things when I was kind of thinking through it, they've got one major shareholder here, Hardy DR, I'm just looking at the Bloomberg. And it looks to me like he, I mean congrats to this guy, because it looks to me like he bought Serica in like the mid-2010s if I'm remembering correctly when the share price was hovering in if I'm looking at this correctly like in the £20 pence per share or something so...

Jeremy: He's crushed it.

Andrew It's a 15 burgery even after the drop and turning to, but he owns 10% of the company. He's a 50, it's a 15 bagger. My understanding from talking to other people is it's a pretty material piece of his net worth. Has he said, anything about the deal or anything because I've heard too many conspiracies about it.

Jeremy: He hasn't said anything. I've reached out in a number of ways to try to contact him directly, actually previous to this transaction, 6-9 months ago, when I was also involved in the stock. I tried to contact him. He's a private individual, who lives in the North of England, it's very interesting. He's not a, he's not a big institutional investor or anything like that. He bootstrapped himself into this into this position but he's mainlined, he's actually just a businessman, I guess, retired.

So, the Hardys, look, they've done very well on this investment. My sense is, they believe they owe current management, kind of like a debt of gratitude given how much value they've created in the past. And so, I can't speak to his intentions, or how he's going to vote. I have not been in contact with him. I've tried to, maybe he's seen my letter and I'm sure he's aware at least of some of the counter position on this deal. He's going to vote how he's going to vote, but I guess my point would be he's 10%. It's not as if he's 30-40 %.

So, after him, it's an extremely open register. There's very, very few institutions involved and it's a retail-dominated float. So, I'm not going to say this is a done deal, either way. I think it's very much a 50/50. Basically, every incremental inquiry that I've had and I've been contacted by dozens and dozens of investors of various sizes and shapes has been incrementally negative. Maybe 1 out of 10 has said, well it's actually not that bad and here's why. But that doesn't mean they're voting, yes. They may be voting, no or they may not vote, but you're right. I mean, I think it's quite interesting to see how he's going to vote or if he votes with management.

I would assume management would not have gone ahead with this deal without his support. It would be strange. So, I assume he's a vote fit for this deal, but that's not the be-all in it. If he was like a 25% shareholder, yeah, I would say it's probably hopeless, but at 10%, well, I think it's more like a 50/50 given the amount of outrage generated by these terms.

Andrew I don't disagree with anything you said. It's just like, it could go two ways. There's the old, if you're a private equity company and you have a company and you hit a home run, right? It's a 10x. You've got a management team who's 10x the value, a lot of times, especially if you've already IPOs and taking a lot off the table, you'll see the management teams get like a little bit of extra stock comp that they shouldn't get. Or maybe the private equity firm gives them a little more rope to go empire building. They get a couple extra bonus, something like that.

And as an outside shareholder, you're like they're destroying value, what's happening. But from the private equity's firm, they're like this guy already 10X my value. Like, it's all free money here. Who cares if it becomes a 10.8X instead of 11X, and we give that extra point to the management team, they did so well. It's like a tip or whatever and we want to keep them happy for the next time.

So, one school of thought here is, these guys are 15 times on their position in six years, maybe they don't care. Maybe the management team did so well for them. They just say, "Hey, we're voting with the management team, we're going to trust them to keep creating value like they've already done so well, who cares." Because to me if I own 10% of a company and 5 months ago, somebody offered me 400 per share and then I had this dilutive deal that's going to burn a lot of cash, I would be apoplectic but I could see both sides of it.

Jeremy: Look, it's certainly possible. What I would say is that perspective is unique to the Hardys. The vast majority of the holders here are retail who have been told and sold a different story than what was promised, than what was delivered to the Hardy's in the sense that, when they rejected the Kistos deal. This is kind of informal. This has never been publicly stated by management, but I've spoken with many shareholders who said they were softly told that they should expect a very large special dividend out of that cash balance like a pound a share or something. So, the vast majority that cash would be coming back in return for rejecting that Kistos deal.

