Odyssey Marine Exploration Inc (OMEX)

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http://seekingalpha.com/article/2595215-odyssey-marine-victory-and-vindication?uprof=44

Odyssey Marine: Victory And Vindication
Oct. 24, 2014 1:34 PM ET | About: Odyssey Marine Exploration, Inc. (OMEX)

Disclosure: The author is long OMEX. (More...)
Summary

Odyssey Marine (OMEX) granted right to salvage HMS Victory (Victory) by the UK’s Minister of Defence (MOD).
MOD represented the final significant obstacle to the Victory salvage operation.
Victory may hold over three-quarters of a billion dollars in artifact, ingot, and coin value.
OMEX receives 80% of coin value and 50% of artifact value from salvage (under terms of 2012 agreement).
Our base-case assumes a $270 million recovery with net profit of $170 million to OMEX.

The objective of this report is to familiarize investors with the Victory recovery, so that they may gain an understanding of how this project is likely to impact OMEX. The paper is divided into three sections. The first section will present background information on the Victory and her recovery. This section presents evidence to help readers understand what cargo is likely to have been aboard Victory when she sank in October of 1744, and how that cargo could be valued in today's dollars. The second section will offer an analysis of OMEX's liquidity position, and demonstrate how the Victory award and recovery may impact liquidity risk. The final section will detail the significant importance of this project for the UK. It will also discuss how circumstances surrounding this recovery may impact historic shipwreck recoveries in the future. The section concludes with some practical implications for OMEX's stock arising from the Victory approval.
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SECTION I

Victory Recovery Plan Approved

Odyssey Marine (NASDAQ:OMEX) and the owner of the Victory (1744) shipwreck, the Maritime Heritage Foundation, were granted approval by the UK's Minister of Defence to proceed with the ship's salvage operation. This was the final key hurdle in a tedious six-year process.

The MOD statement notes that, "MHF has been granted permission to recover at-risk surface items from the wreck site in accordance with the Project Design once the necessary licence has been issued by the MMO….Consideration of any further phases of work would be made in light of progress reported by MHF." Removing artifacts on the surface of the current wreckage will create a new surface of "at risk" artifacts, demanding that the excavation continue. Consideration of further phases of work should then lead to further excavation per the Project Design. OMEX's progress was smooth and uninterrupted in the first two phases of the Victory project, and there is no reason to believe this will not be the case in the third phase.

Investors and observers will acknowledge that the Victory may represent one of the most significant historic shipwreck recoveries ever. The Victory was the most powerful and technologically advanced warship in the world when she first set sail in 1737, and may have been the most important ship ever lost by the British Navy. The cultural importance of the artifacts recovered, and the stories they reveal, will be of priceless value to the people of the UK.

The decision to proceed with the salvage of the Victory is a win for just about everyone. The scientific and archaeological community will benefit from the creation of meaningful new data and literature that would not otherwise be published. The public will benefit from the display of items that were thought to be lost forever, and from the historical clarification that OMEX's work has revealed and will continue to reveal. The public and the UK government will also benefit from a windfall that could amount to tens or even hundreds of millions of dollars. Last, Odyssey's shareholders have the opportunity to earn returns for the risks borne in this expensive, time-consuming endeavor.

Just as meaningful as the cultural and financial rewards Victory promises, this historic salvage is likely to serve as an emphatic vindication of OMEX management's strategic plan. Short-sellers and long investors alike have criticized management for incurring years of losses to fund investments in long-term assets with uncertain payoffs. Yet, management understood the truth about the company's ability to ultimately earn a return on its investments. They realized that the company's unique skill set, positioning, and high quality work would ultimately enable OMEX to monetize these large assets.

Management now has the opportunity to prove they were correct, as returns from the Victory are likely to not only justify past losses but fund the company through its next series of profitable ventures - whether mineral, commodity salvage, or historic salvage. The economic gravity of the Victory project will prove OMEX's business model, and further expose the weak and biased analyses upon which short-sellers have relied.

OMEX's ever-growing portfolio of successful shipwreck recoveries in the US and UK is having a profound impact on the company's future opportunities. The UK and US are leaders on the world stage. Both have highly respected and well-established maritime salvage laws, regulations, and oversight. OMEX's ability to thrive within these highly regarded jurisdictions, to earn returns for taxpayers and shareholders, and to protect and record priceless cultural artifacts is undoubtedly attracting notice in other countries - be they UNESCO Convention signers or not. While OMEX's pipeline of future recoveries is already healthy, it should expand further in the coming months.

The Victory likely represents a game-changing salvage for OMEX, and shareholders should benefit more from this project than they have from past recoveries. The company's balance sheet is in better shape than it has been in the past, allowing OMEX to retain more cash from the project. Its cost structure has been reduced, so the work will likely be more profitable. The potential cargo value on board the Victory is also far larger than it has been for past projects, and the cash-flow resulting from the project will likely produce several years of corporate profitability.

How Much Gold is Buried with the Victory?

There is good reason to believe that the Victory carried hundreds of millions worth of coin (and possibly some ingot) when she sank in October of 1744. The evidence for a large cargo of gold aboard the Victory is circumstantial, but is well corroborated and seems likely. While we will only find the truth with a complete salvage, we will present some of the historical evidence surrounding the Victory below so that readers can draw their own conclusions.

There is a sizable body of historical research surrounding the Victory, its cargo, and commerce between the UK and Portugal in the mid-18th century. Anyone wishing to get his or her hands around the central issues regarding the cargo should pay attention to two documents in particular.

