Tenaz’s Snowball

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Disclosure: The following represents my opinions only. I am long TNZ.TO

I wasn’t planning on writing a note after last night’s tuck-in acquisition by Tenaz Energy (TNZ.TO, last at $2.55) where it basically doubled its stake in its Netherlands gas and infrastructure portfolio, but a mere 9% rise on the news left me wondering if the market fully appreciates the nuances of what’s transpired, so here I am to give my take. I’ve said before that I believe that TNZ represents one of the best risk-rewards I’ve ever seen in the market and I’ll double-down on that statement today. When its most recent acquisition closes (expected in Q3), TNZ will have positive working capital of around $65 million, or about $2.35/share, which means that at today’s closing price of $2.55, the market is valuing TNZ’s pro-forma production base of ~2,800 boepd at only 20 cents per share, or about $5.5 million. That is not a typo. TNZ’s asset base will generate run-rate cash flow of something in the neighbourhood of $35 million per year, $10 million of which will be free cash flow in 2023… and the market is valuing that cash flow stream at just $5.5 million. For those who prefer to think in terms of cash flow multiples, TNZ is trading at an EV/CF multiple of 0.16x. Also, not a typo. This is in a sector where dirt cheap would be 1.5x EV/CF and a “normal” multiple might be around 3-4x EV/CF — and just to say it again, TNZ is trading at 0.16x EV/CF at today’s closing price of $2.55.

Now, obviously Exxon isn’t in the habit of just handing ~500 boepd of production, a 10.1% interest in a key natural gas pipeline system, and $61.8 million in cash to companies for no reason. In exchange for getting these goodies, TNZ has assumed the decommissioning liability associated with them, which today has a present value of $29.2 million. To that end, of the $61.8 million of cash that is within the entity that TNZ is acquiring, $15.3 million of it will be pledged as a decommissioning security deposit when the deal closes, leaving TNZ with an extra $46.5 million of dry powder. Add that to the net ~$18 million that TNZ already has on its balance sheet and you’re looking at net positive working capital of $65 million on closing. This is where all you Warren Buffett fans should perk up, because TNZ is giving a MasterClass in non-dilutive financing here.

By taking on these producing assets, and the liabilities that go along with them, TNZ has been able to capture both cash flow and straight cash today in exchange for paying a decommissioning liability that is 13 years in the future. Thirteen years. That is a market eternity. During those 13 years, Mr. Marino and his team get to use the excess $46.5 million in cash as they see fit; which in this case will be to finance future acquisitions. At this stage, TNZ’s total dry powder of $65 million is enough to take on a $100 million acquisition without having to issue a single share if I assume a 65/35 cash/debt split. This is how you build value per share folks…

What TNZ is doing is not totally unlike what Berkshire Hathaway does in the insurance business. In that case, Berkshire takes on a calculated future liability in exchange for insurance premiums collected from its customers today, and then it invests that money in the meantime. It gets to use that cash, for “free”, to generate equity returns that accrue to its shareholders. This is not a game for people who don’t understand insurance (or the energy business in TNZ’s case), but if you have a management team that knows what they’re doing, the value creation can be epic. Look no further than Valeura Energy’s (VLE.TO, last $1.83) deal in Thailand in December to see an example of that. After VLE announced its acquisition, the stock rose 400% over the next two months, not in a day. Relative to what VLE bought, TNZ’s assets have a longer life and better margins, but that’s not the point. The point is that it takes time for the market to figure out what’s going on. You probably know about TNZ because you read about it from me, but the broader market is totally asleep on this one. Market efficiency breaks down in the small caps which is why it’s where I focus most of my time — and it’s where I’ve had my biggest wins when I’m patient.

Most people have never heard of TNZ, but from some of those that have who don’t own it, I have heard “too small”, “too illiquid”, “too boring”, and “I’m dying a death of a thousand cuts out there, so I’m not adding names” as excuses to not to own TNZ. And I do mean excuses… because none of those are valid reasons to me when there’s money on the table. Is there some other business out there with a pristine capital structure trading at around 1/10th of the multiple of the cheapest companies in its group, run by one of the most experienced and connected teams in its industry, that has $100 million of firepower for its next sure-to-be-accretive deal? Too small? It’ll grow. Too illiquid? It will be until it isn’t. Too boring? Just watch. Getting your head slowly handed to you in the market? Here’s a newsflash, I hear that from almost everyone — so either react to new information and ideas, or underperform… your choice. This is the summer doldrums folks, and I think it’s a great time to keep an eye out for the TNZ’s of the world while everyone else is “bored”. With just 27.6 million shares out, TNZ shareholders have serious leverage to the value that management rolls up along the way… and roll it up they will.

This is the nature of Tenaz’s snowball. It starts small, but every revolution — every deal — makes the snowball significantly larger than the last go-around. After just a few turns, the weight starts to pile up quickly, and before you know it you’re looking at a substantial piece of business. Last Thanksgiving, who would’ve thought that TNZ would have the capacity to make a $100 million acquisition without issuing a single share of stock just less than a year later? And yet that’s where we stand today. TNZ’s deep industry connections allow it to access a wide range of deals in its quest to grow to 50,000 boepd through thoughtful, and accretive, acquisitions. That’s a very real competitive advantage. Finding deals is easy, but finding the good deals is where TNZ shines. TNZ has now staged a veritable war chest for its ongoing M&A strategy and I expect the company won’t ease up on that front given its most recent statements about the status of its transaction pipeline. TNZ is a buyer at a time when everyone is just kind of “meh” when it comes to energy stocks. That’s exactly when you want them to be a buyer, not when everyone has energy as their top sector pick of the year, right? Enough said.

With its $2.55 close today, TNZ is trading at ~0.2x EV/CF (that’s me rounding up from 0.16x). At just 1x EV/CF, the stock would be $3.60. At 1.5x EV/CF, the stock would be $4.25 and would arguably still be very cheap given the optionality it represents. Where do you think the stock will be after TNZ pulls off an acquisition of a $100 million plus asset? With only 27.6 million shares out, 25-cent moves in the stock move the market cap by less than $7 million, so I have to laugh when I see buyers and sellers sparring over nickels and dimes on a name like this. I have little doubt that smart institutions and high net worth individuals will recognize this in time, and relieve less thoughtful holders of their stock with little regard for even a 50-cent move in the share price — because when you want/need size, paying up is a sure way to get it when the sellers run out at a given level. Once the mid-2’s are cleaned out of what I can only assume are myopic sellers (sorry, but if I’m long and you’re a seller at 0.2x EV/CF with A+ management, you get that label), I think the stock moves/melts up into the mid-$3-4+ range while the market waits for TNZ to roll another asset in.

At some point, this story is going to get critical mass and start rolling downhill on its own due to gravity; and once a snowball is rolling down a hill under its own power it just gets bigger, and bigger, and bigger. I’ll point out that since the start of the year, roughly 50% of TNZ’s outstanding shares have traded hands at an average cost of about $2.25, so for those who think they’ve missed it, I would suggest that is not the case. TNZ made a very savvy move with this deal, and it undeniably sets the stage for much bigger things in the future. I don’t think this lasts in the mid-$2’s, but we’ll see…

Happy hunting.