Description

Odyssey Marine Exploration

A Sea Change in Opportunity and Risk goes Unappreciated 

Odyssey Marine Exploration, (OMEX as is it is know on the NASDAQ) probably should not be a public company; but it has been and it is.  Odyssey’s business (as least as of yet) is not recurring, periods are not comparable, and many standard business valuation metrics are irrelevant.  That said, Odyssey is a company addressing multiple large economic opportunities with unique technology, strong intellectual property, and extensive experience that cannot be easily duplicated by others.  While, the past has been difficult, we believe that an investment in Odyssey common equity is now compelling.

Odyssey was born out of treasure hunting:  searching for and recovering the valuables from historical shipwrecks.  Today, however, Odyssey has transformed itself into a diversified company with multiple lines of business.  Odyssey’s experience, technology, and expertise surveying the deep ocean floor and recovering materials from miles below the sea have broadened Odyssey’s opportunities.  In addition to Historical Shipwrecks, Odyssey is pursuing Modern Shipwrecks holding valuable commodities and the Exploration and Mining of Minerals from under the sea.

While Odyssey has not been a disaster for shareholders over the past ten years, the past six years have been difficult for most involved.  In 2003, Odyssey achieved a moderate success with the salvage of the SS Republic, a Civil War era wreck yielding over 50,000 coins and 14,000 artifacts from nearly 1,700 feet below the surface of the ocean.  Odyssey then delayed a salvage of the HMS Sussex (off the coast of Gibraltar in partnership with the United Kingdom) to pursue a project OMEX code named “Black Swan”. 

Not going into too many details of the “Black Swan” project (you can read a summary here: http://en.wikipedia.org/wiki/Black_Swan_Project); in short, in 2007, Odyssey recovered a treasure from an unidentified wreck and/or wrecks that was estimated to be worth over $500 million.  Odyssey transported the treasure to the U.S. and filed in the U.S. Courts for an arrest of cargo to establish a legal claim. 

Under various international maritime laws and conventions, 85-100% of recovered salvage is awarded to the salvage firm.  However, Spain sued to claim the entire ownership of the cargo, asserting it was from the wreck of the Nuestra Señora de las Mercedes.  Spain refused to pay any salvage award arguing all the assets recovered from the Mercedes were protected by sovereign immunity.  Cables released by Wikileaks point to the U.S. Government conspiring with the Spanish Government to relieve Odyssey of the haul. 

Regardless of the maritime law details, and the merits of the case, Odyssey, after a long court fight, lost the treasure in 2012, the cost of the salvage effort and the expense of the court battles that ensued.  (The Spanish are still after Odyssey for their court costs as well.)  Furthermore, the animosity with the Spanish Government has prevented Odyssey from pursuing the Sussex because it lies in (potentially disputed) waters off Gibraltar.

Odyssey survived the difficult period between 2007 and 2012 primarily through equity dilution and project level financings.   This allowed Odyssey to continue operating, albeit at significant cost to existing shareholders.  The visible scars include a doubling of the basic share count over the past decade to almost 80 million (79.625 million shares exactly), and Net Operating Loss Carryforwards that stand at $129 million.  The less visible scars include a short interest that amounts to 19% of the float, several legacy project financing arrangements that leak some value out of future projects and a host of burned investors who likely consider Odyssey an expensive E-ticket ride akin to Pirates of the Caribbean.

We, however, believe Odyssey is an attractive investment today because, despite the setbacks of the past six years, the opportunity is real.  Odyssey’s wreck identification capabilities are proven.  And, recently, Odyssey’s recovery of 110 tons of silver from the SS Gairsoppa, three miles below the ocean surface, proves its recovery technologies and capabilities are profound.  Odyssey has unique technology; capabilities and experience that create a competitive advantage and a true moat around its business. 

