This is all going to sound at least somewhat familiar — the Stansberry folks are sending around a teaser ad that cites Hillary Clinton’s huge non-government earnings on her tax returns, and tells us that through the miracle of “Mainz Income” we can all make money using this same technique.
It’s familiar because it’s been used by these same copywriters several times over the years — the politician they use as an example differs as times change, so for a while it was George W. Bush, then Bill Clinton, then Barack Obama, and now Hillary Clinton.
Why use these individuals to headline your ad? Well, they are polarizing figures — and strong feelings get attention and get you to read, and the marketers don’t care whether you start reading out of hate or out of love.
And they’re also all bestselling authors — so although the comparison with the kinds of investments eventually being touted in these ads is a bit spurious, it does at least make some logical sense. More on that in a minute.
In case you missed the ad, it’s a pitch to get you to subscribe to Matt Badiali’s S&A Resource Report … here’s how the new version opens:
“It’s public record that Hillary Rodham Clinton made $186,600 per year as Secretary of State.
“But what most Americans don’t realize is that the former ‘First Lady’ is also tapping into a secret income stream – something I call the ‘Mainz’ income stream – which has enabled her to collect, on average, more than $57,390 PER MONTH since leaving The White House.
“That’s more per month than the average American makes in an entire year – and she’s been doing it NONSTOP for the past 14 years. That’s a total of more than $10 million….
“So, how come you’ve never heard about this before?
“Well, quite simply because the majority of people taking advantage of these income streams aren’t too eager to talk about them with the public.Are you getting our free Daily Update
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“As Thomas M. Rees, former Democratic Representative from California said of his ‘Mainz’ income stream, ‘It’s one of my most closely guarded secrets.’
“But what’s perhaps most surprising is that just about anyone can use these secret income streams to generate huge amounts of income. In other words, they ARE NOT reserved solely for politicians, public officials, or government employees.”
He lays out a bunch of other examples along the way, with stories and quotes about people who’ve made huge gains from these “Mainz Income” secrets. So what’s he talking about?
Well, quite clearly the basic pitch is still the same: Royalties. Royalties are a great way to make enduring income from an idea or asset — in the case of an author, royalties are how you earn your share of the book sales once those royalties exceed your advance, if you’re a landowner you might earn windfall royalties on the oil or gas or gold found on your property, or if you build or create something you might earn royalties from the development or commercialization of it — whether that’s a trademark or a patent or whatever. The great thing about those kinds of royalties is that they might pay off for a long time without you ever having to make a financial investment.
As investors, however, it’s different — there are royalty investors out there in several different industries, and when you buy into a royalty stream what you’re effectively doing is investing to own a piece of that royalty. You still shouldn’t, in most cases, have any ongoing financial commitments — the royalty money comes in without you being obligated to invest further in the company or endeavor — but you have made the initial investment. So like buying an annuity or a CD, it’s a case of figuring out how much the royalty might pay out over time and what you’re willing to pay for that.
Which is a pain in the neck. So there are also royalty companies out there that own or are buying or creating royalties, and when you buy those you’re buying some estimate of what their portfolio of royalties might be worth … but you’re also buying into a management team and their ability to keep managing that portfolio of what are effectively passive assets.
Here’s how Badiali describes the basic concept of the royalty investment and the logical connection to the “Mainz” name:
“Get Paid Over and Over Again, For Life
“In every industry there’s usually a backdoor way to get paid OVER and OVER again for a single idea, property, or patent.
“In the drug business, for example, the big money is in patents.
“After all the work is done developing a new drug, for example, a scientist can partner up with a larger company to handle the expenses and risks of testing, marketing, and distribution.
“Then the patent holder gets paid for every prescription that gets filled. The guy who developed the popular pain medication Lyrica, for instance, shares in more than $2 million per month because he owns the patents. The ladies who owned the patents on the anti-fungal medicine Nystatin shared in more than $50,000 per month.
“In the publishing business the big money is in royalties.
“Once you do all the work writing a book, you just sit back and collect your share of the profits. Hillary Clinton, for example, makes on average more than $57,000 PER MONTH from sales of her best sellers, Living History and It Takes a Village.
“In fact, this is why we call it the ‘Mainz’ income stream secret.
“You see, the Guttenberg Press, which was invented in Mainz, Germany, is generally considered the invention that first made collecting regular royalties possible, by allowing book publishers and authors to make a fortune after creating a valuable piece of work.
“And to this day, the ‘Mainz’ secret remains one of the great low-risk ways to get rich in America.