The first is research published by OMEX in its series "Odyssey Papers" by Neil Dobson of OMEX and Dr. Sean Kingsley of Wreck Watch International (Wreck Watch was a paid archaeological consultant to Odyssey Marine). The paper describes initial Victory site findings and provides a detailed historical context. Of special interest is section 12, "Prizes and Bullion," which begins on page 37.

Another paper to consider is Wessex Archaeology's Archaeological Desk-Based Assessment of the Victory wreck site. The Wessex report was paid for by English Heritage, a vocal opponent of the Victory salvage project. It concludes, somewhat unsurprisingly, that the presence of a valuable cargo is "highly unlikely."

There are a number of independent historical research papers that have proven helpful in understanding the difference between OMEX's perspectives and those of Wessex. These reports indicate serious deficiencies in a number of Wessex Archaeology's key arguments, and present compelling corroborating evidence for a commercial cargo aboard the Victory. A number of these research papers will be discussed in the following section.

Investors should read the papers cited in this report and make their own judgments as to what the Victory may have carried when she foundered in 1744. My opinion is that the weight of evidence supports a belief that the ship carried hundreds of millions of dollars' worth of coin and possibly ingot.

The Evidence

Admiral Sir Lord John Balchin commanded the Victory, and a fleet of British warships, that operated off the coast of Lisbon and Gibraltar prior to the ship's sinking in October of 1744. Part of Admiral Balchin's military mission was to liberate a fleet of provision-carrying British ships that were blockaded at Lisbon. Another part of Balchin's mission, however, was likely personal.

It was common practice at the time for warships to engage in commercial activities in conjunction with their military duties. These included transporting specie (for a 1% fee) and taking a cut from whatever was found onboard captured ships. Payments from these ventures could be quite large for the ship's captain and flag officer, so there was strong motivation to participate. To put this motivation in perspective, a captain's annual salary was typically around £110, but he could earn thousands of pounds transporting payments. He was entitled to earn even more money by capturing ships with valuable cargo, however, this was more dangerous work.

Admiral Balchin was pulled out of retirement at the age of 74 to command Victory. He may have seen the command as an opportunity to not only defeat the French and help his country, but also to pad his retirement account, especially given the circumstances in Lisbon at the time.

Lisbon was a key source of commercial revenue for naval officers. The port connected them with merchants and intermediaries who had a great demand for gold transport services to help finance a large Portuguese trade deficit with the UK.

There is not an English Man of Warr [sic] homeward bound from almost any Point of the Compass that does not take Lisbon in their way home…. every body knows that they have no other business in life here but to carry away Money. (Tyrawly, 1741 link)

Demand would have been unusually high at the time Admiral Balchin sailed the Victory to Lisbon, as Britain was at war with France and Spain in the War of Austrian Succession. The French had established a naval blockade at Lisbon for the four months preceding Balchin's arrival (from early May of 1744), preventing trade between Portugal and the UK, and blocking a British convoy sent to supply troops based in the Mediterranean Sea.

Portugal and Britain had a thriving trade, with Britain shipping large quantities of woolen items in exchange for port wine, oils, and gold coins coming from Portuguese gold mines in Brazil. During the four month blockade, Portugal would have been unable to replenish British goods or pay British merchants. So, when the Victory-led fleet arrived, a large backlog of trade would have existed.

With a war underway, shipping anything had become a dicey proposition. Privateers and the French fleet were always on the prowl, seeking to capture cargoes as prize. The Victory was the most advanced and powerful warship at the time. She would have naturally attracted enthusiastic demand from merchants and trading groups in Portugal as the single most secure means to transport payment to the UK during wartime.

From Lisbon bullion was also shipped on homeward-bound English men-of-war, both frigates and ships of the line. Strongly armed as well as possessing diplomatic immunity from search, they were almost ideal for bullion carriage and it was in fact common for captains to supplement their incomes in this way. Fisher (1971:99) link

A logical reading of the circumstances would indicate that Lisbon's merchants and trading houses, desperate to restock shelves and rectify accounts, would have immediately sought the safety of the Victory, and its highly-regarded Admiral, to carry their specie to England.

This, in fact, is precisely what occurred according to The Amsterdamsche Courant (Dutch Newspaper) which wrote, "People will have it that on board of the Victory was a sum of 400,000 pounds sterling that it had brought from Lisbon from our merchants." 18/19 November 1744.

The £400,000 would represent a large cargo for the time. Most of the accounts from similar warships carrying commercial specie shipments noted cargoes that were somewhat smaller, although not dramatically so.

Records of warship freights date back to at least 1711. On 19 October of that year John Milner wrote from Lisbon to the Lord High Treasurer that it is "not easily computed what vast sums goe by enemy Convoy, nay every packet. The fleet with Sir J. Norris tho they staid a very few dayes, carried away large sums, several houses sending… thirty to forty thousand pd [pounds] a house & all some. (SP 89/21)

In 1728 two naval ships from Lisbon carried treasure to England, one consignment amounting to £137,000, the other to £27,000….A year later HMS Liverpool carried $100,000 to London from Cadiz and in 1750 HMS Blandford was reported at Portsmouth with ten wagonloads of Lisbon money, valued at £115,000 sterling. link

Within a year HMS Pomono came from Cadiz "with eight tons of money. Link p. 28

In June 1771 "three wagons, guarded by soldiers, loaded with money to the amount of 1,200,000 dollars, brought home from Cadiz by the Tweed Frigate arrived at the Bank for the use of the merchants." link p. 28 (Dollars refer to Spanish silver coin. For comparative purposes, this shipment would weigh roughly 10x the amount of Victory's commercial shipment, and would be worth 75% of its value)

All the same, £400,000 it is not an unreasonable amount given the economic and military context of the period. At the time, Lisbon was importing approximately £1.2 million in gold per year from Brazil, and British exports to Portugal were worth approximately £1 million annually. A four to five month backlog (five months if we include the time after Victory arrived until she left in early October) could have reasonably translated to £400,000 in gold for shipment.

