Tellurian: a potential 100 bagger?

Could Tellurian be the Holy Grail of investing: a 100 bagger that pays out more in annual dividends than we paid for the stock?

In January 2021, I bought a position in Tellurian (TELL), a small-cap company aspiring to build a huge scale global natural gas business from scratch. The company had previously caught my attention due to its dramatic share price decline in 2020 from over $6 a share down to under $1. The stock currently sits below $2 a share with a $700m market cap.

Tellurian is looking for financing to build its Driftwood project: a mega-terminal in Louisiana to produce and export liquified natural gas (LNG) to customers worldwide. 

Being convinced of the need for increasing natural gas supply, particularly in Asia (see The Oil & Gas Conundrum), what initially attracted me was the business plan.  The corporate presentation includes projections of circa $2 billion of free cash flow (FCF) at full operations of Driftwood LNG and $5-7 FCF per share to TELL shareholders. This is three times the current share price. 

A conservative valuation of 10x FCF (according to projections once full operations begin), would value the company at $20 billion or $60 per share – a 30x from a $2 share price. 

We must ask: 

1.    How accurate are the company’s projections? Is the management team able to execute? 

2.    What are the risks? What happens to the company if a final investment decision (FID) is not reached? 

3.    How likely is the project to achieve FID? 

The management team and their projections 

On the accuracy of the projections and the ability of the team to execute, I was impressed to find the most experienced team in the business:

  • Charif Souki, Executive Chairman and co-founder (and the largest individual shareholder), previously founded Cheniere Energy in 1996 and served as Chairman, CEO and President until the end of 2015, when he was ousted by the board, influenced by activist investor Carl Icahn, over a disagreement concerning the direction of the company: Souki planned to build his mega-terminal to export LNG whereas Icahn essentially wanted to concentrate on paying dividends. Souki was down and out for all of three months before he started Tellurian, to build his vision, Driftwood LNG. 

  • Martin Houston, Vice Chairman and co-founder of Tellurian, was previously COO at BG Group plc until 2014 (acquired by Royal Dutch Shell in 2015), where he is largely credited with being the key architect of the company’s leading LNG business. He turned down the CEO job at BG Group to co-found Tellurian. 

  • Octávio Simões, President and CEO, joined the company in late 2020 from his role as CEO of Sempra LNG & Midstream, a large and established LNG player.  

  • Several members of the Executive team were with Souki at Cheniere. These are experienced people who know the playbook – they’ve already done it once – creating a major LNG business from scratch. 

The company says Driftwood is “shovel ready”, having secured all necessary permits for construction and operation, and has a $15.5 billion lump-sum turn-key engineering, procurement and construction contract with Bechtel that guarantees cost, performance and schedule.

I have great confidence in the management team, their projections and their ability to execute. Charif Souki is the real deal: exactly the highly motivated owner-operator that investors dream of finding early on in a company’s life.

Commercial deals 

A shortage of supply deals is one of the risks to investors, and we have not yet had any commercial supply deals announced. In 2020, few deals were done globally and Tellurian’s deal with Petronet, India’s biggest gas importer, fell through. 

Charif Souki has said, however, that there are deals in the pipeline that should be announced in the near future. Regarding the dangers for short-sellers, in his latest update video, he asks the leading question: “So what do you think is going to happen when we start announcing some of these long-term commercial agreements that we have been working on for so long?” This seems to imply the possibility of a short squeeze occurring over the next few months as a result of deals being announced.

On the reality of commercial deals, for now all investors have is our trust in the management team.

Financing risk 

The main risk is financing risk: that further investment partners for Driftwood fail to materialise. 

The financing model is that Tellurian is selling a stake in Driftwood Holdings, a subsidiary company, to equity partners, in order to fund construction of the project. 

Total SA made a commitment in 2019 to invest $500m into Driftwood along with an LNG purchase agreement. Total also agreed to purchase $200m of TELL common stock at almost $10 a share. Including the prior stock purchase they made in 2017, Total has invested $400m in TELL directly, making them the largest shareholder, still with 31 million shares (8% of the company).

Total can back out of its Driftwood commitments if Tellurian does not declare a final investment decision (FID) by June 2021. This is a risk. (However, it is hard to find a reason why they would pull out when they are the largest shareholder of TELL and have recently invested in other LNG projects, including the Energia Costa Azul LNG export project in December 2020.)

According to the corporate presentation, the remaining partner equity required to finance the project amounts to $5.5bn, along with debt financing of $9.8bn. 

In December 2020, Charif Souki claimed Tellurian was talking to two-dozen interested counterparties and “the likelihood of getting FID is very high”*. However, having been aiming for a summer 2021 FID, it looks like expectations have been pushed back again. CEO Octávio Simões recently told naturalgasintel.com, “There are some scenarios where we think we could do it before the end of the year, and there are some scenarios where it would be early next year.”** 

He said the team was planning to start the construction of the owner obligation costs this summer, however, (not covered by the Bechtel contract) and also commented on the financial health of the company: “We have cleaned up our balance sheet, we have gathered liquidity for executing our objectives… and we’ve been successful at having enough cash on hand to grab the liquidity needed to execute. So things are lining up to a much more comfortable position now than before.”

The outcomes for the company seem binary and to hinge on FID. Other writers have already argued that TELL is either a huge winner or a zero. However, Tellurian is cash flow positive, is paying down debt and should soon be debt free. They are resuming drilling and are planning to acquire more Haynesville acreage. The management are extremely energetic and ambitious. This does not look like a company that is going bankrupt any time soon. 