“You make just one investment… or control one valuable asset… and then get paid over and over again, while somebody else takes the risk of marketing, development, and distribution.
“Now… don’t get me wrong… I’m not saying you should go out and develop a new drug, or write a book, or record a record, or anything like that.
“You see, what I’ve found is that there are some incredible (and low risk) ways to use this secret as an investor. In short, you avoid all the normal risks of doing business… and simply collect incredible royalty streams for owning a very valuable asset.”
So that’s the general idea being teased — and they’ve teased it before, with very similar language.
But since the miners and mining royalty companies are getting so clobbered this year, I thought I’d check in and see WHO Badiali is teasing this time — is it the same group of gold mining royalty firms he pitched last Summer under the “Mainz Income” banner, or something different?
For some answers, let’s see what clues he offers in the ad.
“I believe that one of the easiest and safest ways to turn a small investment into an incredible income stream over the next few years is to own royalty interests in the world’s most profitable industry.
“In other words… your only investment is in the ownership of the valuable asset… the oil or gas field.”
Ah, so we’ve moved away from the gold and silver royalties as the “Mainz” idea and back toward oil and gas royalties — which is a much larger business. That’s not a brand new pitch either, of course — Badiali teased some “Mainz” oil and gas royalty stocks back in 2010, again using pretty similar language. But I suspect his choice of specific royalty owners must have changed since then, so let’s dig in and see if we can identify which ones he likes now.
Badiali throws in a couple charts and examples that illustrate how much stronger some of the oil and gas royalties owners have been than the big oil companies — like the BP Prudhoe Bay Trust, for one, and it’s dramatic outperformance versus BP (the operator from whom they earn their royalties) or big oil majors like Chevron and Exxon.
But the clues about which specific oil and gas royalties he likes are a bit elusive. Here’s what he says:
“For the past 6 months I’ve been looking very closely at the one of the oil and gas industry’s best kept investment secrets… the royalty interests I’ve been describing in this report.
“If you’re interested in getting the full details, I would like to give you access to, absolutely free, my full Research Report on the subject called Oil and Gas Royalties: The Real Secret to Generating Huge Returns in America’s Petroleum Markets….
“My top 2 ‘MUST OWN’ oil and gas royalty investments, which are paying huge annual distributions…in the 10%-20% range and are located in an area industry experts are calling “one of the nation’s hottest oil plays….
“… listed right on the New York Stock Exchange….
“… the current market environment means the wealth you could accumulate with these stocks will likely come primarily from their current income streams. Most of my favorite royalty companies are paying annual distributions in the 15%-20% range. Their share prices could rise considerably if oil and gas shoot higher, but I’m expecting the bulk of the gains to come from these income streams.
“Just to be clear, turning $1,000 into a million dollar gain isn’t something you should expect going forward….
“It’s reasonable to expect a gain of 200% – 400% over the next two or three years.”
Well, even a 20% annual yield won’t get you close to 200% over three years, so presumably Badiali thinks oil and gas prices are going considerably higher as well — or perhaps he just thinks investors will flock to these investments and drive up capital gains even if the actual distributions don’t rise (a stock that’s bought primarily for current yield and yields 14% today, for example, could double with no fundamental change from the company’s operations or performance if investors come to believe that the distribution is sustainable and become willing — gradually, one presumes — to buy in for a 7% yield instead).
But that’s about it — not a lot of clues, right?
Well, we’ll have to massage the Thinkolator a bit more thoroughly this time, and throw in a wee bit of guesswork around the edges. But yields that high are still quite rare, so I expect Badiali is teasing some of the more “beaten down” trusts … and the Thinkolator points us at two in particular: Sandridge’s Mississippian Trust 1 (SDT) and Mississippian Trust II (SDR).
Why those? Well, they do have the huge yield (both around 18%, which is very high for any kind of investment, but high even for oil & gas trusts), and they are in an area that’s been called “one of the hottest oil plays” (and indeed, pitched as the “next Bakken” a few times), the Mississippi Lime in Oklahoma. And they are both listed on the New York Stock Exchange — though that’s true of most US oil trusts, so that’s not a huge indicator.
So what are they? Well, these are two of the new crop of oil trusts that were formed in the last few years — there have been oil and gas trusts in the U.S. for decades, but a wave of them hit in 2010-2012, including three from SandRidge (which, if you don’t know the name, came to prominence when Tom Ward, who cofounded Chesapeake Energy with Aubrey McClendon, bought into the company in 2006 and took over as Chair and CEO). SandRidge is now focused on big investments in the Mississippian oil plays in Oklahoma and Kansas, and has spent the past couple years mired in balance sheet troubles similar to those that beset Chesapeake (debt-fueled growth), though on a smaller scale, and they essentially rebuilt the company to focus more on oil and natural gas liquids and less on natural gas. Just like anyone else who’s had that option over the last few years.