The Wessex Archaeology report cites two key reasons to doubt this commercial load exists. First, newspaper accounts at the time were similar to gossip columns, and were not to be trusted. Second, there is no mention of the gold shipment being received in the ship's official log books.

While newspapers from England were guilty of printing plenty of unsubstantiated rumors, this was not the case with respect to the Dutch, and specifically the Amsterdamsche Courant. The Courant was the Dutch business paper, it was the Wall Street Journal of its day. The Courant published prices of stocks and commodities regularly and was relied upon for its conservatism and accuracy.

The prices in the Amsterdamsche Courant were an official source of information, supervised by the City of Amsterdam, and could be used to monitor brokers….From this perspective it would have made most sense if the official prices reflected something like a midpoint of all transactions taking place. This way both buyers and sellers could check up on the brokers acting in their interest. Koudijs, p. 6

The accuracy and reliability of Dutch financial newspapers extended beyond the reporting of prices, to monitoring ship and cargo traffic.

It was the Dutch newspapers, rather than French, Italian, or Spanish, that contained the greatest detail and most accurate accounts of the annual or biannual treasure fleets arriving in Spain from Mexico or South America. Neal, p. 37

The track record of accuracy in Dutch gazettes is also confirmed in scholarly work comparing newspaper accounts of gold imports to Portugal from Brazil in the 1740's with official records. Figures from Dutch gazettes are remarkably similar to those reported in official Portuguese "Manifestos" as well as "Consular Correspondence," indicating the high premium which Dutch business papers put on accurate information flow from Portugal.

Wessex argues that no entries regarding commercial freight aboard the Victory appear in the ships' official logs, so it is unlikely that any commercial cargo was present. Yet, the absence of commercial business in naval logs is not surprising. According to the National Archives website, log books were used to record essential information such as location, movements, orders, naval actions, and weather. Occasionally logs might include information about work and disciplinary actions on board, however, logs were not used to record non-naval business.

Unlike the taking of prize from enemy merchant ships or war vessels, which was regulated by the Navy, the taking of commercial freight on board a warship was a private matter. The freight and charge was dictated by an agreement between a ship's command and the command's client. The Navy did not take payment and was not involved in the transaction. Since this business might introduce an agency conflict between the navy and a ship's commander, it is not surprising that official ship logs did not make mention of commercial shipments.

A case in point is shown in the history of Admiral Augustus Hervey, a colorful character who served as a commander in the British Navy in the mid-18th century. According to Hervey's personal journal, the Admiral used his ship to transport money regularly. Yet, none of these commercial exploits are noted in his ships' official record logs (Admiralty Logs, National Archives, 51/692).

Royal Navy captains were not allowed, as French officers were, to carry merchandise, but the rules permitted them to employ their ships as armored trucks for merchants and governments who needed to transport money. The one-percent fee was handsome, and Hervey was one of many captains who dallied in port to maximize his earnings from this source. In 1752 he lingered at Lisbon for five months--spending most of the time chasing women, it seems--until quantities of coin and bullion were ready to be shipped from there and from Cadiz into the Mediterranean. The aspects of an active officer's life that are seldom revealed in official records….. Link

In a review of research papers and ship logs from the 18th century, I was unable to find a single reference to commercial shipments appearing in official logs. This doesn't mean that these references do not exist. It does indicate, however, that recording commercial freight and associated logistics in a ship's log was not a common practice. Thus, the absence of information regarding commercial freight in the Victory's log books is not sufficient reason to believe no commercial freight was on board.

Conquests may have provided another source of valuable cargo held aboard the Victory. The fleet operating under Sir Admiral John Balchin and the flagship Victory was said to have captured several enemy ships carrying substantial coinage. Some of that specie may have been aboard the Victory when she sank, as the captured prize money may have found its way to the safest ship in the fleet.

Wessex Archaeology has pointed out that the holds in captured ships were likely to be sealed and brought into harbor when practical, so the Victory may not have carried prize money. While this is a valid point, during wartime this course of action may not have been feasible. There is also the possibility that some of the ships may have been ransomed and proceeds taken aboard Victory. Also, personal valuables from sailors on captured vessels may have made their way aboard the Victory.

While Wessex Archaeology concludes that, "On the basis of the available evidence the presence of a valuable cargo, in the form of valuables taken from prizes and/or a private cargo of specie/bullion, is considered to be highly unlikely, though not impossible." We believe that it is Wessex's conclusion that is highly unlikely, and that given the weight of circumstantial evidence, there is likely valuable cargo in the Victory wreckage.

Valuing the Victory's Cargo

Before discussing Victory's cargo, we need to establish the distinction between trade artifacts (e.g., coin, bullion, ingot, personal valuables) and naval artifacts (e.g., cannon, navigation equipment and other ship hardware). Per UNESCO archaeological principles, and in accordance with British law, only trade artifacts are to be sold. The remaining artifacts are likely to be assigned a value and placed in a museum or under conservation.