Andrew It does strike me here. So, the way they set this up as you said and I'm just speculating here, but it strikes me that Tailwind is getting in total 28-29% of the combined company. And as you said under the UK laws, Tailwind, they only need to vote if Tailwind's getting above 25%. It does strike me there's a way to reach management, could get religion on this or shareholders vote this down. You could quickly recut this, just cut the Tailwind shares. They're getting in, cut it to 66%. So, they get 20% of the company. They don't even need to vote on it anymore. But, for Serica shareholders, you keep a lot more of the value of probably goes from 270 of value to 360 value. It's not 400 value, but it seems like that could almost be a win-win for everyone. But I don't know,

Jeremy: You say that but I don't think Tailwind would take that because at their current ownership. Look-through ownership stake, they have the power to block any subsequent scheme of arrangement. So, this is also key to the thesis like the numbers themselves are horrendous and heinous enough in terms of the destruction of value, and the relative disparity between your current trading price of your equity and what you're paying for the new assets.

But when you consider the qualitative factors as well, this becomes like it goes from heinous to borderline abhorrent because in the UK, if you create pro forma Mercurio, which is the parent company of Tailwind, they're going to own 25% of the pro forma equity. To pass any consensual merger transaction in the UK, you need 75%. That's a scheme of arrangement. So, because the scheme of arrangement is binding on all shells, it's a high threshold.

Twenty-five percent Mercuria can block any deal that they don't like and guess what? Mercurial is not just Tailwind. Mercuria, is a Swiss trading house that has a bunch of marketing and hedging relationships, not just with Tailwind and soon-to-be Serica, but with a bunch of other assets we have now know nothing about but it's a much larger entity. So, if any kind of strategic, North Sea and ENP or whoever, even private equity, comes along that they don't like, another trading house, they can just stuff any transaction, they can block it just off its bat.

Andrew It's so creating insubordination basically. It's funny because like what, Serica shareholders vote this through, give us controlling stake for this really bad deal, and then we'll have a controlling stake in will block any future deals. Can't trust this management team to do good deals going forward.

So, let's talk timeline. The vote's next week. Unfortunately, as we said, they jammed this through so quickly that, it would have been really tough for an activist to come in here, become a shareholder record. Get on here. Obviously, you have shares so your weight running this campaign but I want to talk to you, this isn't investing advice. Nothing on here is investing advice, but if you're a shareholder who thinks like there's more value you want to get to February, let the cooling-off period expire. You want this to be a standalone company, you don't think this transaction on these terms should go through. What should a shareholder who doesn't want this deal to go through, what should they do? And then, what do you see if this deal? Let's take it could slow down. What do you think the next steps for the company should be?

Jeremy: Okay, if you are a shareholder of a record and you do not like this transaction. Then as I said, this is not investing advice but what I'm doing is I am voting against the resolution at the EGM. That is the resolution to issue the new shares to Tailwind Energy to Mercuria, the owner of Tailwind Energy.

Voting against the share resolution is basically only the only condition which can kill the deal. So, they need a simple majority of votes to approve the issuance of the new shares. And if you vote that down then the transaction cannot go through. If the transaction gets voted down, as I said it just needs a simple majority of votes cast at the meeting. So, it's more votes against the better from our perspective. If it gets voted down, I believe management's credibility would be completely destroyed given this as a board approved under it and deal and the manner in which they tried to rush it through as we've discussed.

Now, I can't speak to what the future holds. I've publicly asked the chairman to essentially consider all strategic alternatives and also open up the board to potential reconstitution with new members, who would be more aligned with the interests of shareholders.

So, if you think about it, they've promoted this transaction. If it gets voted down, that'll be a huge signal from the shareholder base that the board is simply massively misaligned with the wishes of the majority of shareholders, and no longer represents the will of the shareholders. Therefore, it should be reconstituted. I am not a large enough shareholder to kind of process that myself. But I'd be very willing and able to support any kind of board reconstitution after that move and I would expect they would either be wrong, reconstitution and/or the pursuit of strategic alternatives or both.

Andrew To me, no one knows for sure but the writing is so clearly on the wall. If you have a simple, "Hey, 50% of shares up down to just to issue these shares." I don't even believe there's an ISS recommendation or anything coming out and saying, this is a routine matter. I think routine. I don't know about London. So, I won't talk about like automatic voting by brokers and everything, but if 50% of shares, come out and vote against a routine matter to issue shares. Like at that point, the writing's on the wall and board embarrassment is a thing.

If 50% of shares are withheld from a director in a US company, the director-general resigns because it's just such a glaring red flag that shareholders don't support you. You might as well resign or change something because if you don't, it's the easiest activism gig ever for someone to step in and say, "Hey 50% of shares I have to buy one and just put a better plan forward and people will support me." Fifty percent of shares come out after this; I think it's a very clear signal. Hey guys, you have no faith. You can either go run a strategic process. Sell yourself to the highest bidder now or the next open window, shareholders are going to vote you out an instant. So why don't you save yourself that embarrassment? Go do it and go out winners.

