(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 USO.V)
Out of Money, but USO Moves Higher... Hmmmm....
I noticed something odd last week... U.S. Oil Sands gave an update on the PR Spring project and other corporate matters on September 29th, 2016. You can link to the full press release here. To quote from the release:
"In summary, the Company is planning to start up the Project in Q4 this year as previously announced. Construction is estimated at 98% complete and a forecasted remaining expenditure of $1.2 million is required for mechanical completion. Project total installed cost is now targeted to be under US$62.5 million, approximately 4% over the original budget. Completion, commissioning and start-up will require additional capital, and the Company is actively pursuing financing alternatives to meet the liquidity requirements...
...Since the Company’s June 30, 2016 report, estimated Project costs have increased by approximately US$2 million due to extra completion costs and rectification of deficiencies. As a result of these additional costs, the Company no longer anticipates having sufficient capital to complete construction of the Project as indicated in the June 30, 2016 report and the Company will require additional financing(*). The Company currently estimates that with these extra construction costs, along with remaining commissioning, start-up and operating costs, an additional US$3.0 to US$4.5 million in working capital will be required prior to year end... the Company is actively pursuing funding alternatives in excess of US$6 million in order to meet this working capital deficiency and provide sufficient flexibility during the upcoming few months. "
(*note: the bold emphasis is mine)
Now, I'm just going to say, that for those of you who don't know, companies that say they are expecting to run out of money in the near future are pretty much laying themselves out in the sun for the vultures to pick over. News like that usually sends longs scrambling to sell in order to "re-buy on the deal" or to start making tax-loss calculations. Instead, what did USO's share price do? It went up a penny on about 2 million shares of volume over the next few trading sessions.
To be perfectly clear, USO is approaching the PR Spring finish line not on fumes, but literally coasting without enough momentum to make it there. Now consider that USO says it is "actively pursuing funding alternatives". Most companies about to run out of cash would do that, no doubt about it... but is there a chance that USO could actually be successful? What are the options? Equity? Debt? Would someone actually lend this company money? If so, who?
When I recently wrote about USO, I said that I thought the 2c share price reflected a certain amount of uncertainty. Now, after thinking about it for a few days with my hedge fund hat on, I'm starting to think that USO might not be in such bad shape after all. Both before and after USO's rights offering earlier this year, Anchorage Capital was far and away the largest holder of the stock. Anchorage had actually backstopped the whole rights offering, which means they must still be very much engaged with the company. This isn't that surprising really, with their 1.5c warrants in the money, Anchorage effectively owns 38.4% of USO's stock.
Here's an excerpt from Anchorage Capital's form 62-103F1, filed on Sedar:
"Prior to the completion of the Rights Offering, ACMO owned 223,333,333 Common Shares, representing approximately 26.2% of the outstanding Common Shares. Upon completion of the Rights Offering, ACMO owns 556,716,222 Common Shares, representing approximately 32.6% of the issued and outstanding Common Shares.
Prior to the Rights Offering and execution of the Standby Purchase Agreement, ACMO held no Warrants. Pursuant to the Standby Purchase Agreement, ACMO received 160,725,000 Warrants exercisable on or before November 30, 2016. If ACMO were to exercise all of the Warrants as of the date of this report, ACMO would own a total of 717,441,222 Common Shares, representing approximately 38.4% of the then issued and outstanding Common Shares."
My theory here comes from experience... Anchorage is so far down the road with USO, that it may as well run out of the pits and push USO all the way to the finish line, maybe with enough gas in the tank for a victory lap. In for a penny, in for a pound, right? I can't imagine that Anchorage has come this far just to see USO run out of money before PR Spring is turned on and I find it unlikely that someone else will come along to keep Anchorage's dream alive in the eleventh hour. And by the way, those 160 million warrants that Anchorage has would raise about US$1.9 million in proceeds if exercised...
Fortunately, USO has zero debt aside from a small (~C$800k) bank line secured against specific pieces of equipment and yet there has been over US$60 million spent at PR Spring. Surely that equipment must be worth something to someone, if even at a firesale price, of say, 10c on the dollar? If it were me, and I was in Anchorage's position, I'll tell you what I'd be doing here. I would be actively pitching a secured debt deal to USO management of a size that would fill the anticipated hole. Something in the USD$3-4 million range... I might even be asking for some bonus warrants for coming to the rescue.
By putting a debt piece into the company, Anchorage would be setting the final domino in place for PR Spring and USO. Either the project works as expected and the equity rallies, or it falls flat and Anchorage enters the oilsands equipment sales business. My point is that if Anchorage backs up their own equity stake and takes funding worries off the table for the time being, there's a chance that USO can rally significantly if the PR Spring project performs as expected.
The way I see it, USO may as well pledge its assets against a Hail Mary debt deal in order to get PR Spring to production. Let's face it, if the PR Spring project is a flop, it's unlikely someone else is going to spend another $100 million and 3 years to do it all over again, so USO will have been the "Yeah, they tried that once back in 2016..." story. End of conversation. The only other alternative that I see is another equity deal, but that would mean a) roughly 20% dilution, and b) that Anchorage would be just be another shareholder with expensive wallpaper if PR Spring doesn't go so well. Given that USO has no real debt to speak of right now, they may as well play the card that minimizes dilution and look at a debt deal, even if it was a one-year bridge loan. I would think that pretty early on it will be clear if PR Spring is a race car in need of tuning or if it's just a really expensive lawn ornament. If things are going well, USO should have little trouble extending the debt or taking it out with new financing.
So is Anchorage already talking to USO about filling the funding gap? I would have to think the answer is yes. If PR Spring goes according to plan and the oil price keeps cooperating, Anchorage could look like rockstar, backing up their investment just in time for USO to hit the mainstream... and I do mean the mainstream. If these guys can use an orange extract to produce oil from oil sands with $30-35k/bbl/d capital efficiencies and no tailings ponds, you can bet that it'll make some headlines.