I often write about the "deep end of the pool," where the swimming is tougher for the small and microcap companies that inhabit my "Mad Money" model portfolio. But the better analogy is the shallow end of the pool, because the small size and relative illiquidity of these companies make them vulnerable to predators -- the shorts.
We saw an example Monday with Torchlight Energy (TRCH), whose shares plummeted 27% after the publication of a critical article on another website that suggested the stock "May Go To $0." The S&P 500 is at an all-time high, but this type of short trade is not driven by any sense of mean-reversion or hope for a garden-variety correction.
Torchlight has been on the road raising debt from private investors. The anonymous author of the above-mentioned piece (which is allowed under that website's policies) acknowledged a short position in TRCH in the disclosure section and chose this time to pounce.
Why now? If the holder of a short position knows that a company needs to raise additional capital to survive, then hampering that capital-raising effort would help his or her position. It's that simple. It's what I refer to as "the death short."
Someone is clearly betting that TRCH will go out of business -- or at least run out of capital to grow the business. So sabotaging the company's capital raise by raising questions about the company's finances and the virtues of the management team addresses both needs of the shorts: to knock out the capital raise and starve the company of its lifeblood.
It's not my place to comment on other articles, but there were a number of factual inaccuracies in the Torchlight "May Go To $0" piece. The "death short" is usually accompanied by all sorts of historical financial legerdemain and ad hominem innuendo, and this piece was no different. I prefer to focus on the fundamentals, which is easy to do with Torchlight; it produces oil and gas as a non-operating partner (it will be the operator in upcoming wells, but is not currently) with bigger partners. So, one might think analyzing the company is as easy as counting the barrels of oil and cubic feet of gas produced -- and it is.
Monday morning, Gastar Exploration (GST) provided an operational update on wells that it participates in Oklahoma with privately held Husky Ventures. Torchlight participates in many of those wells. Husky's Grizzly well produced at an Initial production (IP) rate of 387 barrels of oil equivalent per day and the latest five-day average has been 272 boepd.
Grizzly was just about average for the Husky wells in terms of IP. There have been some massive gushers (like the Kodiak well, with an IP of 1,666 boepd) in that play, but also a few fizzlers. Gastar management has referred to the Hunton Limestone many times as a "statistical play," i.e., there will be a large deviation but the average well will produce at a very high Internal Rate of Return (IRR).
The key point on Grizzly is that TRCH has a meaningful working interest (15.8% in that well) vs. earlier wells where the interest was quite small (1.4% in Kodiak, for instance). So, TRCH's net interest from Grizzly is 61 boepd at IP and 43 boepd over the last five days.
These may not seem like huge numbers but a) on a 2Q company-wide production goal of 500 boepd 61 boepd is significant and b) it belies the "death short" case that TRCH is run by incompetents who have joined with an "obscure" private company in Husky Ventures.
Five minutes on the phone with oil execs would have indicated that Husky CEO Chuck Long is a legend in the exploration-and-production business (hardly obscure), and two minutes on the computer would have shown that Gastar's operational update confirms TRCH management's comments on well results.
My analysis shows that Torchlight can produce enough oil -- with a cadence of 250/500/1250/2000 barrels of oil equivalent per day for the quarters of 2014 -- to generate sufficient cash flow to fund liabilities. If it fell off that path, I would be worried; but having seen management present three times in the last two weeks, I have absolutely no indication that's the case.
Patient investors in TRCH will be rewarded, and nothing has changed fundamentally. I am sticking with the price target of $8.25 that I published in my May 21 column.
