Monday, June 14, 2010

Working The Numbers Backward Can Be Enlightening

Houston American Energy [ HUSA ] has been causing me some pain lately. I'm still ahead of the game, but don't enjoy the cushion I once did. The last several days have caused me to question my thinking and consider covering my short position. OK, I've considered my options and I'll stay short. The pain may get worse, before it gets better again, as HUSA's new found market cap makes it a likely candidate for inclusion in a Russell Index at the June 30 rebalancing. Inclusion will cause some one time buying by index funds and remove a little float. But it doesn't change any of the fundamentals of the company itself and those fundamentals are very over valued.

HUSA is a three employee operation that has some small working interests in a couple of Louisiana and Texas wells that hardly produce any oil/gas. Additionally they own other minority working interets in some Colombian properties. That's right, Colombia land of the drug cartel and women that wear funny hats. Those wells are producing some oil, but not huge amounts. Basically the Colombia properties are speculative in nature, not proven reserves. They do happen to be near proven properties and that leads to the hype. And that is what I believe is in full gusher at HUSA, hype, not substance.

Here are the numbers that speculators are willing to pay:
Price/Book 12X
Price/Earnings 108X
Price/Sales 35X
Market Capitalization $434 million

Can it get better than that? Do buyers really think shares can double? Let's work some numbers backwards from the current market cap of $434 million. If HUSA was a real operating company with current production and very good future prospects, an investor might be willing to accept an earnings yield of 5%, or a 20 P/E. That would mean the $434 million market cap should be justified with $22 million of after tax earnings. HUSA has been making about $500,000 per year until last year when they lost $670,000. They did do considerably better in the 1st quarter as they made $800,000 or annualized, $3.2 million. Clearly current revenue and net income doesn't justifiy the current market cap. What does then?

In the last quarter of 2009 HUSA raised about $15 million at about $4.50 per share and used that money to buy some Colombia concessions. Magically the stock price rose and the company is now worth multiples of that equity raise. Additionally, most of their producing Colombian properties are for sale. Hupecol, the managing partner, is attempting to sell wells and leases that produced most of HUSA's $4 million of revenue in the 1st quarter. How much can $4 million of revenue be worth? The unproducing areas require lots of expense and risk, so how much can the rest be worth? The company points to a similiar, they say, sale by Hupecol, 6/08, that fetched $920 million with HUSA's share amounting to $11.5 MM. Those proceeds didn't last long as HUSA needed to raise cash in 2009 and will spend an additional $10 million in 2010, fortunately they have about $14 million on hand and no debt. Even if Hupecol can arrange a sale that, pick a number, gets HUSA twice the proceeds, they have more cash and no operating wells. What would you pay for cash today? It's still going to be a company that is valued on hype because they won't have any production after a sale.

Can 1000 barrels per day production and a bunch of leases be worth $400 million? I think there is little danger that actual business results begin to justify the current share pricing. Therefore, the price will adjust downward again as soon as the euphoria ebbs.

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