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Circle Of Competence Issue #23

Quote of the week: "Don't judge each day by the harvest you reap, but by the seeds that you plant." - Robert Louis Stevenson

Food for Thought

Activism and reaction

A few weeks ago John Goff, a Texas billionaire, bought a large stake in Contango Oil (disclosure: long MCF). Since then, MCF's price action has bounced around from about $4.40 to almost $7 per share before sliding back to the current $5 per share. I scan most 13-D filings to look for large activist purchases that I can research and potentially invest alongside, and Goff's 13-D filing caught my eye given that he had experience with purchasing large portions of small oil companies previously.

Contango Oil is an independent oil and natural gas co that has 189.3 billion cubic feet of proven reserves and as the article above reasons, the property in the Permian basin could prove to be immensely valuable to the right buyer. Though MCF is a money losing entity, it is trading at a depressed 60% of book value with modest debt and some desirable acreage in the Permian Basin. There are also structural reasons that lead several investors to believe that oil prices have nowhere to go but up. Thus, I began purchasing shares in MCF since I believed it traded below intrinsic value, it possesses desirable hard assets in the Permian, a knowledgeable energy investor purchased a large stake, it has modest debt, and there is a solid bull case for oil.

And then this happened: Contango adopts tax benefit preservation plan to preserve net operating losses. As explained in more detail in the 8-K filing associated with press release, Contango plans to 'protect' its net operating losses to protect future income which would be substantially limited should an 'ownership change' occur per the IRS. To protect their NOL tax asset, the company adopted a rights plan in which they offered 1 'right' per common share owned to purchase 1 share of common stock at a 50% discount IF the rights plan is triggered. And how is the rights plan triggered? Only if a purchaser acquires over 5% of the company's shares or if someone who owns over 5% currently (John Goff!) continues purchasing shares. What's more, the party who triggers the rights plan will cause their own rights to become null and void - essentially diluting their share in the company by half! To protect their NOL asset, they essentially adopted a massively diluting poison pill for any potential acquirers. Not surprisingly, the stock has traded down by 5-10% on the news.

So here are my concluding questions (I'd love to hear from readers on what they think!):