Under the agreement outlined in 2012, Odyssey was entitled to 80 percent of the value of trade artifacts, and 50 percent of the value of non-trade artifacts. I would assume that the company would receive its 50 percent value for non-trade artifacts out of proceeds from the sale of trade artifacts (thereby raising the 80 percent figure). This agreement may have changed in the last couple years, however, I would assume that OMEX would retain similar economics regardless.

Please note that the UK has not signed the UNESCO Convention on the Protection of the Underwater Cultural Heritage. They abide by its archaeological principles, but the Convention conflicts with British law. British law allows museums to "deaccession" items and offer them for sale. The Treasure Act of 1996 allows for treasure finds to be sold to museums or on the private market. The Portable Antiquities Scheme is much the same. Items of British cultural heritage are bought and sold every day under British law (this may be a key reason why the UK has not signed UNESCO).

The shipment from Portugal would have principally come in the form of Portuguese or Brazilian gold coin of various denominations -- the coins were sometimes called moedas, moidores, reis, and peca. The most popular was the 6400 Reis. While some of the shipment may have been in gold ingot or in silver coin, research indicates that gold coin was the currency of choice for international trade between Lisbon and England. In fact, by 1742, the single, double, and quadruple moedas were so prevalent in Britain that the moeda was renowned as "in great measure the current coin of the Kingdom" (Vallavine, 1742) Link.

In 1717, Sir Isaac Newton, Master of the British Mint, had set the price of gold at £ 3.89 per standard ounce of 91.6% fine, effectively setting the gold standard in the UK. That price remained in place for over 200 years. The stability established by the gold fix, the relatively high exchange rate offered for gold, Britain's trade surplus with Portugal, and the abundance of gold being produced for Portugal in Brazil combined to produce a large influx of gold ingot and coinage to the UK from Portugal in the 18th century.

At a price of £3.89/oz, a shipment of £400,000 would have equated to approximately 102,827 ounces of gold moedas. Since we have an idea of the weight of the cargo, and we have a good sense that it is mostly in gold, the simplest way to estimate the value of the commercial shipment is to fix a value to an ounce of gold recovered based on today's value of Portuguese/Brazilian coins from the period. In the table below, I have presented some completed transactions for coins that could have been aboard the Victory.

(click to enlarge)Portuguese and Brazilian Coin Schedule - Realized Prices

If we eliminate the outliers (both high and low shown in yellow), the average price per ounce works out to approximately $16,260. To remain conservative, we will discount that value by 50 percent to $8,130 per ounce. That 50 percent discount reflects a wholesaler spread (15 percentage points), increased supply (15 percentage points), and another 20 percentage points for conservatism's sake. In this analysis, we will ignore the fact that collectors will normally pay a premium for certified shipwreck coins (especially those originating from famous shipwrecks). We will also ignore the fact that the average grade of coins coming from the Victory would be relatively high -- possibly comparable to the MS64 grade at which the average SS Central America coin graded during that ship's first salvage.

If we assume that 80 percent of the cargo was gold coin and 20 percent was gold ingot, and the gold ingot could be sold at 4x melt, which is roughly the same price that smaller SS Central America ingots have fetched (registration required), then we get a value of approximately $660 million in gold coin and $105 million in ingot for the £400,000 of 1744 gold. (Note that ingots from the period appear to be rare and we are likely undervaluing them considerably. These two Brazilian ingots from the 1800s sold for over 50x melt value.) If we were to assume another £25,000 in captured prize and personal gold, all represented in gold coin, this would add another $50 million so that the total gross proceeds would equal $815 million.

We are excluding the possibility of silver coin in this analysis. If we were to include a proportion of silver coin it would increase the value of the salvage. Though silver coins of the era command a lower price per ounce in numismatic markets (roughly $1,700), there would be approximately 15 ounces of silver to every ounce of gold shipped due to the rate of exchange between the two metals in 1744. Thus, our one ounce of gold value of $16,200 would be compared with a 15 ounce numismatic figure of around $27k in silver.

As shown in the above table, a project that produces gross proceeds of $815 million will yield net profit of approximately $571 million to OMEX. Note that costs are covered in the agreement, so the $25 million of costs reimbursed to OMEX means $596mn in total proceeds. Also, note that this project can be accomplished using the Odyssey Explorer (OE). We know that the OE has operated off the coast of the US for the last few months at an approximate cost of $1 million per month. The Victory project is in shallow water and is closer to port than the SS Central America, so monthly expenses may be lower for this project. Some have speculated that the costs of the Victory salvage could be as high as $40 million, however, this seems unreasonably high. The $25 million is a conservative estimate to account for an 18+ month salvage as well as conservation of items.

While the above scenario is certainly possible, I have used more conservative assumptions in my base case with the hope that the company will surprise to the upside. The base case assumes that for whatever reason, OMEX is only able to recover one-third of the published commercial load and captured prize stated above. If this is the case it would mean a gross salvage value of approximately $270 million and approximately $169 million pre-tax profit.

Base Case

This scenario may prove overly cautious, but it puts the recovered commercial payload at £133,000 (1744), roughly in-line with some of the other known warship cargoes at the time. Neither scenario anticipates any value recovered in artifacts. The 100 cannons alone could fetch over $10 million and there are certainly other significant naval artifacts in the wreckage. Since half of the assessed value in artifacts will accrue to OMEX and that value will likely be monetized through trade artifacts, the net proportion of trade goods due to the company will be greater than the 80 percent stated in the contract.

