Orca Exploration Group: A Highly Profitable Business For Free

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Orca Exploration Group is a holding company with headquarters in Tortola, British Virgin Islands, and listed in Toronto (CVE Exchange) under the ORC.B ticker as well as in the US OTC market under the ORXGF ticker.

It holds a 92.07 % stake in Pan African Energy Management (PAEM) which owns 100% of Pan African Energy Tanzania ((PAET)), the leading natural gas producer in Tanzania. Their gas is sold in Tanzania at contract prices in USD and the business is immune to natural gas prices fluctuations until 2026.

PAET has a producing agreement until 2026 which can be renewed upon agreement by both parties.

In addition, the company has an ample net cash and investments position (in USD), which represent more than its current market cap as well as receivables (currently being paid) representing roughly half of its current market cap.

The investment is compelling to us because the company currently trades below its cash (including liquid investments) at holding company level and we get receivables and the business for free while the private market value of the business has recently been appraised at multiples of its market cap as shown by the Swala transaction terms :

"Pursuant to an investment agreement (the " Investment Agreement ") with Swala PAEM, Swala PAEM has agreed, subject to conditions, to acquire up to 40% of the outstanding shares of Orca's wholly owned subsidiary, PAEM, a Mauritius-registered company and the sole shareholder of PanAfrican Energy Tanzania Limited (" PAET ") for a purchase price of US$130 million (subject to certain purchase price adjustments). The investment transactions are based on an agreed value of US$325 million for PAEM (US$265 million net of the outstanding IFC loan to PAET). PAET owns and operates the Orca Group's natural gas exploration, development and supply business in Tanzania."

Amazingly, the company is not in distress at all: its situation is improving over time and the company recently started to pay dividends ($ 0.6 CAD per share paid in 2018 and $ 0.05 CAD per share have already been announced for Q1 2019).

In addition, several potential catalysts on the horizon could help the market realize Orca's value.

Short history of the business

The company was formed as a spin-off from Pan Ocean Energy, a company led by owner-operator David Lyons. Pan Ocean was subsequently sold to Addax Petroleum at $ 1.6 billion USD.

The company faced a serious issue in the past (its main client, Tanesco, was not paying its bills) and this led to a collapse of its share price in 2012. Of note, the company was still generating positive cash-flows despite not being paid.

This resulted in the accumulation of unpaid receivables, which totaled nearly $ 80 Million USD net of payables and have been written-off from Orca's balance sheet (while the payables remained, though they will not be paid before Orca recovers its receivables).

In late 2017, Tanesco became current on its bills and started to pay down its receivables. Their outstanding amount was $ 59.5 Mil USD at the end of Q3 2018 as can be seen in the latest quarterly report .

Business dynamics

The only operating business of the company is PAET, which produces and sells natural gas in Tanzania (Orca Exploration also owns exploration rights in Italy: we will ignore that asset in this write-up).

There are only two sources of energy in Tanzania currently: water and natural gas. As rivers are drying, natural gas is the way to go and new gas plants are being built. One of them came online in the end of 2018.

Orca is a key player in the Tanzanian Economy and is likely to benefit from the ongoing electrification of the country. Competition has intensified somewhat in 2015 as some majors like Engie (a leading French energy conglomerate) entered the Tanzanian market, but only one other operator was able to operate profitably. As a result, most operators are leaving the country and PAET should be able to keep its leadership. The most recent Swala presentation helps in gaining a better understanding the current context in Tanzania and explains why historical producers should be able to keep their advantage: new license terms for Oil & Gas companies look too challenging. Both Orca's significantly better license terms and its status as the biggest producer lowering their cost per unit sold should help PAET sustain its leadership in the country.

The rates at which PAET sells its gas are defined by contracts (with price hikes every year). Contrary to most commodity producers, the business is not dependent on commodity prices and has superior economics (especially when its bills are paid by its clients) compared to traditional E&P companies.

PAET can easily double its gas production if required, and recently announced additional gas orders that will use its increased delivery capacities. Some of the increase is already planned for 2019 as shown by Orca's latest presentation which states: "January 2019 AG sales averaged 63 MMscfd (40 MMscfd for the year ended 31 December 2018)" and guides for 60 - 75 MMscfd production in 2019. Orca's production capacity is currently more than 180 MMscfd. This capacity is expected to be tapped as new gas plants come online.

Increased deliveries should help the bottom line and may serve as a catalyst as the business is likely to screen better on a PE ratio basis starting in FY 2019.

It should be noted that despite its challenges with Tanesco, the business generated on average more than $ 25 Million USD in cash from operations in the last five years and that it generated $ 48 Million USD in FY 2017. The trend is likely to improve as Orca collects Tanesco receivables and delivers additional volumes.