As an integrated player with an ability to adapt their plans to circumstances, they may have many future chances to achieve FID. And even if Tellurian fails to secure FID for Driftwood, there are other possible outcomes here apart from bankruptcy. 

ESG and regulatory risk 

In an investment and political environment that has never been more pro-green energy, ESG and regulatory risk are important factors to consider.  

The pro-ESG case for Tellurian is an extremely good one.

In developing countries, increasing energy supply is needed in order to grant more people the living standards and opportunities we enjoy in the West. At the same time, countries such as China and India use coal and other dirty fuels for a large part of their energy supply. In the developing world, for the foreseeable future, renewables are unable to replace the existing coal-generated energy and meet growing demand.

Natural gas is a vital part of the energy transition in order to increase energy supply while reducing urban pollution and CO2 emissions. Lifecycle carbon emissions are reduced by approximately half when using gas to replace coal-generated electricity. Pollutants meanwhile – such as sulfur oxides, soot and particulates that cause air pollution and damage human health – are virtually eliminated. 

Increasing LNG exports from the US, therefore, have the effect of reducing pollution and emissions in the developing world. Were supply to be curtailed, coal, wood and oil would be the main replacements.

Add to this that the gas has to go somewhere. Mostly natural gas is produced as a biproduct of oil drilling. The US produces more gas than it knows what to do with. If it is not captured and consumed, natural gas is flared, a shameful practice, wasteful and damaging to the environment, that Tellurian is campaigning to end. 

The ESG case for Tellurian then is actually a no brainer, a slam dunk. Nevertheless, politicians have been known to pursue a course of action that is popular or consistent rather than pragmatic, and so ESG and regulatory risks remain for US LNG. 

Tellurian has its main permits in place for Driftwood, but the ambitions of the company are not free from possible regulatory conflicts. 

How likely is Tellurian to secure FID? 

This is the million-dollar question – and one that’s hard to answer with any precision for an outside observer like myself. But let’s take a look at what the market thinks. 

If we target a $60 share price within five years, today’s price of $2 per share gives us approximately 30:1 odds on the project panning out according to plan. 

To estimate that five-year return in terms of equivalent money today, we can apply a discount rate. If we generously assume a 10% annual discount rate for five years, we get a real return of 18.5x. (Let’s call it 18x or 17:1.)

The market is giving us 17:1 real return on Tellurian realising its business plan.

I, however, firmly believe the chances of FID and commercial success are far greater than 50%.

Let us consider the following:

  • Need for the product

  • Tellurian’s ability to produce it at low cost

  • Excellent fundamentals to attract equity partners

  • Major permits obtained and building contracts in place 

  • Tellurian is cash flow positive 

  • Industry, government, banking connections

  • Proven, tenacious and experienced management team

  • Belief in owner-operator Charif Souki 

  • High insider ownership 

  • The people with the most knowledge, the management team, clearly expect it to work out, having left or turned down top jobs to work at Tellurian (as recently as late 2020 in the case of the CEO)  

  • Past success in a very similar situation (Cheniere) 

A bet on Tellurian is really a bet on Souki and the management team: that they will – through sheer force of will, determination and skill – survive long enough, whatever happens, to eventually succeed.

For the purposes of this example, let’s assume a 50% chance of success and that, if FID is not achieved, the stock goes to zero (even though this isn’t necessarily the case). If we take our probability of success, 1:1 (50%), and our market odds of 17:1, that means 50% of the time we end up with zero and 50% of the time we end up with 18x our money: on average we make 9x return in real terms.

This bumper reward compensates us handsomely for our risk and allows for a margin of error. 

Of course, these estimates hinge on my belief of at least a reasonable chance of FID. If I’m wrong about that, that changes everything. 

Life after Driftwood

If Driftwood is successful, there will be many Tellionaires. (I’m in a Discord group of 800 fellow TELL investors, many of them with enormous percentage allocations to TELL: retail has noticed this stock!) After commencing full operations, Tellurian should be returning significant value to shareholders in the form of either dividends or share buybacks. It could even be the dream stock, the Holy Grail of investing: a multi-bagger returning more in dividends/buybacks annually than we actually paid for the shares!

Further, Tellurian is bursting with ambition and ideas, and the management team has several other projects on the horizon. It may dawn on the investor that Driftwood could be just the beginning! The company could become a massive growth engine for further energy projects and a long-term compounder for shareholders: a 100 bagger. 

In conclusion, Tellurian presents a rare, mis-priced opportunity of asymmetric risk/reward. Where I generally believe investors are wise to employ a margin of safety and to focus on making investments that are unlikely to lose money over a 10-year time horizon, there is surely a price at which uncertainties look attractive. At current prices, Tellurian could be a once in a lifetime opportunity. 

This is a high-risk investment – not for the faint hearted – and investors will be wise to carefully consider position sizing and risk management, not allocating more of a portfolio than they would be comfortable to lose in return for the potential legendary gains. 

If, like me, you’re in the stock, you’d better buckle up and get ready for a bumpy liftoff!

https://www.spglobal.com/platts/en/market-insights/latest-news/natural-gas/123020-interview-souki-says-tellurian-isnt-betting-on-european-utilities-to-lift-driftwood-lng-in-2021

** https://www.naturalgasintel.com/tellurian-adapts-driftwood-lng-plans-on-heels-of-covid-19/

 

Disclaimer: This article is for information purposes only and does not recommend the purchase or sale of any security. Please see the disclaimers page for further information.

Disclosure: The writer may or may not own any of the securities mentioned in this article.  

 

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