Jeremy: I think that's right. I mean, I think the only thing that I'm missing or at least thing that I expected, may happen that has not happened is, why didn't activists coming like a larger activist get involved publicly already, right? So, the stock itself is not that liquid. And as you mentioned, it's barely two trading weeks to establish a position. However, there are ways to acquire stock. So, let's say, the stock trading at 270, now it's been trading, kind of like a 250 to 280 range, basically, for the last 2-3 weeks.

If you're some prototypical activist, I don't want to name names. But you have $50-75 million looking for an activist campaign. This is kind of a pretty juicy target, low-hanging fruit in my view. Couldn't you just go to a broker and say, get me 7-8% of the company, pay through the market, pay 300. Just find seven percent of the company, eight percent of the company.

As I said, given the openness of the register and the retail, the retail shareholding and broad dissatisfaction, it wouldn't take a lot to kind of...and then once you can kill this deal, as you said, it's almost fulfilling thing where you can quasi take control of the company and do what's right by shareholders, whether that be strategic alternatives, reconstitution of the board, what have you.

In a similar way to what's happening with Capricorn, which you mentioned. Now that hasn't happened. Now, I don't know if why that hasn't happened other than the timelines are simply too short; like there's no time for anyone to go good ahead.

Andrew If you are 70 million, if you started the next day, you could have done it. But at this point, again, the press released it. You went on for Christmas, you went to New Year's, you came back boom, shareholder records gone. If you buy now, you're trusting the prior shareholders to vote this deal down. So, I think the trick is, again, if you're shareholder record, you don't like this deal. The whole thing hangs on, you have to vote "no" next week.

Jeremy: Yeah, for sure. And I guess you could say, look, if the deal doesn't get up and then there is still no change subsequent to that. At that point, you would most likely see some activists emerge; it's an easy trade. All right. Do we need to do anything more on Serica? Go, or did you lie?

Andrew It's 9:15 my time but I'm excited we haven't talked in a while so, let's talk what other events are in your mind. The coal trading or anything else popping up these days?

Jeremy: What's going on? What else is in the event place? Did you have any questions from some of the people or do I just go through my book and tell what's most interesting.

Andrew Tell us what your favorite trades are, when you're putting them on and everything else. I'm pulling up the list. There were lots of questions here. We've got lots to talk about. Let me just start with a generic one. He is the coal Godfather. I know you have done really successful in coal recently. How are you think about coal these days?

Jeremy: Am I thinking about coals? I'm thinking, I probably should have sold some, my coal stocks, like two weeks ago. That's what I'm thinking. I don't want to say it's long in the tooth, that would probably be the wrong way of putting it. The correction in TTF, so European gas prices. And the concomitant reaction in things like Asian LNG prices, US Nat gas prices, has obviously been a lot more strident than I would have expected. So, whether it's really kind of thrown a lot of these trades for a loop, at least recently.

The fundamentals of the setup in coal are exactly the same. In fact, they're probably getting better because just today, it's good we're doing this call today, the New South Wales government. So New South Wales is the main thermal coal-producing region in Australia. And by definition, one of the largest thermal coal-producing regions in the world and the largest seaborne producer of thermal coal in the high-grade Newcastle coal.

So, 6000 kilocalorie coal, which is the highest-grade spec coal for thermal. They just announced a new plan where they’re trying to basically Indonesian the market. Meaning in Indonesia, 25% of domestic production, 25% off each mines production has to be reserved for the domestic market. To ensure there is a continuity of supply for domestic producers’ power plants.

Now, it's not going to be 25% in Australia, but it seems like they want to do around 10%. So, essentially, they're taking tonnes that otherwise would have gone to the Seabourn Market, reserving them for domestic use, a whole lot of problems with this, not least, because a lot of the domestic boilers do not run on the kind of coal it's mined in Australia or at least the high-grade, Newcastle coal, great succinct kilocalorie that doesn't fire the boilers in Australia or vast majority of them run on dirty coal, lignite things like that.

Put that aside, the net result is the shortage of coal in the Seabourn market is only going to get exacerbated. And more nuanced the shortage of high-grade 6000k coal, Newcastle grade coal is probably going to get pronounced. Because it was already massively short. Russia is already kind of half in half out of the market, Japan stopping by and Russian calling in a couple, in a month and change.