SandRidge spun out these trusts, as best I can tell, because they needed the money — in effect, for them a trust was like selling the wells for cash to new shareholders, but retaining control and a partial financial interest. The other one they spun out, by the way, was the SandRidge Permian Trust (PER), which is perhaps a little less frightening to some investors and pays out a slightly lower 15% yield at the moment.
So why are these Mississippian Trusts paying out such a massive yield? 18% is a helluva lot of income to earn from something that’s passive and somewhat inflation-protected (since it’s based on energy prices). And the best answer I can give you is that investors don’t think it will be keeping up these payouts for long.
The original IPO of Trust 1 (SDT) was in April 2011 at better than $20 a share, and it was very well received and spiked as high as the mid-$30s in the months before the second trust was launched. They have fallen pretty significantly short of their targeted distributions (they’re yielding about $2.30/year at the current rate, the IPO prospects projected payouts of more than $2.90 by now), and they have drilled more than expected and with a substantially more gas production (vs. oil and liquids) than expected, so the potential upside seems to be coming in far short of what was anticipated just a year or two ago. Still, 18% current income is a lot.
And the IPO of Trust II was in April of last year at about $20, since which it has declined rapidly to the current $12 and change, despite rising distributions and a rising natural gas price. And they have kept up pretty well with the payment schedule they anticipated at the IPO, though that schedule would have them paying out about $1.80-1.90 this year (a little less than the current distribution rate of 55 cents/quarter) and jumping up by more than 50% over the next few years.
Over the last year, the two trusts have both moved down at similar rates — though SDR has held up slightly better than SDT. So what’s going on? Why are these trusts priced so low when the underlying commodity prices are decent and the yield is so hefty? Well, it seems to me that the biggest problem is the success (or lack thereof) of SandRidge’s wells — from what I can tell in my relatively quick scan through the latest info, SandRidge has been keeping production up and the Trusts have been getting their cash, but they have drilled far more wells than they anticipated having to drill to get that production, and the wells have not been as productive as anticipated, particularly in terms of oil. That means the total number of wells being drilled in the future will be lower, which gives less room for production increases and more room for disappointing depletion.
SDT was expected to have SandRidge drill all of its obligated wells by December of 2014, and to stop protecting shareholders with a boost from the subordinated shares four quarters following that last well being drilled. Now, with the accelerated (and less successful than hoped) developmental drilling, the obligation to drill new wells with these royalty interests will end probably in about a month — they’ve almost drilled all of them. So probably by the middle of next year, the subordinated shares will be gone and, judging by current experience, the distribution would drop because SandRidge will share equally in the Trust with their shares (until 12 months after the drilling was done, they got a haircut on distributions to their owned shares because they were subordinate, and that cash goes to common shareholders).
That may not make a huge difference, so far it’s been only a few cents a quarter that shareholders have benefitted from the subordination, but the fact that development drilling will have stopped for the Trust by this Summer means I’d be a bit worried about production declining sooner than expected, too — I have not studied the production curve or the production data of the SandRidge wells at all, to be clear, and I’m not an expert on this stuff by any means, but if they had to drill that much more aggressively to keep production at expected levels I’d be worried about what happens to production once they stop drilling. These trusts have 20-year lives, with the value of the royalty interest at the end of those 20 years being effectively split between SandRidge and the Trust, but by then there may not be any value left. Payouts might decline pretty substantially if production declines (depending, of course, on gas and oil prices). There’s a pretty analytical piece here from SeekingAlpha about this and the cautions to consider for SDT. That analyst believes that the nature of the SandRidge wells in the Mississippian has been a lower initial production but also less production decline over time than expected, which is why the drilling was accelerated to get to the desired production levels. That may be good if the lower decline means production can stay at these levels for longer
SDR is newer and has been producing for less time, so that one might be trading a bit lower just because there’s uncertainty still about how difficult their wells will be for SandRidge, and what the production profile will look like over time. With the Mississippian apparently now producing slower initial production and more gas than the IPO had investors expecting, there’s clearly a big investor discount being applied to these stocks — though, to be fair, there are also similarly huge yields on the Chesapeake Granite Wash (CHKP), which is also about 50% natural gas and has similar trust life and disappointing results issues, and the Whiting USA Trust II (WHZ), which has a better and oil-focused production profile but dissolves in eight years. The trusts connected to SandRidge and Chesapeake are also, it seems, being discounted somewhat because of the parent — if the operating company goes bankrupt or simply can’t produce profitably from these wells, the Trusts will all suffer and possibly have substantial impairments or delays.