To date, Odyssey’s greatest vulnerabilities have been its risk taking, capital structure, and reliance on only the volatile and controversial historical shipwreck business.  However, Odyssey’s corporate governance and management approach has evolved following the Black Swan.  Odyssey has changed its legal risk threshold for pursuing salvage opportunities.  Previously, Odyssey was willing to rely on maritime law to ensure they could legally claim ownership of tremendously valuable salvage.  Their experience with the Black Swan has circumscribed that belief, and now, Odyssey is focused on projects where they have an upfront contract with whoever was the last owner of the target cargo; thereby eliminating a significant legal risk.  Odyssey will also pursue targets without any potential claimants.  Most deals seem to be structured with Odyssey bearing the expense of salvage, then being reimbursed for those expenses from any recovery.  Any recovery in excess of project costs are typically split 80/20 or 90/10 in Odyssey’s favor.

The success of the Gairsoppa has validated Odyssey capabilities and established a cash balance from which Odyssey can fund its business plan without dilution.

Finally and most importantly, Odyssey has expanded its business activities beyond Historical Shipwrecks to modern Commodity Shipwrecks, and Undersea Mineral Exploration and Mining.  Odyssey has also diversified its operations geographically so that salvage operations will be conducted year round as opposed to only in the North Atlantic’s temperate summer months.

We believe the commodity shipwreck business alone can justify today’s market cap.  If you give Odyssey credit for their equity stakes in several undersea mineral exploration and mining ventures, you are one or two moderately successful salvage projects away from getting Odyssey’s business for free.  Both the Mineral Exploration and Historical Shipwreck business have the potential for finds worth multiples of Odyssey’s current market cap.

Odyssey is engaged in three lines of business:  Historical Shipwreck Recovery, Modern Commodity Shipwreck Recovery, and Undersea Mineral exploration and Mining.  Odyssey conducts its shipwreck recovery search and salvage operations from the Odyssey Explorer, its owned 251 foot Class II dynamically positioning ship.  Odyssey also will charter other vessels, as was done with the SS Gairsoppa, if the situations requires.  Odyssey conducts its underwater mineral exploration activity from the Dorado Discovery, a specially equipped over 300 foot vessel under long term lease to Odyssey.

Historical Shipwreck Recovery:  Research, location, and recovery of cargo from historical shipwrecks with cargo values in excess of $50 million.   According to Odyssey, There are scores of shipwrecks above US $50 million in value, with the most valuable projects approaching $500 million to $1 billion.   The rewards and risks here are massive as demonstrated by the Black Swan project.  

It is difficult to price long term, out of the money options.  However, if the commodity shipwreck business builds on its recent successes, the series of options embedded in the historical shipwreck business become significantly more valuable.

Odyssey needs to demonstrate success with a historical shipwreck recovery (in cooperation with an owner) for investors to properly discount future potential cash flows from this business.  That said, a single recovery could be worth twice the company’s market capitalization and some option value probably is warranted, but not priced in.

Currently, Odyssey is waiting for the go ahead from the UK Ministry of Defense (MOD) to commence the salvage and archeological excavation of the HMS Victory wreck.  The HMS Victory was the preeminent ship of its time when in 1744 it was lost to a storm in the English Channel. 

Some estimate Victory’s cargo could be worth in excess of $1 billion.  A previous Odyssey investor presentation suggests that $250 million is reasonable.  Odyssey’s contract with the UK Government stipulates Odyssey will receive reimbursement of its project costs, 80% of the value of the coin and commercial cargo and 50% of the value of any artifacts recovered.   Mitigating the opportunity somewhat is Odyssey’s project financing agreement with Galt Resources, LLC (an entity controlled by John Morris, Odyssey’s former CEO).  Under the agreement (by which Odyssey raised $7.5 million in 2011), Odyssey must pay Galt 50% of the first $30 million of Odyssey’s net proceeds from the Victory and 7.51% thereafter.  Assuming the recovery from the Victory is $250 million and project costs are $20 million (benefited by the shallow location, ability to use the Odyssey Explorer, offset by the time and care required by archeological obligations), Odyssey’s profit after paying Galt would be over $150 million.  A $50 million recovery would net Odyssey $12 million, whereas a $1 billion treasure would net Odyssey over $700 million.      

