UPDATE 4 MARCH 07:45AM – Holding announcements out. Looks like Schroders was the seller not Vanguard but v encouraging to see us in the company of Ora Capital’s Richard Griffith who popped up over the disclosable threshold with 6m shares. If there is one thing this man knows what to do, it’s make money!

After nearly 20 years in the stock market, every now and again you come across an investment offering that has such an attractive risk/reward profile that it can, if things play out, completely transform your portfolio without, most importantly, having to take an excessive amount of concentration risk. They say investment is all about avoiding losers (and also timing), and I’d certainly wholeheartedly echo this statement from my own experience but, equally, success in investment is about finding those trades where the upside far, far outweighs the downside – it is the few multi-baggers that really deliver the excess returns to a portfolio.

Recent examples of what we call “asymmetric risk/reward profiles” in the stock market were Kazakhmys at sub 200p, and of course the entire gold mining spectrum in early Dec where we wrote here, with the somewhat unsubtle title of “why we are mortgaging our grannies” – of the incredible value that was on offer. Needless to say said granny has now paid off her mortgage thanks to us catching the low for the sector on this piece almost to the day!

Here at SBM we believe, in complete contrast to a certain well-known share blogger, that a potential portfolio transforming prospect is presently being offered by “Mr Market” in Gulfsands Petroleum (GPX). So much so that we offered said blogger a 5:1 odds bet with a buy in off just £1000 on his part that the shares will be higher in a year’s time from the level where he recommended a resolute sell (see here – – at 33p last Friday.

We declare right at the outside of this piece that we, and connected parties, believe so much in the value proposition in GPX that we have a sizeable exposure to the stock in our own name and in related entities.

So, just why do we believe the upside far outweighs the downside?

The stock price had recently been forced down to just 29-30p just over a week ago as there was a sizeable seller around. Indeed, over the next few days, we may see a holding announcement such is the volume of shares turned over during the last 4 trading sessions – some 6m and being almost 5% of the company. The likely suspect is Vanguard Intl whom, at the last RNS on the 13th Feb disclosed they had a residual holding of 3.5m shares after some recent selling. This dropped them to below the key declarable threshold of 3% and so we will not see a holding RNS from them if it was them as they now have no further obligation to disclose. Either way, the seller seems to certainly have been cleared going into the close today, and given the tight shareholding structure (see below), the free float in these is now likely to be pretty small. Net effect – volatility on both the upside and downside. We will lay out why we think the downside volatility is minimal.

We can see from this disclosure that almost 80% of the stock is held by the top 13 shareholders – quite a concentration. Importantly to us however, just over 10% is held by Directors. We have learnt of old that were there is no Director’s alignment in a stock that the end result is usually bad for shareholders (a certain Plus quoted media entity of gaelic leanings excepted of course! ;-)). Vice versa, excessively large Directors holdings, as in the case of ENRC, can be problematic as minorities can be kicked around (Essar Energy shareholders may or may not shortly find this out shortly too…), particularly when the holding is over the key 75% level.

In GPX’s case, given the balanced Directors shareholding (not too large and not too small) and the fact that Waterford Finance & Investment which is owned by Russian investor Michael Kroupeev and Soyuzneftegas Capital Ltd appear to have paid close to 200p per share going by the dates of their stake declarations in 2011, it is safe to say that our friendly and cuddly “bloggers” assertions that a placing is imminent, while not to be ruled out totally, is unlikely to be one in which existing stockholders would be shut out and disadvantaged. In other words, there is no vested interest in a heavily discounted placing with 3rd party investors and indeed a rights issue is a more likely option in our opinion should a capital raising occur.

For those unfamiliar with the GPX story here’s a very quick overview – The company was, until May 2011, happily receiving handsome revenue from its wells in Syria from an area known as Block (26).

Indeed, the funds derived from here were the bedrock of the Group’s profitability. The imposition of sanctions by the EU on the country resulted in “Force Majeure” being declared on GPX’s operations on the 1st Dec 2011 and as a consequence of this, for the last 2 and a bit years, it has not been able to recognise the revenue from its Syrian assets in their accounts. GPX’s partner in the Syrian fields is the Chinese company Sinochem. Importantly, according to the company, GPX continues to accrue its share of revenues during the Force Majeure period as relayed in this statement made by the company in Sept 2012 –

At present, GPC are not paying the Group for its share of the oil produced, nor can it currently be accepted by the Group and accordingly no revenue has been recorded from the Syrian operations in respect of the period since 1 December 2011. There is, however, a provision within the PSC that requires a settlement of this figure after the lifting of the current period of force majeure.

There is no official updates estimate as to what this figure is, but at the first half stage in 2012 this was estimated at $55m by Edison Inv Research. Additionally, the company only recently stated  –

We are pleased to confirm that the Company’s local staff continue to monitor these important assets, the Khurbet East and Yousefieh fields remain closed in and not producing and the infrastructure on the fields remain intact with security in place and continuing to be provided by cooperative arrangements between the central government and local communities.”

It is a fair assumption that given that the fields stopped producing in late 2011 that the $55m + interest is a good estimate of the accrual due to GPX at some stage when the state of Force Majeure is lifted. With a current market capitalisation of circa $75m (as at 3 March), this alone almost accounts for the company’s value.

At the last accounts reporting stage in Sep 2013, net cash was circa $57.5m but they had additional bank resources of around $15m available resulting in gross available funds of just over $72m. To be conservative in this exercise, we assume that the company has burnt through another circa $25m of cash over the last 6 months with the drilling in Morocco and Tunisia in recent months but stress that this is a rough and ready estimate as there is a dearth of analyst coverage on the stock (something in itself which is an “opportunity” as the wider market is patently not fully appraised of issues within the company as is the case with other more widely covered stocks).

