(Disclosure: The following represents my opinions only. I am not receiving any compensation for writing this article, nor does Hydra Capital have any business relationship with companies mentioned in this post. I am long POE.V)
Anyone who knows me will know that I'm not one to shy away from risk. Risk can be more or less equated with expected volatility, but I've found that the level of volatility that is "expected" (and thus the perceived risk) will vary from person to person depending on their level of comfort with a variety of economic and market factors combined with their specific knowledge of the company or opportunity being evaluated. If you accept that risk and volatility are correlated, then, in the absence of any additional information, "risky" situations have equal ability to create outsized positive and negative returns. That to me is kind of like playing roulette, which is not a game that I like to play in Vegas… I prefer to play games like blackjack and poker, where your knowledge and the game, the deck, and/or the players allow you to know where you stand as the game progresses. The interesting thing to me about blackjack and poker is the fact that eventually you can recognize bets that you are either very likely to win (or very likely to lose) if you are paying attention. The follow-on is that during the game, depending on what's going on in each player's head, not everyone's perceived risk is the same… and that's what makes a market.
Going a step further, asymmetric situations are situations where your knowledge tells you that your downside of betting is limited while your upside is significantly more than your downside. Or to put it another way, your expected volatility to the downside is much less than your expected (or potential) volatility to the upside. In a mathematical sense, if you can bet with the belief that a loss will only cost you a dime but could make you $5 on a win (implied odds of 50:1) on what you believe to be a bet that actually has 5:1 odds, you're looking at asymmetry. I have found that these situations present themselves in many forms in the market, but the simplest (and the ones with the most torque) are often in cash-rich resource exploration companies that trade at or near cash value. To use a real life example, I've included a summary on Pan Orient Energy below. The company put out a corporate update on Tuesday which reminded me exactly why I keep coming back to it.
Pan Orient Energy
Pan Orient (POE on the TSX Venture, or POEFF in the U.S.) is a bit of an outcast in the international junior energy space, having fallen from grace in early-mid 2008 when the volcanic reservoirs it was drilling onshore Thailand started watering out faster than expected. This was of course compounded by the 2008 financial crisis and coincident oil price collapse. The company's share price has moved in fits and starts since that time, but has failed to deliver any "breakout" exploration success that would have brought it back into the mainstream.
Pan Orient's business model is simple. It captures, matures, and drills hydrocarbon prospects in the hopes of then monetizing any discoveries for its shareholders; then repeats the cycle again. Over the last three years, POE has pulled off two corporate asset sales at valuations far in excess of analyst estimates. As a result, POE has maintained a balance sheet that any junior exploration company would envy, even after paying a one-time special dividend of 75 cents per share back in August 2012. Granted, the share price performance has been far from exciting (POE is back near all-time lows), but such is the nature of the exploration game. When you're missing on all of your wells, you're a loser... but when you make that discovery you've been hunting for, boy do things change quickly. The POE board and management are not strangers to the exploration business… they've done a good job of keeping the lights on with lower-risk development-type drilling onshore Thailand, but have all the while been hunting for the company-maker discovery that all oilmen dream of.
So what is it that makes me think POE is an asymmetric situation? Well, in terms of downside mitigation, it trades at about a 10% discount to its cash value of ~$94 million (~$1.67/share), with no debt, and has an active normal course issuer bid (NCIB) in place. POE has repurchased over 1.3 million shares under its NCIB at an average of $1.51/share which shows that the company is willing help those who feel that they should sell their shares at less than cash part with their stock. The fact that the company trades at less than cash with an active NCIB and zero value attributed to any of its assets would seem to make the limited downside case pretty simple, but what about the upside?
POE closed at $1.48 on Tuesday despite issuing a press release that really served to strengthen my investment thesis. In that press release (link to it here), POE detailed that: 1) its first SAGD well pair is exceeding the "Best" case estimate from its reserve evaluators ("best case" is like the P50 case), 2) the company is getting ready to drill a well in Indonesia in August that is up-dip of a discovery on an adjacent block, 3) it has only committed $6 million of firm capex from its war chest over the next 12 months, 4) it has completed its 51% East Jabung farmout with Talisman Energy (now owned by Repsol), and 5) it will continue its low capex efforts in onshore Thailand in order to maintain a modest production base of 600-800 barrels of oil per day. By now, if you're not getting a sense that perhaps there is something of value in POE's asset portfolio, then remind me to sit at your table next time you're playing poker!
I'm not going to detail all of the assets here, but I do think that there's one worth delving into a little bit because of the potential size of the prize. The East Jabung PSC, which is now a 51/49 JV between Repsol and Pan Orient, contains the Anggun prospect which is almost certainly what led the Talisman (now Repsol) team to farm in to the block. This is what "long tail" optionality looks like. Anggun is a simple 4-way dip closure (think of an inverted bowl) that would have been drilled 40 years ago if it wasn't in a park at the time. Well, Anggun is no longer in a park and the plan is to drill it in Q2 2016, with Repsol as operator. The size of Anggun has not been formally estimated, but POE has stated that a prospective resource estimate should be completed and released to the market sometime this month (July 2015). The prospect's maximum closure is roughly 80-100 square kilometres in size at two levels and it sits adjacent to a proven and mature oil source kitchen. The Anggun prospect also appears to coincide with a dominant regional structural high in the basin since the time that the source kitchen reached peak oil generation.
Anggun is one of those targets that you just don't see in junior exploration companies very often, and Repsol pays for the first $10 million (+ overhead) of the first exploration well which should come pretty close to covering the whole cost. It's a company-maker target, with a good zip code, and there's nothing left to do but drill it. Once POE releases a prospective resource estimate, I'll speculate a little on the upside potential, but at this stage I'll just say that I think it's "significant". Of course, we've all seen these exploration targets drill and fail before in many incarnations, so buyer (i.e., gambler) beware, but the point in my mind is that if I'm going to play poker in the junior resource market, these are the bets I want to make, full stop. Discovery is a fantastic wealth generator and getting exposure to discovery at little or no cost is something that I'm always looking for.
I should point out that I've written similar notes on Pan Orient in the past when their (incredibly unsuccessful) Indonesian exploration program was underway 2-3 years ago, but Anggun has always been "the one" that I reallllllly wanted to see drilled from the day that I learned about it and, in mind, POE is now back to an attractive level for speculation. Even if you agree that the downside should be limited by the company's cash balance alone, you still have to have a strong stomach for these kinds of situations and the patience (12 months in this case) to let them play out. It's easy for me… at the poker table I'm the kind of guy that will stick around waiting for that flush on the river all day long if I can get there without having to put much in the pot. I don't see this any differently. At these levels, I like my odds, and that's all I need to know.
Best of luck and happy hunting.
Link to POE's June 2015 corporate presentation here: