The Era of Cheap Oil is Over

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I’ve heard some very smart people speculate that oil prices will decline as new supply comes online – mainly related to shale oil. This just isn’t the case.

– Harris Kupperman, Adventures in Capitalism

 

Harris is 100% right. And I’m going to prove it to you.

Side note: This is Part 1 of my 3 part Unconventional Oil theme (you can read more about my themes here and my investment approach here). Over the coming weeks I’ll publish Part 2 (a playbook of how to evaluate unconventional oil opportunities; update: published here) and Part 3 (a specific idea within this theme that I suspect will make investors a lot of money over the coming years; update: published here). To get these notes the second they are published, enter your email here:



But now onto Part 1 – understanding the forces driving a sustainable bull market in oil.

Let’s start high-level. There are 3 factors that influence the price of oil:

  1. Demand – driven by per capita consumption and population growth
  2. Supply – driven by new discoveries and spare capacity
  3. Inventories

Diving into each and doing simple math will lead you to the same indisputable conclusion I have come to: the era of cheap oil is over.


InterDigital (IDCC) – Sometimes, Lucky > Good

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Sometimes in investing, you just get lucky.

Six days ago, I wrote about a window of investment opportunity to go long patent holding companies due to failed patent reform legislation (source). Today, one of the 5 companies I highlighted as “interesting” (a word I use to convey particularly strong conviction), is a top gainer in the market, up ~20%. The reason?

A 10 year licensing deal with Samsung covering 3G, 4G and future wireless products. This deal boosts quarterly recurring revenue from $56MM – which the Company expected in May (source) – to $76MM (source). That’s $80MM / year in additional recurring revenue from Samsung. IDCC’s new recurring revenue estimate is now just north of $300MM / year.

Even at these levels, IDCC continues to be “interesting”.


The Winners of Failed Patent Reform

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Last Wednesday night, patent reform was effectively killed (source). And given upcoming mid-term elections, it is unlikely that efforts will get rebooted anytime soon. This is a significant surprise to many as patent reform had largely been a bipartisan effort and was seen as an easy win for politicians. (I put the word surprise in bold because it is perhaps the single most important word in investing… wherever there is surprise, there is opportunity.)

A natural question follows every surprise: who benefits most?

In this case, the answer is clear: Intellectual Property holding companies. In the short to intermediate term, this news completely eliminates the biggest fear surrounding the sector: political risk. Any investor that believed a significant impairment to future earnings was coming has to completely rethink their position. In the longer term, a failure to enact patent reform implies the IP holding companies are in a significantly stronger political position than the market previously believed (some insight here). And this makes me think any future legislation will have little impact to the patent enforcement / patent licensing business model going forward.

This surprise opens a window of investment opportunity as the market begins to re-rate sector risk. And because lower risk equals higher multiples and higher stock prices, I believe the following companies are positioned to outperform the market over the coming months:


Premier Exhibitions (PRXI) – Lots of Uncertainty; Not a Lot of Risk

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As I mentioned in this note, I don’t make a habit of writing about small cap companies with very little liquidity. This time I’m making an exception with a huge “flashing lights” warning – this stock trades $35,000 in dollar volume per day. Buying or selling more than $3,500 worth of this stock in a single day will likely move the market. So if you are inclined to take the risk, put the trade on in your PA, not your fund.

Below I present the investment case for Premier Exhibitions (PRXI) via excerpts from the April 22 shareholder call (read it in full here):

First, let me update you on the strategic alternatives process being pursued with JP Morgan. Our Board, along with JPM, continues to review strategic alternatives. As part of this process, our preliminary valuation work based on financial data provided to JP Morgan by Premier indicates that our shares are trading at a discount to the intrinsic value of the cash flows from operations.  While no valuation from an investment bank is precise, the range of values being indicated by JP Morgans’s preliminary valuation of Premier’s operating business exceed the Company’s current market capitalization before consideration for the value of the Titanic assets.

Buyside Notes: On an operating basis, PRXI shares are cheap. If you include the value of their exhibition assets, the shares are very, very cheap.

Premier owns a unique, one-of-a kind collection of artifacts and intellectual property related to the most iconic underwater wreck site in history. You are also aware that the auction process in 2012 did not yield a buyer for the collection. Without revisiting history, the process gave us great insight into the asset and the complexities involved in selling it. While the current market price for Premier’s stock indicates investors have established a diminished value for the Titanic assetswe remain confident that these assets hold tremendous value for shareholders.

Buyside Notes: A 2009 appraisal done by the courts found the fair market value of the Titanic artifacts to be $110,859,200 (see page 8 here). Management stated that the “value of the assets with the IP surrounding the collection is $189 million” but that the $189MM doesn’t include “intellectual property that was obtained in the dive in 2010, […] a database of information related to all the artifacts, all of the video, all the photography, all the passenger stories […].”

Let’s assume the low end is the right value. $110MM doesn’t include the “IP” nor does it include any appreciation since 2009, but let’s use it. Now compare $110MM to the current enterprise value of the Company, which is $42MM. The difference between the value the market is assigning and the intrinsic value is a gaping $68.7MM (note that in a sale, there will be tax implications so shareholders wouldn’t realize the entire $68.7MM but the point remains: based on the assets alone, this Company is seriously undervalued).


The Demise of the Set-Top Box Makers

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 How does change happen? Slowly, then all at once.

I recently wrote about the disruption of cable TV (note here). As I dive further into the Cord Shaving theme, I find myself struck by the unnecessary complexity of the set-top box industry. And I can’t help but consider the parallels between today’s set-top box makers and Nokia, which went from a dominant handset maker to irrelevant in just a few short years (background here).

Instead of reviewing the maze of middleware, software and protocols that defines the set-top box market, I think it is more helpful to abstract the complexity away and start with a very simple question:

What is a set-top box?

To me, it’s just a technical layer that translates input to output.

Once you understand that part, you get to the question that really matters:

What’s proprietary about this “technical layer”?

And the answer to that question may surprise investors: Nothing.