With over $180 million in net operating losses (NOLs), OMEX shareholders would receive the $169 million base case profit tax-free (unless Oceanica uses the NOL first). Thus, the base case implies $2 per share in value to OMEX shareholders. The optimistic scenario yields almost $5 per share in after-tax value.

A wide range of outcomes could result from the Victory salvage, however, the cash-flow break-even point on the project is very low, limiting investor risk. This is due to the fact that costs are reimbursed out of the gross proceeds, before Galt or the government receive their compensation. Thus, even if OMEX is only able to recover pocket change from the 1,000 people aboard, the company would likely break even at minimum.

SECTION II

Odyssey Marine Liquidity Analysis

Some have argued (over and over and over and over again) that OMEX faces imminent bankruptcy, and is, in fact, insolvent. While liquidity is clearly an area where all shareholders would like to see improvement, it is not nearly as dire a situation as short-sellers wish you to believe.

Odyssey had $6.5 million in cash at the end of July ($5.8mn unrestricted). Below we show how the liquidity is likely to have progressed since.

Liquidity Analysis

Based on the above analysis, Odyssey has access to cash today that would fund it through approximately early February, assuming a $2.1mn/mo. burn rate (per the last conference call). This assumes that the company can tap the second $5mn tranche of its marketing partnership agreement. We believe the marketing agreement is with a numismatic coin dealer, so our thought process is that the Victory, and its potential hoard of gold coins, would represent the second trigger in the loan agreement (the SS Central America being the first). We don't have confirmation on this, but we believe it to be a reasonable assumption. Notably, this analysis does not include any monetization of the Central America proceeds.

Numismatists, with whom we have consulted regarding the value of the Central America salvage, put that value between $40-45 million. This estimated value is without the benefit of seeing the coins and other artifacts to understand the grade of each, but is a reasonable estimate based on previous Central America coin grades.

We don't know how the Receiver and Odyssey will monetize the Central America salvage items, but we know that both are motivated to monetize them rapidly. They might do so through an auction, or they could sell to a wholesaler in one transaction. A wholesale transaction would bring less money, but would bring it sooner. Numismatists tell me that an average wholesale discount is in the 10-15 percent range. Since this is a very large transaction, we will assume that the wholesale discount is expanded to a very conservative 30 percent.

SSCA Monetization

As shown above, OMEX should net approximately $15.9 million in a wholesale transaction. Proceeds would immediately be applied against the 5th 3rd line which was collateralized by the gold ($7.4mn per last 10Q + $200k in assumed draw in 3Q). After that line is paid, another $8.3 million in cash is available to OMEX in addition to the $8.8mn today, or roughly $17mn (less whatever has been burned in the first few weeks of October). This $8.3mn would translate to approximately four months of additional cash on a $2.1mn burn rate, and would extend the company's runway from early February to approximately June 2015. Because the marketing facility is a multi-year loan, we assume it will be repaid later with proceeds from Oceanica or Victory.

If RLP and OMEX were to market the coins directly to consumers they could capture much of the wholesale spread (and eat the wholesaler expenses) so that the economics would be improved. This scenario might yield OMEX closer to $20mn in total proceeds, however, it would take longer to realize. RLP and OMEX could also use a hybrid approach and sell through both the wholesale and retail channels.

Short-sellers argue that OMEX is simply prolonging its life by leveraging the firm. The above analysis has shown this to be inaccurate. OMEX took $7.6mn on the 5th 3rd line and will take $10mn on the marketing loan for a total of $17.6mn in debt. Yet, OMEX will conservatively net approximately $16mn from the SS Central America, so it is easy to see that these debt facilities simply allowed the company an early monetization of what they were due. The net debt increase is only $1.7mn dollars.

While short-sellers try to portray OMEX debt size as a significant threat, this is not the case. The company's overall leverage is relatively conservative when viewed in the context of a realistic assessment of two of its largest assets - Victory and Oceanica (we will exclude Neptune for now). We will try to account for the value of these assets to provide a more accurate representation of the company's balance sheet in the following paragraphs.

How much is the right to salvage the Victory worth today? Creating a probability distribution of different profit outcomes can help us get an expected value for the project.

(click to enlarge)

We have modeled these probabilities in a very simple, conservative, discrete distribution above. You will notice the positive skew and a thin tail on the right and a steep, fat tail on the left. The median value in the above distribution is the $170mn figure we derived in our earlier analysis. The high end is represented by our optimistic scenario and is assigned a three percent probability, and the low end anticipates a zero profit outcome. This analysis points to an expected value of approximately $150mn for the Victory recovery.

We have analyzed Oceanica's value in the past. Ultimately, the asset could fetch over $1 billion, but this assumes an environmental approval and that risk will need to be weighed. If we assume that today the asset is worth $400mn, this translates into approximately $200mn in value to OMEX (pre-tax).

Here is a more accurate view of OMEX's balance sheet, taking into account its two largest assets.

(click to enlarge)Theoretical Balance Sheet

The point of this exercise is to illustrate how OMEX's debt balances relate to a realistic estimate of its assets. Odyssey's total liabilities of $30mn equate to under eight percent of total assets. Obviously GAAP won't allow the company to recognize these asset values officially at this point, but since they have already provided the company with significant cash in the past and are likely to provide much more in the near future, they should not be ignored by investors. Note that this balance sheet builds off of the latest 10Q by adding some of the recent financing transactions and SS Central America monetization. It has not been reworked for anticipated changes in working capital or cash burn and is not meant to reflect an accurate up-to-date representation of OMEX's GAAP statement.