Future capex should be minimal as PAET has already done all the infrastructure upgrades required to increase its future production.

Recent Swala transaction highlights the private market value of PAET

In January 2018, Swala Oil and Gas Tanzania bought a 7.93% stake in PAEM (which holds 100% of PAET). The transaction valued PAET at $ 265 Million USD net of the company's debt (contracted with a subsidiary of the World Bank).

This shows that the value of Orca's stake in PAEM can be appraised at $ 244 Million USD on a private market value basis, which represents approximately twice the current share price of Orca Exploration Group.

Swala Oil and Gas Tanzania can increase its stake to 40% until 03/31/2019. Swala recently raised $ 30 Million USD from a Tanzanian investor and is in the process of raising additional funds.

The completion of Swala's investment may serve as a catalyst should it be completed.

Of note, Orca paid a generous dividend of $ 0.6 CAD per share after the completion of the first tranche of Swala's investment. Additional dividends may help investors as well. The recent corporate presentation highlights tha t dividends will now be considered on a quarterly basis.

Tanesco receivables should be paid

Management states in several of their past presentations, for example this one one slide 17, that they expect to recover the full amount of the Tanesco receivables: "Despite IFRS reporting requirements the Company expects to receive full payment of the total TANESCO receivable". The continued collection of the receivables is very encouraging.

The most recent investor presentation provides up to date amounts regarding these receivables: "Working capital including cash of US$80 million as at 30 September 2018 excludes a US$59 million gas receivable and US$25 million of related late payment interest from the electricity utility, TANESCO. These have been fully provided for in Orca's financial statements. The gas receivable element peaked at US$74 million in 2016; since then TANESCO has repaid US$15 million of this amount."

A recovery of the provision should help investors using low price to book screens uncover the investment opportunity as this provision significantly depresses the book value of the company.

It should also help investors recognize the earnings power of the company (and the stock should also better screen on a PE ratio basis in the future) as Tanesco long-term receivables have been written-off from the balance sheet and the recovery of the amounts would increase Orca's reported earnings (through reversal of the provision) and cash-flows.

The process may still take a year or two, but it seems reasonable to expect a positive outcome as Tanesco will likely need additional gas volumes from PAET in the future.

An interest amount of ~ $ 25 Mil USD may also be collected.

The company has a rock-solid balance sheet and capital allocation has been cautious

As briefly mentioned above, Orca has an ample net cash position and all the debt is in its PAET subsidiary. Orca only guarantees $ 30 Million USD of PAET's debt (which is $ 58.6 Million USD), but the guarantee shall not be enforced if PAET stays profitable (as we expect). The terms of the loan can be read in the lates t quarterly report :

From our perspective, Orca is thus debt free at the holding company level. We don't expect any refinancing of PAET coming from Orca.

The latest balance sheet shows:

- Cash & Equivalents: $ 61.44 M USD

- Short term bonds: $ 66.6 M USD

- Long term bonds: $ 3.76 M USD

- Investments (Swala Oil & Gas preferred shares): $ 3.97 M USD

Total cash and investments: $ 135.77 M USD

We believe it is reasonable to count Swala shares as its Kilosa permit may have significant value and because it has managed to raise money on very good terms recently. However, the amount of the investment is not meaningful for the thesis: even it this investment goes to zero, we should be fine at the current stock price.

It should be noted that the deal in which Orca sold a minority stake in PAEM to Swala entitles Orca to keep all the proceeds from the past Tanesco receivables pay-down: "Under the Investment Agreement, Orca would have the right to monetize the benefits of certain assets, and the obligation to bear the burden of certain liabilities of the Tanzanian business that relate to the period prior to 1 January 2017 (the "Effective Date" ). Pre-effective date assets include, among other things, the right to receive payment of the arrears of Tanzania Electric Supply Company Limited and arrears owing by Songas Limited as at the Effective Date, being a total of US$125.3 million, less an estimated US$51 million in TPDC Profit Gas payable under the Production Sharing Contract for the Songo Songo field on receipt of net revenues realized from these arrears. Pre-effective date liabilities include, among other things, any tax liabilities, liabilities resulting from litigation or other dispute resolution processes, and any environmental liabilities related to operations conducted by PAEM and its subsidiaries, which occurred or relate to any period ending on or before the Effective Date. Pre-effective date liabilities do not include any liabilities to IFC under the IFC Loan or certain related agreements. Pre-effective date assets of US$80 million cash, US$9 million of working capital and US$4 million of Tanzania Electric Supply Company Limited arrears were distributed to Orca during 2017."

Fair value is multiples of the current stock price

Intrinsic value of Orca's net assets can be appraised using a sum of the parts approach by adding its cash and investments, the Tanesco receivables net of payables.

