Oil and gas firm Ascent Resources (LSE:AST) soared yesterday on the news that it launched a strategic review and formal sale process. Taken at face value, investors welcomed this news with open arms. This is most surprising when it seems the company has all but admitted it is unable to take forward its flagship Petišovci gas project in Slovenia on its own. On top of this, there are a number of red flags surrounding the company, which further call into question its fundamental value. The shares closed at 1.1p, valuing the business at £24.4m. With such a rich valuation there appears to be a genuine risk of Ascent descending from here.
The top line of yesterday’s “Strategic Review & Formal Sales Process” RNS was that Ascent has decided to seek either an offer or a partner with whom to develop its assets, all under the banner of maximising value for its shareholders. On its own, this is a standard stage of development and follows Ascent becoming operationally cashflow positive last November with the delivery of first export gas from Petišovci.
However, looking at the reasoning behind Ascent’s decision raises some question marks. Ascent claims that the planned further development of Petišovci and potential diversification into other regional projects is not currently an option for the business without the ‘potential of significant dilution for shareholders’.
Significant issue
Ascent’s use of the term ‘significant dilution’ is troubling. By their very nature, fundraises have a dilutive effect on shareholder value. Ascent’s use of ‘significant’ can, therefore, be interpreted as a sign these standard levels of dilution would be made worse by the placing being carried out at a substantial discount to its current price and market cap. In other words, the firm is strongly hinting that it believes it is currently over-valued – a possibility unlikely to be helped by the 26pc increase in the shares by yesterday’s close.
Raising money at a discount is not always a bad thing – indeed, we recently covered Serabi Gold (LSE:SRB) and Condor Gold (LSE:CNR) which both raised “significant” money at modest discounts to fund their projects. These investments reflected confidence in the gold market and the fundamentals on offer. But Ascent’s unwillingness (or inability) to raise sufficient funds at current levels suggests it does not have the confidence of serious money in either its assets or the market going forward.
It is therefore surprising that Ascent’s results for 2017, released alongside the strategic review announcement, offer a contradictory message. Non-executive chair Clive Carvey claimed Petišovci’s net present value is around ten times Ascent’s current £20m market cap, adding that the currently lagging share price is reason enough for not raising:
‘With the net present value of the Petišovci project estimated to be around ten times the current market capitalisation of the company and the share price lagging behind analyst estimates, now is not the time to dilute the underlying value in the company’s shares based on the levels at which they presently trade. Additionally, the board is clear that diluting from such a low level is not an option most shareholders wish to pursue. Equally, we recognise doing nothing is unlikely to be in the interests of shareholders generally,’
This so-called undervaluation becomes more complicated – and, indeed, more ominous for shareholders – when you consider the reality of Ascent’s financial situation, beyond the headline figures in its latest results. According to its latest presentation, the NPV10 of Petišovci is £199m. With net current assets currently sitting at c.£1.26m (Current assets (£1.84m) – Current liabilities (£576,000)), the market is valuing Ascent’s assets at around £18.59m at its current £19.85m market cap.
On the face of it, these figures are roughly in line with Carvey’s claims that the project is worth 10X the company’s value. However, one look at the firm’s cash situation shows that getting to this NPV and realising value will be far from straightforward. The business burned through a total of £6.75m last year, made up of c.£2.1m spent on operating activities and c.£4.7m spent on investing activities. With the help of two cash raises (here and here) throughout the year, the cash burn was mitigated to the tune of £4.5m in issued equity.
In its headline numbers, Ascent claims to have had cash reserves of more than £1m as at the end of 2017. However, this figure isn’t reliable. We can immediately discount £400,000 of this because it is restricted. To be frank, the manner of that disclosure is a bit of a red flag in its own right.
All-in-all, a less flattering picture emerges on digging into the numbers. Looking at the consolidated cash flow statement and Ascent started the year with around £3.2m cash and ended it with £721,000. With Ascent making just £240,000 from operating activities in 2017, it will almost certainly have to raise funds in some way to avoid entirely running out of money if it continues this rate of cash burn.
We are now four months into 2018- who knows where the cash position sits now?
The company hasn’t raised more money, and there is no indication the company has started to generate “significantly” more revenue. Although Petišovci’s NPV far outweighs Ascent’s market cap, the company’s financials create the feeling that yesterday’s announcement about a sales process might well set the foundation for an eleventh-hour funding attempt.
Debt funding?
This feeling of unease about Ascent’s current valuation intensifies when you consider other potential sources of financing. Another way of funding development and diversification would be through debt funding. Despite Ascent working on Petišovci for a long time –it became involved in the project in 2007 – today’s notice suggests it has been unable to secure debt funding needed to develop further. After all, if the company were able to secure debt, surely it would have done by now?
What might this failure to secure debt funding say about the quality of Petišovci? Might it mean it is not of sufficient quality for a debt provider?
Another indicator that Ascent would struggle to secure debt funding is the apparent lack of serious institutional support it suffers from. A quick look at yesterday’s disclosed shareholder register reveals that the company does not have a single large institutional holder. The top holders are all execution-only brokers, indicating the stock is held by retail investors. For a company with a £24.4m valuation, this is another concern and also an indicator of trouble to come.
Of course, the point about lack of debt funding and institutional support is speculative, but it would be foolish to ignore it. By all means, offer a counter-argument, but the fact is were Ascent able to fund Petišovci it wouldn’t now be looking to sell it.
Valuing Petišovci for sale
Now that it seems debt funding is off the table and Ascent’s board claims it cannot raise equity without ‘significant dilution’, this raises serious questions about Petišovci’s fundamental value. If any of the ‘expressions of interest’ from third parties it mentioned in today’s notice turn into some form of partnership or sale, then how much would Ascent make?
If the answer is ‘much less than expected’, then this will no doubt have significant negative implications on the company’s current c.£24.4m market cap, given Petišovci underpins its value.