Readers should be aware of a couple additional points regarding OMEX's liquidity situation. In addition to the funding sources referenced above, the Victory approval has undoubtedly opened more financing doors for OMEX. They likely won't need it, but OMEX could find a number of project finance sources that would lend the company $10 million on relatively attractive terms even though the project is already encumbered by Galt. The Victory is a well-known and researched entity, its location and identity are confirmed, the paperwork is in place, and the contract terms are known, so the risks are relatively limited (vs. other salvage jobs). With salvage of the Victory potentially starting around year-end, this may also provide OMEX with near-term cash. Odyssey could arrange another bank line with 5th 3rd, or another entity, to partially monetize coins as they are salvaged.

The cash provided by the marketing facility and the Central America monetization should offer more than enough runway for the monetization of Oceanica. Management has stated that they are working on a monetization now, so we might expect one in the coming weeks or months. An Oceanica monetization may bring OMEX a $10mn receivable owed to it by Oceanica, and it could also trigger the exercise of Mako options, depending on the transaction. The Mako options would bring approximately $19 million in cash if fully exercised. Alternatively, OMEX might sell its stake in Oceanica outright, bringing investors hundreds of millions of dollars immediately.

SECTION III

The Right Move for Britain

The UK government made the right decision in allowing the Victory salvage to move forward. They took their time with the decision, and vetted OMEX carefully before allowing the salvage to proceed. That OMEX was selected for this work against a backdrop of slanderous claims in the UK media, speaks volumes to the firm's expertise and track record.

The resources, both financial and cultural, that Odyssey will recover for the people of the UK are tremendous. The idea that this salvage might have been prevented by the self-interest of a couple jealous narrow interest groups does not seem fair to the people of the UK. Fortunately the Ministry of Defence saw through the political maneuvering and popular media manipulation of these special interests. The Ministry weighed the merits of the Victory recovery based on facts rather than inaccurate emotional appeals.

The opposition's key position is that they believe that the Victory site should be left alone, and that a "commercial interest" should not be allowed to exploit a national war grave. If that war grave is to be disturbed, the work should be done by archaeologists who are not motivated by the prospect of profiting from the operation.

The idea of leaving the site untouched (in-situ) is impractical. Studies demonstrate that the action of fishermen and tides threaten the artifacts on the site, so the idea of leaving it alone equates to allowing the site to be destroyed by these forces. The more important idea, however, is that the site's location is well known at this point, and it is not difficult to access as it lies in less than 100 meters of water. This makes it a very tempting target for illegal looting by less scrupulous "black market" salvors.

In fact, in 2011, a Dutch group stole a 24 pounder cannon from the site using a hydraulic grab. The shallow position of the wreck means that pirating artifacts from the site does not even require expensive equipment such as hydraulic grabs or ROVs, the Victory may be reached by scuba divers. It is impractical to guard the Victory round the clock into eternity (along with the thousands of other wrecks around the UK) so the site simply will not survive in-situ.

The interests opposing Odyssey's Victory salvage believe that a commercial group, such as Odyssey, cannot do good archaeological work as the company's profit motive will interfere. This stance is based on a generalized view of shipwreck salvors, some of whom have not respected archaeological principles in past excavations. Odyssey's history, however, demonstrates a standard that is equal to, or higher than, those of most respected academic archaeological groups. In fact, Odyssey has produced an impressive library of high quality archaeological and scientific work regarding deep sea wreck sites which rivals any produced by other archaeological sources. Also, Odyssey's work has created the opportunity for outside interests to use the Odyssey platform and/or Odyssey research to extend the benefit of Odyssey's operations. I note that since finding the Victory in 2008, there have been at least ten research reports published which leverage information gathered from the site, greatly expanding the amount of information available about the Victory.

The argument that a profit motive will get in the way of good archaeological work is a diversion. There is simply no reason to believe that Odyssey's archaeologists, as well as those it may hire for this work, cannot produce quality work. Anyone who knows Odyssey's people will tell you this is a group that share an enormous passion for the archaeology and history of shipwrecks. They love what they do, and take pride in the work they produce. They would do the same work regardless of who signed their paycheck - whether a university, a government agency, or Odyssey.

Odyssey's work has always been based upon a level of high scientific standards and transparency with regulators, and this will not change. Under the watchful eye of the UK's Ministry of Defence and a hostile archaeological crowd, Odyssey will continue to uphold the high standards that the company previously set. No one in the world has more experience excavating underwater wreck sites of important cultural heritage than Odyssey. This is the primary reason they were selected to continue the salvage of the SS Central America. The company appreciates the historical importance of the Victory, and is motivated to do an excellent job in this high-profile recovery.

Some archaeologists object to what they term as the "desecration" of a war grave by Odyssey. This is a curious line of argumentation for archaeologists, many of whom spend their careers hunting for and digging up human remains. While some archaeologists unearth bones purely to extend our cultural knowledge, the majority have commercial interests in mind. In fact, bones are disinterred all over England in the name of developing shopping centers, buildings, roads, railways, and more. Some of these graves, no doubt, belong to fallen soldiers. Not only do "rescue archaeologists" exhume remains for commercial gain, but they are paid to work with great haste. If the UK is willing to rapidly disinter human remains for the cultural heritage offered by a new shopping mall, then it should absolutely stand behind a decision to carefully and methodically salvage the Victory for the cultural heritage and economic benefits this work promises.