So, the masses spread between Newcastle grade and some of the lower grades of coal probably last longer than is expected on even than I expected. That's probably going to be good for guys like Whitehaven that produce a lot of Newcastle coal. Also, not too bad for guys like Yancoal where I have a position that produce a lot of 6,000k coal as well as low grades of coal.

So, the overarching point, I would say is weather's kind of caused prices to correct a bit faster than expected. But the higher for longer thesis. If anything is getting better because all these historically pro coal investment and pro kind of fossil fuel extraction, economies like Australia, are suddenly getting this ESG-woke religion in the weirdest ways and it's calling all kinds of distortions. So, look I'm not necessarily in the coal trade to trade the next 2-3 months so I can deal with a bit of volatility but a lot of these names still are implying zero or negative terminal value out beyond the next 18, 24 months. So...

Andrew As the Koala said, if you're a pod boy[?]. If you're out of pot shop and you get judged every day. Basically, like you've got to be up to it but I do just keep coming back and its coal, it's all these things. Like I just see a world with shortages. For a lot of these guys like literally was coal every day. You can be like okay, well they earned another 1.5% of their enterprise value today as long as prices don't go down 40% tomorrow, they are on another 1... and it's so hard when all this cash. It's literally just pouring in and you see the shortages like okay great, we had the warmest winter ever. And yes, it's slow down the price of bit. Like the structural change isn't there. They're still minting money. All this is coming in and you're buying all of this and it's like, I'm buying the next four years of cash flows. If I'm unlucky on the prices and get it everything, as long as management doesn't do anything too stupid, it's and whole tankers [inaudible] it's the same.

Jeremy: I think you're actually too conservative. You're probably buying the next one and a half years of cash flow, not even. Because, the other thing to think about with some of these names is you see the spot price that's going to 400 a tonne; let's just use Newcastle's it's easier. Everything trades under root of that, but Newcastle went to 400 a tonne and now it's back at like 350 or whatever, and the curb is quite backward-dated, right? So current prices are way higher than six months in the future, but because of the structure of these contracts, there's a big lag.

So 4Q cash flows are obviously largely known. I mean, we don't know volumes of these guys and there's been floods but 4Q cash flows and 1Q cash flows are not quite known but almost known because of the lagging structure of these contracts. So, when you see spot price really coming from say 400-tonne to 300-tonne to 250 tonne for the next six months. Newcastle, Whitehaven coal New Hope coal and Yancoal, a lot of these guys will still be earning on the basis of not 400, but somewhere between 300 and 400 a tonne. Because of the lag structure of a lot of their contracts.

So, if you actually just assume kind of normalized volume throughout this period and do the math on that as you said, you're not actually betting on for years out, you're betting on actually the end of 2023. Assuming they don't burn the cash, they create in the next 12 months, assuming most of that comes back in dividends or buybacks which for most of these Aussie guys is a reasonable assumption.

I mean the terminal value of these things is that record lows. Yancoal is a name I like because firstly it's kind of a funky or entity. It's largely owned by the Chinese, but all the assets are in Australia. So, you have kind of "bad shareholder base," but very good assets. Secondly, because they have a lot of low-grade coals. You're not actually betting on; you're not making this bet that the price premium between Newcastle coal and some of the lower grades lasts forever. Which Whitehaven is making crazy money right now and may continue to make crazy money. But you implicitly making this bet that you’re, spread between 5500 kcals and 6,000 kcals, will stay at record levels for some extended period of time...

Andrew You are making the scarcity [inaudible] energy, which goes critical.

Jeremy: Exactly. So, what I would say is, if that continues on, probably make more money in Whitehaven, but you'll still do find Yancoal. But if that crunches tighter, you could still do okay. Or pretty good in Yancoal, but Whitehaven will take it on the chin, just kind of the way I think about it. But the kiwis not Yancoal is this typical value investor bit is I think, even at like current prices, you're buying Yancoal at close enough to the lowest levels. It's ever traded on an EV per producing tonne basis. Some guys on Twitter give me crap saying this is the wrong metric to look at. You have to look at profitability, not just the value of the producing assets. But in the depth of the Covid recession, it traded on about $150 a ton for producing assets.

Now, these are all 20-30 you mind so, in NPV basis, you can do that if you want, but there are such long life mine, you can look at it on this basis, Runway basis I think it's okay. And, they will have hundred years of reserves. So, these assets are essentially going to last for undetermined periods of time.

