Hero Technologies Inc (HENC)

[tchauncy]

A Closer Look at the latest HENC, TGC Revelations/Machinations…

With background as a former Co-founder of Merrill Lynch’s Oil & Gas Tax Incentive Investment division in the mid-1970’s and later Stock Brokerage/Investment Banking firm Founder/CEO that specialized in Oil & Gas investments (over 25 years retired); I first became aware of HENC as a public company from a longtime friend who was interim CEO in 2007. This, shortly after a local Houston based private Engineering company, Hollolman Corp.(HC), rolled a massive Cooper Basin AU, acreage position into its public predecessor Company, Endeavor Energy. What particularly sparked my interest aside from the fact that the Cooper Basin was an emerging international “hot-spot” for oil & gas E & P, was the fact that not long after the assets were rolled in, HC ‘s long time Globally respected top Executives, also assumed similar top Management and BOD positions in HENC. Not only did they assume the top positions, but shortly after the completion of the roll-up, several started buying HENC’s stock in the open market at prices as high as $.85 a share. Today, some 8 years later, these same Executives and Directors are still on board in both Companies. Perusing all past insider filings, it is noteworthy that the total investment by HC itself and past insider purchases, put total dollar value invested by current management and the parent, at over $20 million.

While it never was the intention of HC/HENC insiders to actually build a robust Independent E&P company organically, instead, Joint Venture with another entity to provide financing and take over the role to build a company, there was no question, even in the early years, that the massive million plus acreage position contributed, could provide an E&P base that in itself could grow to multi-billion dollar value.

Call it luck if you like, but in the early years, as HENC’s only “asset”, there was no active exploration within a hundred kilometers of either of HENC’s major concessions, PEL 112 and PEL 444. In fact, my own personal experience in showing it to a top Geophysicist in Houston found him almost laughing at the “folly” of even thinking the oil trend of the Cooper would come anywhere near what is now called the “Western Flank”; However, within a year, serious “wildcatting” was begun on adjoining licenses by the likes of AU based explorers Beach Energy, Drillsearch, Victoria Petroleum (now Senex) and others who began using enhanced 3D seismic. To everyone’s surprise, not only were discoveries being made, but 1000 barrel a day tests were becoming common-place and even a few 5000+ bod discoveries were being found, all from wells no deeper than 6,000 feet. Making it even better was the crude being discovered was very light and sweet, garnering as much as 10-15% premiums to Brent (currently $65 bbl before premium). Most all being exported to such fast growing Western Hemisphere countries as China, Viet Nam, Korea and even Japan. And with a “wildcat” discovery percentage approaching 50% and offset wells around 90%, the recent year finding costs in the Western Flank has now dropped to under $25 a barrel.

Around the turn of the Decade, a noteworthy acreage sale by the AU government of smaller concessions which adjoin both 112 and 444 were being sold upwards of $50 million just for the right to drill on this acreage. In 2009 and shortly thereafter wells were being discovered within a few Kilometers of both HENC concessions. In mid-2009, HENC engaged AU’s most well respected Petroleum Engineering firms, ISIS to do an evaluation on just a few dozen leads covering only around 32,000 ac on 112, and they came up with a volumetric evaluation showing a 90% potential (P90) of over 25 million barrels recoverable in just this one section. Even late last year, after prices started to decline and acreage “picked-over”, untested licenses were still moving at the $50 million plus level.

You can find and download the ISIS reports mentioned above on HENC’s website at this link:

http://hollomanenergy.com/technical_reports/

While since early on, several of the above mentioned major explorers were very interested in partnering up with HENC, management felt, (and I agree) that dealing with these local vultures would either leave HENC with just a small interest, or they would put together such an aggressive drilling budget that HENC would either have to dilute itself into oblivion, or be forced to sell out early to cover their shared commitment.

Approximately four years ago, HENC did have a first “go-round” with a start-up Canadian based company that quickly ended due to that Companies lack of performance. Shortly after, another group, with much more wealt backing approached the Company with a similar deal to the first, ie. “carrying” (covering the cost of 3D seismic and the cost of drilling and testing) HENC on up to a 6 wells, earning increasing levels of ownership after each target level was reached. This latter company was Terranova (TGC).

TGC as compared to the first suitor, due to its high profile backers, was able to raise a significant amount of money, to include an IPO, beginning in 2012. In fact, over $15 million raised just from stock sales either direct or through convertible note offerings leaving TGC now with some 82 million shares currently outstanding from a starting 14.5 million. And, as announced by TGC, on Feb 22, 2015, TGC sold 5.833% of its combined 20% earned interest due to completing 3D seismic to a third party, “Percival”, owned by one of its declared “Senior Advisors” Carlo Civelli, for $3 million cash. With the stock raised cash, TGC did pay for all of the cost of the 112 Seismic and the cost of a problematic very expensive dry hole on 112 a year and a half or so ago. They also paid the max required on the 444 seismic, but due to overruns, HENC also contributed over $600,000 toward the 444 seismic cost. All of this clearly earned TGC a 20% interest in both permits, and it appears 5.833 of 112 where the in fact did drill the dry hole. However, as can be seen by “dueling” PR’s and SEC filing, there seems to be some confusion over whether TGC has also earned a 5.833 percent of the permit of current interest, 444. However, a reading of the now “terminated” Farm-in Agreement (FIA), seems to clearly suggest that HENC’s reading is correct that TGC did not earn any interest past the seismic interest in 444, and triggered HENC’s response in its recent SEC 8K that TGC would be required to return 4.833% of its declared interest in 444 to HENC, whereby increasing HENC’s interest in 444 to 53.333%