There is a strong argument to be made that a Victory recovery offers the opportunity to give sailors' remains the dignified burial they deserve. It is exceptionally rare for human remains to have survived in this environment for such a lengthy period of time. Few remains (if any) are likely to be found. Those that were present in the recent past may have been dragged over the bottom of the ocean by fishing trawlers, or illegally removed by pirates. What Odyssey will provide is a dignified reburial of any remains found, in a manner and place dictated by the UK's Ministry of Defence. This will insure that remains will not be disturbed or stolen in the future.

It was Admiral Balchin's entrepreneurial spirit, reflected in his commercial payload, which has indirectly cleared his and his crew's name and paved the road for the restoration of the cultural heritage offered in the wreckage of the Victory. If not for the rich value of Balchin's cargo, the Victory wreckage may never have been discovered by Odyssey, or anyone else for that matter. The discovery of the Victory, some 100 km from the Casquets, where the ship was originally believed to have foundered, indicated that poor navigation hadn't caused the ship to sink. Rather, it was likely the ship's high high-sided design that led her to falter in a violent storm in October of 1744.

In a sense, Admiral Balchin's commercial interests and his profit motive served to insure that his story would not be misunderstood, and that his ship's heritage would not be lost or forgotten. So, it is fitting that his story, and those of his men and his ship, would be told by a commercial interest with a profit motive, whose aim is to complete Admiral Balchin's objective and deliver that commercial cargo to the shores of the UK.

UNESCO's Convention on the Protection of the Underwater Cultural Heritage (UNESCO)

The in-situ argument, and resulting illegal Victory piracy, illustrate a broader point. There is enormous economic and cultural value sitting at the bottom of the ocean within shipwrecks. This value provides economic and other motivation for the salvage of these wrecks. Yet, the UNESCO Convention for the Protection of the Underwater Cultural Heritage aims to protect this heritage by adopting principles which make it difficult to salvage historic shipwrecks legally for commercial gain.

Britain has not signed UNESCO but still abides by the archaeological principles of the Convention. So, the Victory approval, in accordance with UNESCO's annex (rule 2), undermines yet one more short thesis, and demonstrates that the historic shipwreck business remains open to OMEX. Nonetheless, the Convention imposes significant obstacles to legitimate and legal historic shipwreck salvage.

While the Convention is without doubt well-intentioned, its rules are leading to unintended and perverse consequences. These consequences make the Convention, ironically, one of the key threats to underwater cultural heritage. Applying the Convention's principles makes it more likely that shipwrecks will be exploited illegally by private parties, such that the cultural and economic benefits that would otherwise accrue to society are lost to pirates.

The law of unintended consequences is an adage or idiomatic warning that an intervention in a complex system always creates unanticipated and often undesirable outcomes. Akin to Murphy's law, it is commonly used as a wry or humorous warning against the hubristic belief that humans can fully control the world around them….. A perverse effect contrary to what was originally intended (when an intended solution makes a problem worse), such as when a policy has a perverse incentive that causes actions opposite to what was intended. Link

With the advancement of science, seabed exploration has become more accessible to more people. Technologies, once too expensive for all but those with the highest levels of expertise, are becoming available to the masses. Personal submarines and ROVs are being sold on the Internet so that anyone with a few thousand dollars can explore the ocean at depths and retrieve items. These technologies will only become more refined, powerful, and accessible over time. There is little doubt that these low-priced devices are exploring the sea floor today, and for all we know, are salvaging shipwrecks in contravention to UNESCO principles at this very moment. Of course, more sophisticated pirates may also be at work.

UNESCO is preventing historic wreck sites from being salvaged in a legal, regulated, and transparent fashion, and is instead beginning to feed a booming illicit trade in underwater cultural heritage items. While not a perfect example, we saw evidence of this concept the when the Dutch (and perhaps the French) illegally salvaged cannons from the Victory. We will see more examples in the future, but most of these activities will go undetected, and the heritage and economic value of these wrecks will be silently lost to pirates.

Illegal looters, protected by UNESCO from the competing forces of legitimate, law-abiding operations, and the higher costs of conducting legal, archaeological excavations, will derive outsized profits in a protected but illegal market. Those profits, sourced from the economic benefits that would otherwise accrue to society in part, will instead fund larger scale illegal activities so that this pirate industry becomes pervasive, powerful, and very difficult to control.

A more rational and practical approach to governing shipwreck salvage is one that has been exploited with success by regulators of various industries throughout history. This is to harness private companies' profit motive for the benefit of society. Allow the salvage industry to do what it does best - find and salvage shipwrecks while also doing high quality archaeological and scientific work. At the same time, regulate the business -- impose controls, oversight, and restrictions to protect cultural heritage. The lure of profits for legitimate businesses will attract capital such that historic wrecks of value are salvaged legally by businesses that operate under the scrutiny of society and regulators.

Final Thoughts

We consider it extremely unlikely OMEX will be allowed to excavate and exploit the Victory….in our view, OMEX's last treasure hunting project is dead. OmexTRUTH.com, 10/31/13

Short-sellers will no doubt tell us that the Victory has nothing of value to salvage, just as they told us the SS Central America would yield almost no gold. They will tell us that the company will go broke trying to salvage the Victory, that only items currently on the surface are eligible for recovery, and that even if gold is found it will be claimed by others or held up in court indefinitely. We've been told the same stories before by the shorts, we know they are wrong (and so do they).