So, if I traded $150 a tonne in the depths of Covid or even on an aggregate enterprise value basis these entities never traded below say $5 billion enterprise. If you give them credit for the cash flow, they generating 4Q and say the next one, one and a half quarters, it's not much north of that Maybe it's a $5.5 billion enterprise value. So, could it trade at the lowest valuation ever, despite coal prices being the highest where they are on a go-forward basis? I think it's I guess it's possible but it seems very unlikely to be, as long as they're returning the cash, it seems very unlikely.

Andrew I did some post at the beginning of last year, that was just like, tell me what I'm missing. And it was basically, again, coal, steel, all these guys for six months, they had record prices and they generate a Johnny Cash. And the famous thing is, don't buy anything cyclical when the P is low, because that's when things are good and they're making money. And my point was, yes, the P low, but they've already generated six months of the highest profitability they've ever generated. They gush so much cash. They pay down all their debt and as you're saying, like, the EV to producing assets was so low.

So, it was like, it's almost heads you win, if the prices stay high and again. famous last words, you'd look out. You look at this ball. You look at the man. It's hard to see how prices don't say elevated for a long time, Tails, you don't lose because again, they pay down all their debt. You're buying the assets at the lowest production ever. So, you literally need prices to crash immediately and never come back to even start thinking about, kind of again, not on a pot shop day-to-day basis but on a little bit of a longer-term basis. How are you going to lose?

And guess what? Basically, every asset I wrote it, I wish I had just sold everything gone long, all of them ignoring the Twitter trade, but because all of them, the smallest is up 40%. Since I pushed that put that post and obviously you've had plenty of oil and gas and everything that have just moon since then.

Jeremy: Look, I don't disagree with a lot of what you're saying. I mean, some of those have worked really well in some of work less well. So, I think, one way to think about my if prices actually do crash. So, let's say, coal Newcastle coals, kindly like 360 a tonne front month. Let's say it goes to 200 a tonne in the next month, you're going to lose money. You're definitely going lose money. Like spot prices will dictate where stock prices go in the very short term.

But if you have a very concrete view on where terminal value is. What it should be in a conservative scenario, so let's say prices fully normalizing go back to normalized ranges. I don't know, $80-150 a tonne, somewhere in that range maybe at the upper end because there's undeniably a global shortage and you can underwrite evaluation on that basis. The point is, you can get comfortable with taking that short-term draw down because you have a view on through the cycle value.

Now, as you said, if you honestly think price is going to fall 50% in the next month, you shouldn't own any of these things, but it could happen if it does happen then you need to be aware of where you stand. And as you said not for pot shops, whatever those guys are just trading the next two weeks, move, or next week move. But, if you have a more of a mid-term investing mindset then, that's where you can, I think make money through the cycle.

Andrew It's very easy to look at like the spot oil and gas and say Nat gas was nine, oil was 100-120 back in June. And I was looking at this and saying, like the stocks look way too cheap. And you've got this huge thing and as you and I talked today again, this is spot but Nat gas is four and oil is 80. So, down 33% to over 50%. And a lot of oil gas names are up over the same time because again the market just either generated so much cash.

Oils is 120 for one month, you're going to generate a heck of a lot of cash, but the market was pricing in curves, like it just didn't believe the curve. And yeah, the curve was too high, but the market was in pricing in the curve, 40% below where it was and we got ended up with a curve, 20% below, but the stock still went up because of that. Did they go? You still can make pretty good money.

Jeremy: That's my bid. Exactly. That's the margin of safety argument. That's why I like some of these trades like even today a good example is Unit Corp. I think both of us are involved in Unit Corp, UNTC. So, it's a bit of a special situation, a bit of an on-and-off-the-run name. So, it's not representing necessarily but stock 65-66. Today, they've been a bit more proactive on their capital allocation, very cash-rich story, bit of a complex story, but they're largely dependent upon domestic US gas prices.

Last we chatted US gas was $758 per MMBtu. Now gas prices under four bucks and the stocks are higher. Gas has literally gone down 40-45 percent and the stocks higher. So, to your point like of course you would rather have higher prices. But last we were chatting Unit Corp, they couldn't get a deal done because gas prices were too high, no one wanted to capitalize it. Well, guess what? If they actually tried to sell their assets now, there's a bitter with gas prices and more normalized levels. I think and there's still a ton of value left in the equity, right? It's still probably a $100 stock if they can sell anywhere close to like PV 10 of their business, even on like $4 gas or $50 gas.

