Michael Kao, Akanthos Capital “The TAO of Asymmetric Investing”

By Travis Johnson, Stock Gumshoe, April 4, 2014

These are my notes and instant reactions from a presentation at the Value Investing Congress, the notes below might contain errors, paraphrases, incorrect quotes, or misinterpretations.

Michael Kao has presented at the Value Investing Congress before, but the last one was in 2011 and I don’t think I’ve written about him at all recently. He got into GM distressed bonds in 2010 during the bankruptcy process, I think, which was one of his more successful ideas — and an 800% return for him. He likes the odd securities that come out of bankruptcies. He talked about large positions in the preferreds of Fannie Mae and Freddie Mac, too, in which he has gotten 2,000% returns (and still owns them, that’s going through the courts).

He says his fund is both long and short, and uses both debt and equity, with an event-driven focus. They look at equity, credit, and volatility, and have high-weight concentrations but use very diverse thematic ideas (that’s important — concentration is OK if you have great confidence, but make sure the same thing can’t take down several parts of your concentrated portfolio.

And his idea today: TAG Oil (TAO in Toronto, TAOIF on pink sheets).

$68 million in cash, market cap $210 million. Trades at about 3.5X EBITDA.

He thinks TAO equity looks like a distressed convertible bond with possibility for explosive upside if things work well. They have a basic production level that generates steady returns, and the upside is from possible drilling success.

Current wells generate about $40 million in annual cash flow, but he thinks getting past come current problems brings production from 1,400 barrels a day to at least 1,600, so that’s enough that they’d be trading at about 3X EBITDA from that pretty steady production. That’s what he thinks of as the “bond” part of his thinking (though it’s obviously not a bond).

And the upside, the “convertible” part of that “bond” in his way of explaining it, is the future production — the three options are the additional drilling opportunities in the Taranaki basin, the huge potential upside of the East Coast Basin, and the “pie in the sky” possibility of the anterbury Basin (that’s on the east side of the South Island, no drilling there at all, just some seismic data).

Proven and probable reserves are the “safe” value of the stock — reserves plus ...

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