Taking the $25m cash depletion figure, this results in capital facilities available of around $47m at present – enough certainly to get them a good way through 2015 and, we would proffer, hardly indicative on an imminent placing…

So, as it stands, the company is currently in the situation of sitting on an asset that it is presently prohibited from obtaining any economic interest from but which it described recently in its Corporate Update as –

“We are pleased to confirm that the Company’s local staff continue to monitor these important assets, the Khurbet East and Yousefieh fields remain closed in and not producing and the infrastructure on the fields remain intact with security in place and continuing to be provided by cooperative arrangements between the central government and local communities.

The Company understands that infrastructure in the region continues to be operational with significant production from other fields in the area operated by the central government.”

Read-through – as and when sanctions are lifted, an operation that covers approximately 5,414 km2 and encompasses existing fields which have produced over 100,000 barrels of oil per day in recent years will be quite speedily back on stream and delivering (based on historic figs) around $60m of pre tax profits p.a. That is quite a beacon of light at the end of the tunnel.

To us, at a stock price of 100p, the “optionality” of this was cheap, certainly when considering that the “core” NAV which ascribes a nominal value to Syria of its balance sheet cost is estimated at around 75p adjusted for cash. At 38p is a gift from heaven as there is negative value on the optionality.

The “risked” NAV with Syria in at cost makes up as follows: –

Cash – $45m

Block (26) – $102m

Chorbane (Morrocco) – $5m

Rharb (Tunisia) – $42m

TOTAL – $194M

With 117m shares in issue and at a current FX rate of $1.67 this gives a risked NAV of 100p.

Nil value is put on the Gulf of Mexico, Sicily and Colombia assets in this exercise. The latter however could be particularly interesting as its permit on Block (14) is adjacent to fields that have “proved up” reserves of 365m barrels of oil whilst their Llanos block 50 licence is located in the mature North Llanos basis and where 100 km to the North-west, Occidental discovered the giant Canon Limon field with reported reserves of more than 1 billion barrels. The company states – “At 513.7 Km2 in size, the block is larger than most blocks in the basin.” 

The company does admittedly need to generate some meaningful revenue from either Morocco or Tunisia in the next 18 months absent Syria coming back on stream, and while the former has proved disappointing from a drilling perspective, it must be remembered that it sits on a circa 34mboe 2P reserves base there and of course farm in options are likely open to GPX.

Anybody of sane mind then can likely see that with a share price of just 38p at the close of play today, before we even bring in the real blue sky prospect of its Block 26 operating again, that the company is cheap and a financing call has been more than discounted. 

Let’s look at the blue sky scenario however. 

At the current EV, the market is valuing the company on and EV/2P basis of less than 30c a share. We produce below the estimates made by Edison before they ceased coverage of the stock of what a resumption of Syria means to the valuation and which is in fact based on a slightly lower oil price than that prevailing today.

It again doesn’t take a genius to work out that WHEN the situation in Syria is resolved (and at some point it must resolve) that GPX, if able to operate its fields again, is likely to experience a very, very sharp re-rating indeed. Recall that the company in fact fended off a bid from 2 Indian Oil companies in 2010 pitched at 315p a share as materially undervaluing the company.

It is important however to mention that the “exploration” licence over Block (26) expired in August 2012 but management are confident that given the Force Majeure in effect, that this licence will be extended as and when sanctions are lifted. This is particularly important as the company estimated that the fields contained an additional 405m boe. 

So, the fact that there is latent value within the Group’s portfolio should be obvious to all, certainly those that actually do the research. Question now is how to value the potential upside?

There are multitude complex ways to do this, from a DCF calc based on the probability of the Syrian fields coming back on stream and assuming a particular year, ascribing probabilities to success in Tunisia, Morocco, Colombia etc etc. Truth is this is all mere guesswork and one could produce calculations till the cows come home.

To us, even just the remote prospect of a resumption of oil revenues flowing into their coffers in Syria backed by a very supportive base shareholder register that is (a) not likely to heavily discount the stock and (b) has an aligned and vested interest with minorities in rebuilding value is sufficient for us to apportion a decent chunk of our portfolio to GPX whilst remaining liquid enough to actually participate in a rights issue should there be one. 

The real wild card in our opinion is a bid by one of the large shareholders (a completely 3rd party bid is highly unlikely given the entry prices detailed above of Waterford and Soyuzneftegaz who know the value in the assets and so would likely want proper triple figures for their stock) for the entire company. This cannot be ruled and, in their shoes, if I had an inkling of a resolution to the Syrian woes, I would show my hand now while there is still 5-10 times you money possibly left begging on the table. 

Other key issue in relation to such a move though by one of the large existing shareholders is that the balance of shareholding votes (the “king maker” in effect) actually lays with Schroders Inv Mgmnt who hold just under 15% of the stock. In the event of a low ball bid of say 70-80p for the company by either Waterford or Soyuzneftegas in concert with the Directors and Abdul Rahman Kayed, they still would not have over 50% of the votes (a level which creates problems for minorities looking to extract proper value). A figure north of 100-120p is likely to tempt Schroders and Norges and of course the more recent speculators.

In conclusion then, and returning to our very opening statement, the shares of GPX present, to us, an intriguing investment mix of a negatively valued option on Syrian assets that are valued at upto £5 per share, an accrued cash pile waiting for remittance that is only slightly less than the current market cap and some exciting prospects in Morocco, Colombia and Tunisia. The risk/reward is asymmetric and we remain resolutely long.

Seperately, any time “Tommy Boy” would like a lesson in how to analyse a company – give me a call!