Andrew I think that it's alright. People can go, I did a great podcast with Steve Bastian on Unicorp [crosstalk] listen to that but I really like that one. I like the management team; I like the dividend. It's funny because they filed the dividend with Finnraw[?] first. So, I was getting all these texts, I was like units paying a dividend. I was like, get out of here, stop teasing me. And that was crazy for sure.

Jeremy: I was asleep, I missed it that the stock went up $6-7 during the day before they even announced it was crazy.

Andrew The $10 dividend was nice and the stock went up a little bit and I do think the Mark was a little efficient. This is a pinch stock, it's nice. The actual real part of it, which nobody talks about was they said, "Hey, not only, are we paying the $10 dividend. We're paying the $250 dividend after that. It's going to be a variable dividend and basically, we're not keeping cash in the estate, their dividending out." And look would I love them to buy more shares. Yes. But this is super-liquid stock. I'm sure they will if they can but the fact, they're not keeping cash.

They're dividending up, going to increase your IR, reduces the odds of them kind of going on an empire-building thing. And I think it sets them up really nicely for a sale because if you're a buyer in the stocks 60 with $20 per share in the balance sheet and you can pay 70. Yeah, it sounds nice but it's a bigger headline. It's harder to get to the board. If they dividend all out. And now all the sudden stops 30 and you have to pay, they go premium but less of a cheque to write to the board like I think all that's pretty. So, yeah, I like so.

Jeremy: You still, think you still think the most likely outcome there is kind of a slow-motion sale because that's kind of where I am to. I didn't necessarily think the dividend of it, of course I'm pro it, but I didn't necessarily think it was then prepping for a sale. I do think there's certain pieces of the business that are obvious sale candidates. Like the midstream piece, obviously has a kind of process that's going to kick off as soon as the contractual period expires in April.

And then look, it's a very strong market for drilling. I mean no one talks about the drilling business that would, but that was good. You did with David. I really love that. He was kind of understated. I thought he had this dry iconic style that may be undersold the value of the equity. Like it's a very interesting story, like that drilling business $80 WTI. These guys are going to be caking it but leading-edge rates.

You've done a lot of work on, tide water and ice offshore support vessels. I mean it's conceptually, it's a similar concept like they don't need $100 WTI, right? 75-80s is prime, high enough to motivate more spending on rigs not too high to stunt the desire to invest. So that should be a great spot for the next 18-24 months.

There are a few clues in the filings with regard to Leading Edge rates. It says that business could be extremely profitable and justify most of the EV in the company today. And so, I think I'll be very interested to see who or what kind of price they could get if they did put those rigs up for sale but I don't know if that's on the horizon.

Andrew I think rigs would be, you probably could, but I think it would be tough because right now rates are going so parabolic. And when rates are going parabolic and you've got a shortage, it's almost tough because, you saw this with gas when gas was 10 last [inaudible] too.

Somebody's going to come and nobody's going to underwrite that curve and so when you've got the super parabolic prices in the short term, you're getting such a huge cash gusher. That so much of it is how long the current cash gush lasts. It's really so much of the enterprise value.

It's actually really hard to sell because you're just basing it off. Hey, I believe it's going to be two weeks. You think it's going to be six weeks. I think, will be like, it's really hard. It's almost better to let that super normal cycle play out, take all that cash, love it and then sell it at like a normal value once it happens. Guess what? Either way, we're going to get that super normal cash flow. And as long as WTI is here, I think we're going to be getting it and I think people are going to be really surprised Q4, Q1.

There was an article in FTI linked at the end of the Tidewater post. It included a little bit on Shale drilling costs. And if you looked at Rigs, starting in November. So, I think people are going to be really surprised by the cash flow that's going to be putting out in the near future.

Jeremy: Excellent. May have already been talking for an hour and I know it's getting slightly late there. Should we call it here and let you get off and....

Andrew We'll call it but you're going to have to promise me we're going to do another one in the near future because sure, we haven't even talked about your last letter to last minute. We should wrap it up because if I get this under an hour then it's much easier for me to turn around. And I need to get this out quick so that we can make sure people hear about it for the vote. So, Jeremy great having you on, looking forward to having...

Jeremy: Thanks, bud, always a pleasure.

Andrew Definitely.

Jeremy: Thanks, man.

[END]