Maglan Capital August 2017 Commentary

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Maglan Capital commentary for the month of August 2017.

Maglan Capital increased in value by 0.78% (net of all fees) during the month of August.

For 2017, Maglan Capital has increased 3.75% (net).

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Alignment of Interests and Insider Buying

One of the challenges in simply being an investor in a for-profit enterprise (as opposed to additionally being an operator) is structuring and influencing the relationship with the operational executives, so that interests are aligned toward growth, efficiency and profitability. The closer those interests are aligned, the less concern an investor has that management may be operating with alternative motives. One long-used method for achieving alignment of interests is share-based compensation. Sure, it is important that executives have a sufficient cash component to compensation to support acceptable living expenses, however, no executive should get rich off of his/her fixed compensation. Incidentally, we view our position as principals at Maglan similarly. We have worked at pre-eminent law and investment firms and, since 2009, independently. From our combined 40 years of professional experience, we are firm advocates that a success-based compensation system leaves little to argumentation and best aligns interests of operators/GPs and investors/LPs.

In times of under-valuation, stress, pressure or dislocation in a company’s share-price, one of the greatest overt votes of confidence that management and members of the Board of Directors can give to the company is personal, open-market stock purchases. In short, putting money where your mouth is. As long as management and the Board isn’t restricted from purchasing shares due to possession of material, non-public information, management should speak boldly that “the company’s shares are undervalued according to those who know best and most,” by increasing their exposure to the performance of the company’s share-price, further aligning their interests with shareholders.

Specifically, with regard to Maglan’s largest holdings, we can take comfort in the elements of alignment of interests and insider buying. In recent months, stocks in the entire wireline telecom industry have been under extreme pressure. Specifically, the stocks of Windstream (WIN) and Frontier Communications (FTR) have declined 70% since the beginning of 2017. The secular pressures facing the industry are not new, however, those pressures are accelerating and, for a long time, the industry was the beneficiary of investor interest because of the robust cash-flow and resulting equity dividend payout. Now, due to dangerous leverage loads at Frontier and Windstream and the accelerating decline, those dividends are under threat. And, as is often the case, although the symptoms are limited to certain patients, the infection is being ascribed and applied broadly. In response, the leadership at Consolidated Communications (CNSL) has responded firmly and loudly. In recent weeks, the leadership of Consolidated Communications has purchased over $330,000 of shares, implicitly telling the market “now, is the time to buy.”

In the case of Madalena Energy (MVN; MDLNF), the company’s new leadership is primarily compensated in company shares (actual and options). Moreover, the company’s deal with new management was predicated on an investment of $23mm equity-linked, low-interest debt. Furthermore, the composition of the Board of Directors is being reconstituted at the annual meeting of shareholders (Sept. 13 in Calgary) with new blood that is more properly suited for the company’s exclusively-Argentina focus and will be entirely compensated with stock options. Finally, the market has recently seen Madalena’s Chairman of the Board of Directors nominee, Gus Galas, purchase 800,000 shares.

Lastly, in the case of Globalstar (GSAT), Jay Monroe, the company’s Chairman and CEO, controls greater than 70% of the company’s shares and he has never divested himself of any shares. Additionally, in June 2017, Jay purchased another $33mm of stock, adding to his ~$600mm investment in the company. Talk about interest alignment.

Madalena Energy (MVN; MDLNF)

Recent Macro Developments

In August, President Mauricio Macri faced the primary of his first mid-term elections. Specifically, markets were focused on the primary in Buenos Aires Province between Macri’s candidates and former President Cristina Fernandez de Kirchner. The worst case of a potential comeback for Kirchner was avoided. Although Cambiemos did not win the primary handily, given that the opposition is fragmented and Kirchner has a rigid vote cast, most analysts expect that Cambiemos’ majority will grow in October’s final election round. Investors are treating October’s legislative elections as a test of public support for Macri’s efforts to open up the economy.

A victory for the Cambiemos alliance in Buenos Aires province would strengthen Macri’s hand in negotiations with the opposition in congress and allow him to push on with plans to reform tax, labor and capital market laws. All of the foregoing will enforce positive momentum for private enterprise, for oil and gas exploration and production generally and, for Madalena Energy specifically.

Although October’s election should usher in a new round of dealmaking in Argentina’s oil and gas industry, recent months have not seen any slowdown of the momentum already created. In late August, Norway’s energy giant, Statoil, signed a deal with Argentina’s leading energy company, YPF, to jointly explore for on-shore shale oil and gas resources in the Vaca Muerta formation.1 Statoil and YPF will each hold 50% in the Bajo del Toro light-oil exploration block. In addition, Mexico's Pemex stated that it is seeking oil projects in Americas, including, the United States, Brazil, Colombia and Argentina, specifically mentioning the Vaca Muerta.2 And, Shell’s investment in YPF’s Vaca Muerta endeavors was approved by the Neuquen province.3 Finally, on September 1, Exxon Mobil announced that it will commit an additional USD 200mm to Vaca Muerta natural-gas production.4 To support these efforts and others, in August, the Government published a decree eliminating or reducing tariffs on imports of used equipment for oil and natural gas companies, a measure long sought by the industry.5

Second-quarter Earnings

In late August, Madalena reported its first quarter of earnings under the leadership of new CEO, Jose Peñafiel. The highlights from the quarter and the related earnings call6 are as follows:

  • Free-Cash-Flow & EBITDA Positive: Madalena is currently operating on a positive EBITDA run-rate and free-cash-flow basis, and it has been, and management foreseeably expects, to be able to fund working capital activities without accessing the company’s Working Capital Line.
    • Capex Loan: Once the company’s Capex Loan is approved at its annual shareholder meeting (Sept 13), the company will accelerate conventional drilling activities.
  • Argentine Stock Listing: The company has engaged with the Argentine securities commission with regard to an additional listing of the company’s existing shares on the MERVAL. The company is targeting the listing within 6 to 9 months. The company will maintain its Canadian listing and corresponding US ADR.
  • Production Growing and Going Higher: Oil production is currently higher than it was at the end of Q2. The company has increased production significantly in Coiron Amargo Norte and is targeting low hanging fruit, to increase production in Surubi.
  • General & Administrative Expense Reductions:
    • The company completed personnel reductions in the Argentina office and it has closed the Calgary office. G&A expenses have been reduced by half and the targeted reductions are largely complete.

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