(c) In the event Terra Nova fails to commence drilling at least one well on each License in connection with the Initial Well Program, on or before a date to be measured as ninety 90 days prior to the required drilling date set forth in the minimum work commitments, as extended, associated with that License, it shall not earn any Working Interest arising from the Initial Well Program with respect to the License on which it has failed to drill. Further, in that event, Terra Nova shall have forfeited the right to complete the Initial Well Program or the Option Well Program with respect to the License on which it has failed to drill and shall not earn any additional Working Interest in that License.

(Extracted from pg. 6, section 2.5c of the FIA)
http://www.sec.gov/Archives/edgar/data/1324736/000135448812002562/henc_ex101.htm

Now if you do the math re the above transactions, it becomes clear that TGC seems to “want to keep its cake and eat it too” regarding their retained ownership. There is no question that they reduced their ownership earned from the seismic to slightly over 14%. However, they seem to be trying to ignore the fact that they did not earn any interest in 444, by their PR declaration they still own 20.66. They even went so far in that PR to add up the parts they felt were owned by combining their 20.66 ownership along with Percival’s 30.83% and declare together they own over 51% in Both Licenses. Why did they go out of their way to point this out? Well, perhaps either it was done in error, or perhaps to give their shareholders an impression of “controlling interest” in maintaining “Operator” status.

Before I attempt to point out the err of their ways to make the above assumption, to avoid further confusion, let me clarify why HENC only receives back 4.833% rather than 4.833%. To understand this, you must understand that Percival had already bought out two other minority interests each from ACOR and Sahkai

“The foregoing notwithstanding, Holloman agrees to contribute to Terra Nova, in excess of its Working Interest Contribution Percentage, a portion of the Working Interest which would otherwise have been contributed by ACOR and Sakhai on the drilling and abandonment or completion of each of the first two wells drilled pursuant to the Initial Well Program, with the effect that of the 5.8333% Working Interest earned by Terra Nova in each such instance, Holloman will contribute a 4.833% Working Interest, ACOR a 0.5% Working Interest and Sakhai 0.5% Working Interest.”

(Extracted from pg9, Section 3.1 of the FIA linked above)

Due to Percival acquiring the above interest, it in fact, gets the “missing” 1%.

Now for the argument that TGC might be trying to make for its standing as continuing “operator”. From the above calculations, it should be obvious that they Do Not have the right just based on majority interest. At least not on the next permit to be soon drilled, 444. But aside from that, HENC, who was the original operator passed on the Operator status through to TGC through the FIA, the very document that TGC, unilaterally terminated! So with no active FIA, it falls back to HENC having the right to either operate, or chose an operator. What is amazing is that had TGC, just drilled the next well under the FIA, there would be no argument that TGC would be the operator on into the future.

Now why is the “operator” status so important? Well not so much if honest kindred minds are working together. But again reading the TGC PR announcing the termination, and insinuating they will remain operator, one must wonder what their motives for being so specific on this subject really are. You see, the operator, as they mentioned, controls the pricing and billing of each working interest owner’s obligations. Typically the operator will (legally) charge each WI owner with costs over and above actual expenditures and can make a nice profit being operator, even on dry holes.

Now some may wonder the motive behind why TGC just gave HENC an incredible gift, more than doubling HENC’s ownership to as much as 53% as compared to the approximate 25% or what it would have been had TGC not terminated the FIA, and completed its drilling obligations. Logic seems to have “gone out the window” re TGC’s decision. But, just maybe they did it because they had to in order to save face, but with an “outside” chance HENC can’t or won’t come up with their somewhat hefty 53% of well costs, which in such case, Advisor Civelli would come up with the cash and take over HENC’s no pay share.

