Chariot Oil & Gas (LSE:CHAR) reminded commodity firms how important it is to correctly manage their funding strategy yesterday. The company’s shares collapsed by nearly a third on the back of an unsuccessful drill in Morocco. Chariot failed to find any accumulation of hydrocarbons at the Rabat Deep 1 well in Morocco, where it owns a 10pc stake. It has now plugged and abandoned the well, with chief executive Larry Bottomley calling the outcome ‘very disappointing’. That is certainly one way to put it, but what has probably disappointed shareholders more is the manner in which the company raised money at the end of March.
Chariot’s problems began at the end of February when it chose to raise $15m (£10.7m) by placing shares at 13p each to help fund the drilling of a second well in 2018. This placing price represented an eye-watering 36pc discount to Chariot’s market price of 20.3p and came just two weeks before it began drilling Rabat Deep 1.
For an exploration company like Chariot, placing at such a massive discount so close to drilling was problematic for several reasons. It gave out entirely the wrong message to the market about the business’ valuation and suggested it was desperate to raise the cash. In this case, the placing utterly destroyed all the positive momentum that had been flowing into Chariot from the retail market; its shares had risen from 12.8p to 22.2p in just under three months. In the end, the speculation leading up to the placing (thanks to someone leaking it in public) and the placing itself led shares to collapse by nearly 50pc in just two days.
Unfortunately, Chariot’s problems weren’t limited to the significant discount. The damage was compounded by a further €5m (£4.4m at the time) open offer to qualifying shareholders, again at the 13p placing price. Eventually, the firm received subscriptions for 41pc of the open offer shares available, raising £1.8m. While 41pc represents a decent uptake of an open offer, it still sent out a message of weakness to the market.
At the ValueTheMarkets.com we are fully supportive of companies giving existing shareholders the opportunity to participate in fundraising deals. Too many companies ignore their long-term holders, so in this respect Chariot should be applauded. However, open offers (or deals through the Teathers App) do need to be managed in the right way.
By giving retail shareholders the opportunity to participate in deals, companies also invite a vote of confidence in their stock from the secondary market. As such they tread a fine line when sizing the deals. On the one hand it is right to give shareholders a fair crack of the whip, but if the company sets the size of the raise at too high a level this can send out a message of weakness to the market if the deal is heavily undersubscribed.
In Chariot’s case, raising £1.8m from shareholders was a positive endorsement of the company’s strategy; however because it set the size of the open offer at £4.4m the 41pc take up took the shine off the overall. Had the company announced a smaller open offer, with the potential for an over allocation this might well have worked out better, sending out a much more positive message to the market that the deal was oversubscribed.
Whatever the case, the saturation of discounted shares onto the market from the placing and open offer so close to the drill was likely a major contributing factor to the subsequent, continued decline of Chariot’s share price. The overhang was too great and there was not enough time for the market to absorb it and for the shares subsequently to rally. Indeed, the firm fell a further 21pc in the weeks between the placing and today’s announcement. This is the opposite of what is meant to happen when a company is hunting as large a target as what at Rabat.
Alas, the approach cannot always work, and in Chariot’s case, the ‘smart money’ – as it were – got its fingers burned. By destroying market sentiment with a heavily-discounted, poorly timed placing, the pre-drill excitement never materialized. In many ways, Chariot completely killed all of its speculative appeal and the exit of speculative investors further damaged its share price.
What should Chariot have done?
It is easy to comment from the sidelines (and in hindsight) but would it not have been better for Chariot to have placed earlier?
If the business had raised between September and November last year, when its share price was between 15p and 16p, then 13p a share would have been a much less significant discount. This approach would have also got funding out of the way early doors and given Chariot plenty of room to be a speculative play, given that drilling was still some way off.
This didn’t happen, so another solution might have been to increase the placing price of the February placing to narrow the discount. This would have required the company’s corporate brokers to recognize that although the company needed money and they had the whip hand, by inflicting such a nasty discount on the market so close to the drill they didn’t give it enough time to recover and focus again on the potential of the drill. Placing closer to market value would have raised fewer questions around Chariot’s valuation just weeks ahead of an all-important drill, perhaps protecting some of its value in the process.
Not the end of the world
The question now is what happens next for Chariot after getting its funding strategy so catastrophically wrong?
With a massive second drill coming up in the second half of the year, it is by no means the end of the world. Indeed, if oil prices continue to improve and other drills have a decent strike over the summer, then we could find ourselves in a bull market for E&P plays. In this case, Chariot could look more attractive in a few months’ time once the dust has settled – much will depend on where the share price drifts over the next few months.
For the time being, however, there is no rush to buy the business as there is a good chance you will be able to buy it at below the current price. We, for one, have a close watching brief. In the meantime, the lesson to learn from Chariot’s story over the last few months is that oil exploration companies risk destroying all of their speculative appeal if they do not get their funding strategy right. Timing, price and size are critical. Perhaps a company can afford to mess up on one of the three, but to fail across the board is extremely difficult to recover from.