Contango Oil and Gas (MCF, Financial) is a value investing favorite. It is run by a CEO who truly understands that he works for shareholders, and closely follows the management ideals laid out by Warren Buffett. Even better he is the founder of the company, has most of his net worth in the company and pays himself an extremely modest salary.
I first heard of Contango and CEO Ken Peak through Mark Sellers who at the time was running an incredibly concentrated hedge fund. Sellers had put almost all of his fund into Contango. His reasoning was that the company had zero debt, was trading at less than the value of its proven reserves and had upside potential should the company hit something big in the Gulf of Mexico.
Sellers got it right, because Contango made one of the largest natural gas discoveries of the past twenty years in the Gulf of Mexico. From $11 in 2006 the share price of Contango hit $90 in 2008 thanks to the huge increase in reserves from the discovery and a run up in natural gas prices to over $10.
I think Peak sensed that natural gas prices were near a top because in the spring of 2009 he put the company up for sale. Unfortunately though, he was just slightly late as before any deal could be consummated the credit crisis of 2008 caused natural gas prices to collapse and any reasonable offers for Contango to disappear.
Since the fall of 2008 the share price has drifted around the $40 to $50 level which is where we still are today. And every couple of months I take a look at Contango to see if I want to buy some shares. There are so many things to like about the company, consider the following which were laid out in a recent company presentation:
1) Contango was founded in 1999 when Ken Peak at age 54, took his entire life savings of $400,000 and formed Contango Oil & Gas Company.
2) Contango’s 2009 all-in costs to find, develop and produce an Mcf were $2.45/Mcf compared to $5.29/Mcf for the industry (As per Credit Suisse)
3) Since inception, the Company has repurchased 4.5 million shares for approximately $89 million and remains debt-free
4) From inception in 1999 until 2009, Mr. Peak’s salary was $150,000 per year. If and when Mr. Peak received a bonus, he used the proceeds to purchase additional shares of stock such that Mr. Peak is today the Company’s largest shareholder with approximately 19% of its shares.
5) The Company’s directors and executive officers combined beneficially own approximately 23% of the Company’s common stock.
6) Incentives are also aligned with our alliance partners - the geoscientists and “oil finders” who generate the Company’s drilling prospects. These partners do not receive any compensation from the Company unless their prospects are successful. Contango’s partners can become exceptionally wealthy, but never before or without Contango’s shareholders coming along to enjoy the success.
7) Mr. Peak recognizes the importance of the “tone at the top” and for 2003 and 2010 did not ask for and did not receive a bonus because he didn’t believe he deserved one.
8) Contango recognizes that all hydrocarbon molecules are essentially the same, and therefore the only way to successfully compete in a commodity business is to be the lowest cost producer. With only 7 employees, the Company’s general and administrative costs are the lowest in the industry. Contango is “allergic” to debt, so its interest costs are zero.
9) Contango is not followed by any investment banks – on purpose. Mr. Peak has declined requests for “coverage” of Contango because he considers the attention paid to quarterly results to be a distraction in a three to five year time horizon business. In addition, the focus on sequential production growth and “cash flow” detract from the only financial metric that counts – to long term investors - net profits per share.
Management really is exactly what an investor should hope for as a steward of their capital. There is just one problem I have with the company that keeps me from investing. And I can again refer you to their recent presentation for this:
“The Company believes that shareholders want exposure to upside commodity price potential and does not hedge away price downside or upside. Our “hedge” is being the low cost producer and thus remaining profitable even during the industry’s periodic downward price spirals. “
What you see is what you get, and therefore as an investor you know not to expect hedging by Contango and that is great. However, how much value did Peak leave on the table by not laying on some hedges in 2008 ? Instead of locking in $8 or $9 natural gas at that time, the company has instead been selling into $3 or $4 prices. I’ve honestly got no problem with the non-hedging as this is a core belief that shareholders understand. I just have no conviction in where natural gas prices are headed which makes it impossible for me to value this company without hedging.
So I still sit and watch this first class CEO run his business as an interested observer, not as a shareholder.