Oil and gas trusts, like these guys or like the BP Prudhoe Bay trust and several others, are similar in some ways to the old Canadian royalty trusts, though there is one substantial difference: They can’t buy stuff or expand. A trust is set up — usually as a balance-sheet cleansing move by the parent company/operating company — with a set territory and payout, and they just passively collect their set share of production from that territory or the pre-set fields or wells for as long as energy is produced or as long as the trust remains in effect.
Trusts typically last for decades, the expiration (after which a trust is typically worthless or receives some likely-to-be-small payment for closure or selling off of assets at the end) can be tied to the amount of cumulative production, as in the Whiting Trust I (WHX) that’s wrapping up in roughly two years, or to some other specific date like the Great Northern Iron Ore trust (GNI), which will be unwound in April 2015 (20 years after the death of the last survivor of 18 individuals listed in the original trust document).
For those trusts that have been around for a while, or which you intend to hold for decades, do be careful to note the terms of the trust and figure out when or how they will be unwound or ended — the ones I mentioned above have uncertainty about production levels and distribution rates over the coming years, but don’t run into actual wind down of the Trust until 2031 and 2032. GNI and WHX are both, in my estimation, trading for substantially more than their shareholders are likely to receive in distributions over the final two years of their lives, so those are special cases that are near death — but trusts are depleting assets, so note what kind of assets they are and how long they will take to deplete or how likely they are to continue to produce at current or increasing levels.
As passive investments, a trust can’t invest in its territory to increase production, or buy the enticing property next door — all they do is sit back and collect their share of what is produced. That’s great in some ways, because it means they have no exposure to exploration costs or overruns or permitting hassles or the startup expenses with new wells or new territories — trusts are usually established for predictable, long-lived wells — but it does mean they’re not really managed … the managers are the operators of the well, and if they decide it’s not worth drilling more to produce more, or they’d rather invest in increasing production in some more appealing area outside the trust lands, the trust earns less money. Or, if there is no production, the trust earns no money.
That’s one of the reasons I’ve mostly shied away from the Trusts, though they generally have been great when their underlying commodity has done well, and gotten similar commodity exposure for my portfolio from a MLP that owns royalty interests but can also partner in developing projects and has generally been more flexible, long-term focused and stable (most of its land is undeveloped or even unexplored) … but it sure has a much lower yield (less than 7% now) and is levered to natural gas. That’s Dorchester Minerals, DMLP, and I’m not suggesting you go buy it, just using it as an illustration. Trusts, like MLPs, also carry some tax filing complications and obligations that I have not looked into — I think Trusts are taxed as publicly traded partnerships, so you’d get a K-1 form, but I’ve never owned one of these trusts and I’m no tax expert, I also don’t know how much of the distribution would be taxed as current income and how much would be return of capital.
So there you have it — still a lot to like in the “Mainz” idea of passive royalty income, and 18% yields are nothing to sneeze at, but clearly the most likely specific ones being teased, those two SandRidge Mississippian Trusts, are cheap because people are afraid of lower than expected production and distributions over the coming years — and perhaps because the Mississippian production levels in general have investors worried about SandRidge, the overleveraged parent and operator. That might make these a great contrarian play, if they return to public favor or folks get comfortable with the profile and long-term prospects of these Mississippian wells they could easily have 50% capital gains to go along with their high distributions … but from what little I know that’s definitely an “if”, not a “when.”
I’m certainly no expert on any of this, but hopefully I’ve pointed you to a few things to look at for oil trusts (dissolution dates, production levels, drilling commitments) … that doesn’t mean these 18% yielders aren’t worth your investment if you research them and become comfortable that production will remain at good levels for a decade or more, that’s your call — but don’t get so passive with them that you fail to keep an eye on the production and payout trends.
Oh, and I’m generally a huge fan of compounding returns by reinvesting dividends … but unless you want to be quite aggressive with these kinds of investments, please don’t blindly reinvest distributions back into a depleting asset, particularly if the depletion is rapid. They’re set up for you to extract value over time from the trust … if you put that value back into them, you’re buying into something that becomes worse each time you buy it. It might work for a while as the distribution continues, and it can sharply increase your return if everything is shiny and bright for a few years, but it won’t work forever.
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