Since I have not ever had any discussions with anyone at TGC, (or HENC Mangement for that matter) I can only give an alternative opinion based on history, logic and common sense. Consider this:

When one looks at TGC’s cash raises using their stock, it quickly becomes apparent they have run out of the ability to “tap” the public equity market at any reasonable share prices. They did their first $11 million IPO at .25, their second convertible at .20, and a last convertible at .11 per share; hitting all of these price in the first year and a half. Together this raised them the above approximately $15 million. However, if they retained the FIA, in order for them to fully raise their ownership, they would have to pay all of the pre-completion costs of five more wells, which assuming no drilling problems, would require at least $7-10+ million in Aussie dollars which are currently running about the same as Canadian dollars (their home currency). Just the fact TGC had to sell 5.133% (25%) of their “lifeblood” earned interest in both fields to Percival, who already is a large shareholder of TGC, shows that even Civelli, has much less respect for TGC’s stock, then he does of having a working interest in the combined permits. Knowing how Civelli negotiates, due to other interests I have involvement in with him, leads me to believe that he likely did offer to take stock instead, but it would have to be at such a low price that dilution of multiples of the current 82 million shares would be required. So to try to save face before my suspicions became apparent, the latest unilateral move was executed by TGC’s management. JMHO

Now let’s look at the “windfall” bestowed upon HENC with the TGC action.

TGC, (and of course Percival) would like to believe, (or at least give the impression) that HENC, due to its anemic balance sheet on its last SEC filing, would either not want to, or have access to capital to “pay their own way” on the newly bestowed 53% working interest. While that might be the case; as a person who has known HC management, for many years, I know for a fact that their business has been in a major up cycle the past few years and they certainly have the ability to write a check in a heartbeat to cover HENC’s costs. In fact, the reason HENC has survived so many years without doing public share financings is because HC has been “footing the bill” by paying expenditures, and then taking back restricted stock at or a few percentage points below market in exchange for cash spent on HENC’s behalf. In fact, as recently as this past April, HC purchase another 500,000 shares of HENC restricted stock at $.20 a share.

So let’s see how much in US dollars HENC would have to raise in US dollars to fully earn up to the 53% assuming HC would advance the cash. The dry hole costs of drilling a well in the Cooper basin seems to be running around $1.3 mill AU dollars. Due to the strength of the USD on World Markets, where all three currencies were running within 5% of parity just a few years ago when TGC was spending most its money, today while the AUD and CAD are still running within that 5% window, the USD has dropped to the point that it only takes around $.78 US to buy a AU dollar. So, if HENC has to put up 53%, on a multi-well program, its share of the cost would be around $540,000 per well to Total Depth. So it should be obvious that if HC funded as little as $3 million, or about the same amount that Senior Advisor Civilli paid TGC for a 5.833% working interest. HENC would easily be able to cover their own cost on 4 to 5 wells.

Let me see if I can make this even clearer. Percival paid approximately $600,000 per point to buy that 5.133% from TGC and that was only to buy the ongoing right to pay its future 5.133% share. On the other hand, if HENC put up a similar $3 million in USD, HENC picks up approximately 28% which works out to be around $108,000 per percentage point.

Now since HC and its management have already contributed over $20 million over the past 10 years or so for their controlling state, even predating HENC being public, HC/HENC management would have to be brain damaged, particularly after they have gotten some $15 million of what both companies have declared to be exceptional seismic mainly paid for by TGC who now only has maybe 15% on one area and maybe 20% on the other, to not provide the funding for HENC’s major percentage windfall. Even assuming that HEC buys stock at say $.20 a share, for 20 million shares, HENC shareholders would only suffer maybe an 18% restricted dilution raising $4 million, but again, receive more than a 100% increase in its ownership in both fields.

As a long time shareholder who has never received one free share from the Company; for full disclosure, I do have a high six digit position in the stock, bought and paid for at prices from as low as a nickel in 2008 to as high as .50 a few years later and various prices in between. I must admit, knowing that HENC started with an approximate 69% ownership in both fields, I would never have expected I would ever see the Company retaining a position larger than maybe 40% after all seismic was completed let alone with even a test well drilled. Was I disappointed under the terms of the TGC agreement in 2012? Yes, I was. I thought HENC management could have struck a better deal. Now, in hindsight, HENC’s management, looks like they pulled of the “Deal of the Century”; and they apparently did it all thanks to TGC’s mistakes in marshaling their cash assets.

One last thought. While I surly have no knowledge if it will be done in this case, knowing the straight up players that HENC’s management are, and based on how most of these interest disputes are handled in the “oil patch”, if it turns out that a legal squabble comes out over the 5+%, I would expect the parties would agree to co-fund the 5+% and put it in escrow until a legal venue renders a final opinion and then the victor will foot the costs in exchange for the interest.

Again, I remind, I have posted this blog based on my past extensive knowledge of HC and HENC, and limited disclosed knowledge of TGC. I have not attempted to gain any inside knowledge from either firms Management.

Conclusion;

The upside for the two licenses, possibly reach into the tens of billion dollar potential. Not just in conventional Oil, but also in natural gas, shale oil and gas, coal seam hydrocarbon, secondary recovery and horizontal drilling. Most of the latter resources have only become hot areas, even enticing multi-national giants to Cooper, in recent years. No matter which assumption ultimately rule, the few points that might be in question are infinitesimal compared to the tremendous upside for either company based on their current market caps.

JMHO

(btw, I will be out of pocket most of the rest of today, so I will try to catch up on any further questions or comments by tomorrow morning)