The prospect of any commercial or personal interest winning a claim to even a small portion of the Victory's cargo is highly unlikely. The commercial interests involved would have been small merchants and loose "coffee house" insurance syndicates in 1744, and there would be no surviving entity. Also, virtually every record in Portugal was lost in the great earthquake of 1755. Further, as a sovereign warship, the wreck belonged to the UK government who gifted it along with all "artifacts and appurtenances" to the Maritime Heritage Foundation. So, the protection offered by the UK government would pose another hurdle against any potential claimants. That hurdle was too high to overcome in the case of Spain when claimants (even those with verified paper claims) were unable to successfully claim anything from the Mercedes.

The MOD sign-off was the last hurdle of significance preventing the Victory project from moving forward, however, there are some loose ends which will need to be tied up before work can proceed. These would include moving the Odyssey Explorer and getting her outfitted for the job. The conservation facilities would also need to be prepared. OMEX will also need to get an environmental permit from the Marine Management Organization (MMO). Since the MOD was in active consultation with the MMO, it is safe to assume that any MMO concerns were addressed before the MOD sign-off. My guess is that these processes should not take much longer than six or eight weeks to accomplish.

The Victory news is the first in a one-two punch that Odyssey will deliver to short sellers. The Victory may not be an immediate knockout blow, but the next news item will be. An Oceanica monetization will deliver significant cash to Odyssey and will validate the Oceanica claim. The combination of the two projects will create hundreds of millions (possibly in excess of a billion over time) in value to shareholders, and that value will become apparent over the coming months. For more details regarding Oceanica and the value of that asset, please see this link.

OMEX investors have endured months of unfair treatment in the market as a short-seller (and whoever may be pulling his strings) has published deceptive OMEX research, displaying a blatant disregard for the truth, and manipulating shares of this stock lower. Though this short-seller has been dead wrong on virtually every fundamental call he has made, he has been successful in using deception to frighten many small investors into selling their OMEX shares, giving short-sellers the superficial appearance of being correct. OMEX's poor performance is not solely due to short-seller propaganda, however, that propaganda has definitely played a large role.

This author did not care about the truth because he realized that his research did not need to be accurate to win this battle. Publishing unfounded and inaccurate research was enough to deceive investors into doubting this company's ability to survive. That doubt drove the stock downward, creating a self-fulfilling prophecy as a lower stock price made it increasingly difficult for OMEX to monetize assets or raise money. Without the ability to monetize its assets, OMEX would have been rendered insolvent. In other words, it appears that the author hoped to negatively impact the outcome of OMEX's business dealings by publishing deceptive research.

This short-seller seems to admit as much in his annual letter, where he proudly terms his OMEX campaign an example of "inverse activism." If activism means leveraging an equity stake to bring corporate change that increases shareholder value, then inverse activism is the act of using a short interest to cause fundamental change that reduces shareholder value.

The strategy seems to cross a line. Whereas short selling is normally seen as a practice that enhances market efficiency by detecting and correcting overvalued securities, "inverse activism" aims to actively destroy value. When paired with deceptive and misleading research, inverse activism fabricates a new reality for a company and then tries to force the company into that insolvent reality. There is nothing about this combination that is efficiency-enhancing or redeeming.

It is now up to regulators to determine whether this "inverse activism" is legal. They appear to have accepted the charge. According to TheDeal.com, the SEC is questioning this short-seller regarding allegations that his research is illegal and manipulative.

Under normal circumstances, a strategy of deception will not work for long. A business can protect itself by quickly providing fundamental proof that demonstrates the short thesis to be incorrect. In OMEX's case, however, because the gestational period for its assets is so lengthy, and because management must keep quiet about progress to protect shareholder interests, a perfect vacuum of silence was provided for short-sellers to manipulate shares of the stock. The shorts' strategy worked brilliantly until the market was finally confronted with the reality of the near-term monetization of one of the firm's key assets.

Now the strategy's shortcomings are beginning to be exposed. Just as the market is realizing that management was shooting straight regarding the likelihood of a Victory go-ahead, it will also come to realize that OMEX management has been accurate with respect to their characterization of Oceanica. This phosphate concession is a world class asset that is in Mexico's best interest to develop. Short-seller claims to the contrary have already been shown false, and the market will soon be forced to reflect this reality.

Short-sellers have lost in their attempt to deprive OMEX of funding. Victory and the Central America have insured this. Oceanica will further emphasize the point. The next few months will be transformational for the company. Those of us who have been able to hold on, and see through the shorts' connivance, are about to be rewarded.

Is Odyssey really "waiting for approval?" This makes it sounds like it is just a matter of time before Odyssey gets the green light on the Victory. Omextruth.com, 11/15/13

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

Additional disclosure: This note is solely a reflection of my opinion based on my knowledge of the circumstances. I consulted with and relied upon experienced professionals in making my assessments, and we are in broad agreement on these issues. All the same, these are my words, not those of the experts. The Author has obtained all information herein from sources he believes to be accurate and reliable. However, such information is presented "as is," without warranty of any kind - whether express or implied. The Author makes no representation, express or implied, as to the accuracy, timeliness, or completeness of any such information or with regard to the results obtained from its use. All expressions of opinion are subject to change without notice, and the Author does not undertake to update or supplement this report or any information contained herein. This is not a recommendation to buy or sell any investment. We may transact in the securities of OMEX at any time subsequent to publication. Green River is a holder of OMEX shares.