As has been typical of these historical shipwreck projects, there is significant political and cultural opposition to the commercialization of a “gravesite”, and the “nation’s history”.  Odyssey’s argument in favor of the project focuses on the damage being done to the sites by scavengers, the environment, and modern seaborne commercial activity.  Most importantly, the commercial salvage will fund a thorough archeological excavation of the wreck to preserve the Victory’s story and artifacts for all to learn from and enjoy.

Approval for the HMS Victory has been delayed by other UK government priorities, and politics.  A September 2012 Odyssey investor presentation suggested final UK government response was expected shortly.  Since then twelve months have passed with little news beyond a December 2012 debate in the House of Lords on the merit of the project and soft reassurances from Odyssey that the project is still expected to be given a green light. 

The approval could be announced tomorrow or never.  We do not know what is going on behind the scenes.  However, only the go ahead would likely pop the stock 10-20%.  Just as important as the economic value of the Victory, a combined commercial and archeological success would likely bring other countries and projects to the table with Odyssey.

In addition to the HMS Victory, Odyssey is constantly updating its research on potential target locations, cargo values and risks.  Odyssey has developed a database of thousands of wrecks; cataloging cargo information, location information, and legal information.  This should continue to yield attractive targets for years to come.

Specifically, Odyssey has asserted they will pursue 1-3 additional historical shipwreck recoveries over the next couple years.

Commodity Shipwreck Recovery:  Research, location, and salvage of high value modern (typically 20^th century) commodity shipwrecks.  Commodity shipwrecks typically offer smaller targets than historical shipwrecks.  However, the recent ship losses and salvage contracts, with relatively minimal cultural resource issues allow for lower risk projects.  Odyssey’s SS Gairsoppa project (salvage conducted in the summers of 2012 and 2013) is a proof of concept.  Enabled by the experience and technology Odyssey gathered over the past fifteen years researching, locating and excavating historical shipwrecks, Odyssey located the wreck of the SS Gairsoppa quickly, and over two expeditions recovered 110 tons of silver from 15,000 feet below sea level.

Odyssey believes there are scores of shipwrecks worth more than $20 million, with some worth as much as $100-200 million.  Depending on the difficulty of recovery, the financial model can be compelling.  We estimate the SS Gairsoppa project (in total) yielded approximately $84 million in gross cash flows on outlays of approximately $25-30 million.  Odyssey’s operating profit (before its project financing deal with Galt Resources LLC) is estimated to be over $40 million after approximately $30 million spent and far less actually risked (i.e. they would not have spent as much on salvage if the project was not yielding material).

Odyssey says that it currently has over 25 targets in its commodity wreck pipeline with an estimated recovery value of approximately $800 million.  Odyssey’s announced commodity wreck pipeline currently consists of four World War II era wrecks containing non-precious metal cargo such as tin and nickel.  The cargos were estimated to be worth over $230 million in September 2012 and are estimated to be worth $184 million at today’s prices (per Odyssey’s June 30^th 10Q).  Odyssey has not given much detail out about the targets other than to explain the recoveries are believed to be less complex than the Gairsoppa.  Because the silver on the Gairsoppa was hidden and represented only 2% of the gross tonnage of the vessel, it was difficult to find.  The commodity metals on these next four targets are located in the main cargo hulls and represent 52% (on average) of the gross tonnage of the vessels (i.e. you find the ships and you’ve found the valuable cargo).  While Odyssey spent most of the Gairsoppa project searching the wreck for the 110 tons of insured silver and the uninsured silver alleged to be on board but never found; the commodity metal project will be more heavy lifting of the 13,000 metric tons of metal from the ocean. Given that salvage costs are directly related to time at sea, the small time needed to locate cargo should make costs much more variable to the material recovered.

To model the financial impact we have made several assumptions:

$15 million salvage cost on successful vessels ($100K per day for 150 days), $3 million salvage costs on unsuccessful vessels ($100k per day for 30m days).  We believe this is likely to prove conservative both in cost per day and time required.

