|Shares Out. (in M):||60||P/E||0||0|
|Market Cap (in $M):||300||P/FCF||0||0|
|Net Debt (in $M):||150||EBIT||0||0|
|Borrow Cost:||Tight 15-50% cost|
Lilis Energy (LLEX) checks so many boxes as an attractive short candidate that the question isn't if it will go down, possibly to 0, but when. These boxes include:
1) Founding CEO indicted for securities fraud and removed from duty
2) That CEO being paid $1 million to leave plus benefits and stock vesting
3) Multiple toxic debt and warrant financings including penny warrants
4) Chairman who was recently the CFO of a recently bankrupt company that also had financial and regulatory issues
5) a questionable land base with wells only drilled on one side
6) recent borrowings to lease land on the side of the land base that has not been drilled on
Positive attributes of the company include:
1) the wells that have been drilled are highly productive, driving rapid production growth
2) some portion of the land base has been proven very valuable through these prolific wells
3) the company has been able to secure capital (albeit very expensive and with a large warrant overhang) in the midst of a prolonged industry downturn
4) the company has effectively told its story and achieved a high valuation and a following among investors willing to overlook the numerous red flags
So, what is an e&p company worth with only one fringe of its land working? There are comparable transactions and public company comparables that are helpful, depending on the number of zones that work and how economic they are. Approximately 1/3 of LLEX's land has been delineated in the Wolfcamp B. Recent high transaction prices have been on land with 3 or more proven zones, and the high prices have been $40,000 per acre, or about $13,000 per acre per zone, along with approximately $30,0000 per BOEpd. LLEX is over valued even if 100% of its land "worked" for the Wolfcamp B on those metrics, and with only 1/3 proven, it is pricing in full delineation of the Wolfcamp B across land to the East that even Lilis hasn't been brave enough to drill on, and is pricing in at least one more zone working, which hasn't been proven yet.
Lilis has been working a highly effective promotion scheme. To the extent that even energy specialist banks like Johnson Rice and Tudor Pickering are touting recent well results. The most recent result, touted by Tudor Pickering as "delineating" Lilis's land, is to the North and West of the bulk of Lilis's undrilled land. It does not prove much at all, other than that Lilis would prefer to drill on small blocks of land rather than drilling on the main block to the East. When it can raise debt and equity around "acreage value", why would it drill to prove it?
There is a risk that Lilis or other private operators drill to the East and that the wells are productive. It is unlikely, as elsewhere wells drilled on the Eastern fringe in similar depth and pressure environments have been uneconomic. But perhaps new technology or specific geology will change that. Given our history with stock promotions, we will take the "under" on those odds. The other risk is that other zones will be proven to be economic on or near Lilis's land. Again, unlikely, already priced in, and we will take the "under".
What will make this short work are: 1) Gravity is inexorable. Overvalued stock promotions eventually fail. 2) Lots of warrants and debt are outstanding. Warrants being exercised will increase the float and weigh on the stock, and that debt will eventually need to be repaid and interest will need to be paid. 3) Regulatory risk. Considering the active SEC case against the former CEO, there is unusually high risk that regulators do their job and look into Lilis. An annoucement of an investigation, even if nothing is found, could increase the cost and decrease the availability of capital, accelerating items 1 and 2 above. 4) Corporate decline rate - rapidly growing oil companies make for great stories, but initial production declines rapidly. The 5,000 BOEpd guided to by the company for January 2018 will be declining by more than 50% a year. Substantial drilling will need to be done just to hold that production flat, depleting scarce proven inventory and capital.
Gravity. Warrants exercised and debt comes due. SEC investigation into former CEO expands. Rapid production decline rate kicks in.