Here are some recent articles on natural gas prices:
Devon Energy CEO on natural gas prices
http://www.gurufocus.com/news.php?id=105169
The Future of Natural Gas prices
http://www.gurufocus.com/news.php?id=103527
I first heard of Contango and CEO Ken Peak through Mark Sellers who at the time was running an incredibly concentrated hedge fund. Sellers had put almost all of his fund into Contango. His reasoning was that the company had zero debt, was trading at less than the value of its proven reserves and had upside potential should the company hit something big in the Gulf of Mexico.
Sellers got it right, because Contango made one of the largest natural gas discoveries of the past twenty years in the Gulf of Mexico. From $11 in 2006 the share price of Contango hit $90 in 2008 thanks to the huge increase in reserves from the discovery and a run up in natural gas prices to over $10.
I think Peak sensed that natural gas prices were near a top because in the spring of 2009 he put the company up for sale. Unfortunately though, he was just slightly late as before any deal could be consummated the credit crisis of 2008 caused natural gas prices to collapse and any reasonable offers for Contango to disappear.
Since the fall of 2008 the share price has drifted around the $40 to $50 level which is where we still are today. And every couple of months I take a look at Contango to see if I want to buy some shares. There are so many things to like about the company, consider the following which were laid out in a recent company presentation:
1) Contango was founded in 1999 when Ken Peak at age 54, took his entire life savings of $400,000 and formed Contango Oil & Gas Company.
2) Contango’s 2009 all-in costs to find, develop and produce an Mcf were $2.45/Mcf compared to $5.29/Mcf for the industry (As per Credit Suisse)
3) Since inception, the Company has repurchased 4.5 million shares for approximately $89 million and remains debt-free
4) From inception in 1999 until 2009, Mr. Peak’s salary was $150,000 per year. If and when Mr. Peak received a bonus, he used the proceeds to purchase additional shares of stock such that Mr. Peak is today the Company’s largest shareholder with approximately 19% of its shares.
5) The Company’s directors and executive officers combined beneficially own approximately 23% of the Company’s common stock.
6) Incentives are also aligned with our alliance partners - the geoscientists and “oil finders” who generate the Company’s drilling prospects. These partners do not receive any compensation from the Company unless their prospects are successful. Contango’s partners can become exceptionally wealthy, but never before or without Contango’s shareholders coming along to enjoy the success.
7) Mr. Peak recognizes the importance of the “tone at the top” and for 2003 and 2010 did not ask for and did not receive a bonus because he didn’t believe he deserved one.
8) Contango recognizes that all hydrocarbon molecules are essentially the same, and therefore the only way to successfully compete in a commodity business is to be the lowest cost producer. With only 7 employees, the Company’s general and administrative costs are the lowest in the industry. Contango is “allergic” to debt, so its interest costs are zero.
9) Contango is not followed by any investment banks – on purpose. Mr. Peak has declined requests for “coverage” of Contango because he considers the attention paid to quarterly results to be a distraction in a three to five year time horizon business. In addition, the focus on sequential production growth and “cash flow” detract from the only financial metric that counts – to long term investors - net profits per share.
Management really is exactly what an investor should hope for as a steward of their capital. There is just one problem I have with the company that keeps me from investing. And I can again refer you to their recent presentation for this:
“The Company believes that shareholders want exposure to upside commodity price potential and does not hedge away price downside or upside. Our “hedge” is being the low cost producer and thus remaining profitable even during the industry’s periodic downward price spirals. “
What you see is what you get, and therefore as an investor you know not to expect hedging by Contango and that is great. However, how much value did Peak leave on the table by not laying on some hedges in 2008 ? Instead of locking in $8 or $9 natural gas at that time, the company has instead been selling into $3 or $4 prices. I’ve honestly got no problem with the non-hedging as this is a core belief that shareholders understand. I just have no conviction in where natural gas prices are headed which makes it impossible for me to value this company without hedging.
So I still sit and watch this first class CEO run his business as an interested observer, not as a shareholder.
Here are some recent articles on natural gas prices:
Devon Energy CEO on natural gas prices
http://www.gurufocus.com/news.php?id=105169
The Future of Natural Gas prices
http://www.gurufocus.com/news.php?id=103527