We estimate the Tanesco receivables using this information : the arrears of Tanzania Electric Supply Company Limited and arrears owing by Songas Limited as at the date of the swala deal were US$125.3 million, less an estimated US$51 million in TPDC Profit Gas payable under the Production Sharing Contract for the Songo Songo field on receipt of net revenues realized from these arrears, which results in a net amount of US$74.3 million. Since then, 15 million of this amount has been paid and the resulting net amount is thus US$59.3 million.

By adding those numbers as shown in the table below, we come up with a NAV of $ 439 Million USD, or $ 12.44 USD per share. Using the spot USD / CAD rate, it corresponds to $ 16.63 CAD per share.

Parts Valuation (in millions of USD)
PAEM stake 245
Cash and investments 135
Net Tanesco Receivables without interest 59.3
Sum of the parts 439.3
Value per share in USD 12.44

Please note that we didn't account for any possible recovery of interest amounts from the pay-down of Tanesco receivables and thus believe that we are being reasonably conservative in our estimates.

The value per share compares favorably to its share price of $ 3.71 USD (for ORXGF) or $ 5 CAD per share (for ORC.B) , whatever holding company discount one may choose to assign to Orca to account for management compensation. Moreover, this could not be necessary as we didn't account for the $ 25 million in interest owed by Tanesco to Orca and did not assign any value to a potential extension of Orca's license beyond 2026 (which would directly translate in significantly higher values for PAET).

Of note, with a $ 132 Million USD market cap, Orca trades below its cash and investments alone.

Why is Orca so cheap?

The following reasons may explain why the company is not more popular among investors:

- Orca is a small cap company traded on CVE in Toronto and OTC is the US and, as such, may be overlooked by institutional investors.

- Orca's holding company structure may not be well understood by market participants as the company only publishes consolidated accounts. As a consequence, the company does not screen well today.

- The Tanesco receivables are not shown on Orca's balance sheet because they have been written-off (while the corresponding payables are still on the balance sheet).

- Orca's PAET business was in trouble in 2012-2013 and the market may have stopped paying attention to the company. However, the business is still alive and generates cash-flows.

- PAET operates in Tanzania, which is not a country of interest for many investors. Though this may not be the friendliest country for business, PAET has been a successful operator there and has superior economics compared to other Oil & Gas businesses (much higher ROIC, high cash-flow generation).

- PPE strongly underestimates the value of the stake in PAET.

- Orca stopped share buybacks due to a request from the late Lloyd Miller III (for liquidity reasons).

- The trustee of Lloyd Miller III sold a meaningful number of shares in 2018 (though the trust remains a meaningful shareholder of the company), creating an overhang on the stock.

- The founder to the company, David Lyons, who probably was one of the very best Oil & Gas investors and operators, owned voting control (there are two share classes). He unfortunately passed away in August 2018. His estate now controls the company. Though we don't believe they will be unfriendly with other shareholders, this is a controlled company and activism seems unlikely (though late Lloyd Miller III managed to get involved and was listened to by David Lyons).

Potential catalysts:

- The company will likely screen better on a PE and PB basis in the future (as profits should increase and the Swala investment may be finalized).

- A sale of additional PAEM shares to Swala Oil and Gas should help unlock the value.

- Increased profits from increased gas deliveries and higher future prices on existing production.

- Continued dividend payments.

- The company may tender for its shares at some point as Lloyd Miller's trustee sold shares.

- The Board of Directors stated that it wants to increase the liquidity of the shares : an up listing on a major stock exchange (or a merger) may be possible outcomes.

- The Shaymar Trust, representing the founder's estate (and seating on the Board of Directors), might want to monetize its stake in the business at fair value in the future (though they do not have any current plans to sell their shares in the business and intend to let the current team lead the company). One might believe that the founder's heirs do not plan to be actively involved with the business and that a merger deal is now more likely than ever (though this kind of thinking is speculative at this stage).

Main Risks:

- A bad use of the cash on the balance sheet could impair Orca's value

- If the PAET business was to be seized by Tanzanian government, an impairment of its value would meaningfully reduce the value of Orca

- If all clients stop paying PAET, the stake's value would be impaired.

Those risks appear to be priced by the market as Orca's receivables and its stake in PAET are priced at negative value. It seems overly pessimistic to us: We believe any good news should help the stock price at these levels. This is the reason why we are so positive on Orca Exploration Group.


Orca is an amazingly cheap and overlooked company trading well below its liquid assets and receivables while its business has superior economics (although we understand that working in Tanzania may not be easy).

The risks of the investment seem fully priced at current levels while the numerous possible catalysts are being overlooked in our opinion.

The shares might be worth 3 times the current price without considering any possible extension of the PAET license in Tanzania (which could add meaningful value longer term).

See also Roche Looks To Expand MabThera's Reach In Wake Of Reduced Herceptin Sales on

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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