For example purposes we are also assuming identical cargo values for each vessel because we do not know the distribution, and 5% smelting and other costs (60% more than with the silver from Gairsoppa). 

A $184 million recovery (i.e. success with all four vessels) would yield $124 million in gross profits to the Odyssey/Owner partnership and approximately $103 million to Odyssey.  A scenario where two vessels for some reason yielded no salvage, and recoveries were $92 million would yield $56 million in gross profits and approximately $46 million to Odyssey.  Given that we are estimating salvage costs to be $12-$60 million, there are likely to be significant project financing expenses (although some of this can be ameliorated by sequencing the projects, and asset based financing once recovery is assured). 

All that said, $46 to $103 million of potential next 12-24 months project level operating profits are immense for a company with a $250 million market cap and an enterprise value around $60 million.   Yes, there is the possibility of a loss, but it is not the most likely scenario.  Furthermore, Odyssey believes that there are other targets not requiring salvage agreements that can be added to the program and undertaken while Odyssey has a ship nearby.  Work is targeted to begin in 2013.

Skeptics might point to the failure of Odyssey to recover any silver from the SS Mantola in the summer of 2013.  Our response is that Odyssey addressed the Mantola with only the remainder of time from its charter hired to salvage the Gairsoppa.  Given the low cargo value (~$12 million), limited time, and small size of the cargo (i.e. it was silver ingots not beams of tin) we do not believe the comparison is relevant.

Undersea Mineral Exploration and Mining: 

Several years ago, Odyssey began to provide exploration services to several early stage underwater mineral exploration companies.  Odyssey believes mining minerals from the ocean floor will be a large opportunity.  From Odyssey’s website:

Nearly 100% of the minerals and metals consumed today come from land-based mines. However, metal concentrations from sample deposits of recovered seafloor rock are significantly higher than those mined commercially around the world from onshore sites. And these deep-sea deposits can be extracted in a more economically efficient and environmentally friendly manner than in traditional land-based mines

Seafloor Massive Sulfide (SMS) deposits are naturally occurring deposits that contain high concentrations of gold, copper, zinc, silver and other metals in relatively compact areas. Although their existence is possible anywhere that new ocean crust has formed, the highest grade deposits have been found at convergent plate margins and earthquake-prone areas especially in the waters of the South Pacific, New Zealand and Japan.

We know in addition to Seafloor Massive Sulfides, Odyssey and other exploration companies are focused on phosphates, valuable for use in fertilizer.

Odyssey has created tremendous value from its Undersea Mineral Exploration activities.  In working with exploration and mining companies, Neptune Minerals, Inc. and Chatham Rock Phosphate, Odyssey has charged its expenses in cash and taken equity as upside for its services.   More recently, Odyssey has leveraged its capabilities to undertake undersea mineral exploration as a principal through a subsidiary called Oceanica Resources.  Over the past 24 months, Odyssey has invested $26 million in exploration activities using its ship the Dorado Discovery; generated $40.3 million in cash from fees and sales of equity as well as built up equity positions with a current private market value of $179 million.

According to Odyssey there are likely hundreds of ore deposits at the bottom of the ocean with a net present value above $500 million, with many worth billions. 

Odyssey currently has stakes in three companies and will continue to attempt identify and develop other deposits.

Neptune Minerals (private)

Neptune Minerals is a private company run by Odyssey’s former CEO John Morris.

Neptune is aggregating underwater mineral rights in the Southwest Pacific.  Odyssey owns 6.2 million shares, or 30% of Neptune, which at the last private round of $17.50 per share would imply a $109 million value. According to Odyssey’s June 30^th 10Q, “Odyssey and Neptune are currently planning operations in one of Neptune’s highly prospective tenement areas to produce a formal resource estimate.”

Chatham Rock Phosphate (Publicly traded in New Zealand)

Chatham Rock Phosphate has large phosphate deposits off the New Zealand coast and is seeking a mineral license.  Odyssey’s 9.32 million share stake is worth $3 million at recent prices, although a discount is probably warranted given the liquidity and trading restrictions.

