Gulf Keystone Petroleum (LSE: GKP) and Concha (LSE: CHA) are two stocks I’m steering well clear of. Let me explain why.
Oily on a slippery slope
Oil explorer and producer Gulf Keystone owns valuable assets in the Kurdistan Region of Iraq. However, just because a company owns valuable assets doesn’t mean it can’t go bust — witness the fate of oil company Afren earlier this year.
Like Afren, Gulf Keystone is faced with a low-oil-price environment and is loaded with debt. Gulf Keystone also faces considerable uncertainty regarding the quantum and timing of payments from the Kurdistan Regional Government.
The company announced some good news on the latter front on 15 September: a $15m gross ($12m net) payment from the regional government for crude exports, which it anticipated would be the beginning of regular payments. On 15 October, Gulf Keystone announced receipt of another $15m gross ($12m net). However, 15 November has come and gone with no announcement of a payment.
At 23 October, following a half-yearly $26.4m interest payment to bondholders, Gulf Keystone had cash of $48.4m. The company is obliged to maintain a reserve account above $32.5m to avoid breaking a key debt covenant. Production and administrative costs were $49.1m ($8.2m a month) during the first half of the year, so Gulf Keystone is at risk of breaking the covenant by the end of the year in the absence of cash coming in.
Even if the Kurds make good on the $12m a month payments, with costs at $8.2m a month, Gulf Keystone would see a net increase in cash of $22.8m by next April — at which point the next half-yearly $26.4m interest payment to bondholders falls due.
Gulf Keystone’s bonds are trading at a huge discount to par, which tends to be a good barometer for the risk of equity dilution or wipeout. I believe the risk of an Afren-style debt spiral, putting power in the hands of bondholders, is far higher than many rosy-spectacled equity investors realise. As such, I’m avoiding Gulf Keystone.
Rumpelstiltskin required
Concha is an AIM-listed company, created just over a year ago to invest in “potentially disruptive global opportunities in the rapidly changing online social media space”.
The company has yet to make an investment, so its principal asset is cash. At the last balance sheet date (31 December 2014) cash stood at £5.741m. Since then, an exercise of warrants has raised a further £0.565m, and a settlement relating to a dispute from a previous incarnation of the company has been received; quantum undisclosed, but the dispute concerned a £0.467m loan.
So, maximum cash in the coffers would be £6.773m. Let’s work with that figure, even though the dispute settlement is probably less than the original loan and there’s been almost a year of plc, administration and due diligence costs on potential investments.
At a current share price of 5p, Concha is valued at £77.6m — a whopping eleven-and-a-half times the generously-calculated £6.773m cash. Frankly, the valuation appears ludicrous.
Back in March, Concha said it was in discussions “regarding a specific global opportunity, [which] … if pursued to a successful conclusion, the Board believes will lead to a transformation of the Company. At present, there can be no guarantee that this investment will be successfully completed …”
In June, Concha updated that “discussions are on-going” and in September that “progress has been made”, though the proviso remains that “there can be no guarantee that this investment will be successfully completed”.
Unless the deal being discussed involves Rumpelstiltskin spinning straw into gold, I can’t for the life of me see how Concha’s current valuation is in any way justified.