Oceanica Resources, S. de R.L. (private)

Oceanica is an Odyssey subsidiary based in Panama focused on mineral exploration.  According to Odyssey’s June 2013 10Q:

[Oceanica] controls exclusive permits for offshore mineral deposits in an area, which is believed to feature a valuable mineral resource, based on extensive exploratory activities undertaken by Odyssey.

Investors first learned about Oceanica in February 2013 when Odyssey announced the sale of 15 million shares in Oceanica (and an option to purchase another 15 million shares at $2.50) for $15 million to an investment fund called Mako Resources LLC.  Following the transaction Odyssey owned 62.6 million shares out of 100 million outstanding, implying a $62.6 million value.

While Odyssey and Oceanica have not made public what type of resource Oceanica is targeting, it does appear Oceanica has made significant progress in defining its find.  While the March 30, 2013 10Q report stated:

Preliminary resource assessments indicate that the concessions may prove to have significant economic value.

The June 30th 10Q replaced that language with (emphasis ours):

Preliminary resource assessment based on extensive coring and laboratory work suggests that the mining concession, which has been granted for a 50 year period to a subsidiary of Oceanica, is a world-class resource with significant commercial and strategic value. Coring sample assay results and preliminary sample beneficiation tests (sizing and flotation) indicate that the resource can be feasibly and economically mined and processed. A draft Technical Report featuring a formal resource assessment is in process and one of the world’s leading investment banks is advising the company on options for maximizing the value of this asset.

In June 2013, Mako and Odyssey renegotiated a portion of the option contract whereby Mako purchased 8 million shares of Oceanica at $1.25 per share.  While this is below the original $2.50 per share option agreement it is still 25% higher than the $1 per share price from February and did not include any attached options.  The price apparently was adjusted “to facilitate the transaction.”  We read this as Odyssey needed the money for the Gairsoppa salvage operation.  At the same time, “to maintain control”, Odyssey purchased 1 million shares of Oceanica from another equity holder at $1.25 per share and was granted a one-year option to purchase another 1 million shares at $2.50. 

Mako still holds options (expiring December 31, 2013) to purchase seven million Oceanica shares at $2.50 per share.  Odyssey currently owns 55.6 million shares of Oceanica, which if valued at the $1.25 last transaction price would imply a value of $69.5 million.   If the asset truly proves to be a “word class resource”, we believe this stake could be worth significantly more than $69.5 million.

Capital Structure

Odyssey’s clear weakness has been its capital structure.  Shipwreck recoveries and undersea mineral exploration both require significant risk capital, a resource Odyssey has had little of, forcing it into value leaking project financing transactions or dilutive convertible debt sales.  

The Gairsoppa silver recovery and Oceanica share sales have put Odyssey in a position of strength for the first time in many years.  With approximately $25 million of cash pro forma for Gairsoppa silver sales, Odyssey should not be forced into hard money project financing or dilutive equity transactions.

Risks

Further declines in Gold, Silver and base metal prices

Significant declines in Fertilizer prices

HMS Victory Project further delayed or blocked

HMS Victory salvage fails to recover significant value or worse does not cover costs

Commodity projects fail to recover significant valuevor worse fails to cover costs

Undersea mineral mining proves to be uneconomical or impractical

Equity in Undersea mineral exploration and mining ventures proves worthless

Summary

Odyssey Marine Exploration is a compelling opportunity today because the company is well positioned with a capital structure, business plan, and project opportunities that are not understood by the market.  A history of controversy, bad luck and the nature of Odyssey’s business has resulted in the stock being largely ignored by the analyst and institutional investor community.  A significant change in Odyssey’s prospects goes unappreciated, and at current prices one is practically getting future opportunities for free.  Multiple catalysts are near term (next 6 to 18 months) and the downside is limited due to what appears to be meaningful asset values relative to the market capitalization and the more predictable nature of the commodity wreck recovery business as a base line.

Catalyst