Part 1 describes the two segments of Genie (GNE), IDT Energy and GOGAS and the details of the preferred exchange. In order to figure out whether common stock or the preferred are good investments, let’s break down the valuation of the two segments.
IDT Energy has low capital expenditures and a risk free business model:
- It purchases electricity and gas in wholesale markets, but the delivery, billing and collections remain responsibility of incumbent utility.
- The customer bill is at variable rates (bill at cost of commodity plus mark-up). As a result, profits are not affected by price swings of the underlying commodity.
Everything seems to be going well. It is adding thousands of customers and is entering its fourth state, Maryland. As of June 2012, it had almost 500,000 meters enrolled that is a net growth of 25% year over year. Also, it has a consistently positive EBIDTA (see chart below).
Figure 4 IDT Energy Results (Source Genie Energy)
EBDITA is a good measure of profitability because IDT Energy does not have much depreciation and interest expenses. Trailing 12 months, EBDITA was $16.4 million. Earnings would be around $10 million if you factor in taxes.
Even though IDT Energy is profitable, profitability is going down even as it adds customers. The reason for this is the increase in monthly churn. Churn is the percentage of customers who are leaving IDT Energy every month. “Average monthly churn increased from 5.2% in the three months ended June 30, 2011 to 6.6% in the three months ended June 30, 2012.” Simply stated the new customers are not profitable. The cost of acquiring the customer is more than the lifetime value of the customer.
In order to prove this, let’s do a simple crude calculation. The total lifetime value of its customer base is (monthly gross margin/monthly churn rate). For the 3 months ended June 2011, the lifetime value of its customer base is $62 million (($9.8 million/3 months)/(.052)). For the 3 moths ended June 2012, the lifetime value of its customer base is $58.6 million (($11.6 million/3 months)/(.066)). The lifetime value of its customer base is going down even though it is adding customers. The same calculation for quarter 1 in 2011 is $124.6 million and $93.75 million in 2012.
Giving this and the highly competitive industry, IDT Energy deservers a valuation between 5 times and 8 times earnings or $50million to $80 million.
GOGAS is Genie’s lottery ticket. The two subsidiaries, AMSO and IEI have not started the pilot phase, which would prove the viability of the technology at their shale initiatives So, they are almost a decade away from full commercial operations.
AMSO is the shale initiative in Colorado. It owns 50% equity stake in the partnership. Total, the French oil and gas company, paid $3.2 million to acquire a 50% stake in 2009. Under the agreement, AMSO is responsible for “20% of the initial $50 million of expenditures, 35% of the next $50 million in approved expenditures and 50% of approved expenditures in excess of $100 million.” “As of June 30, 2012, the cumulative contributions of AMSO and Total to AMSO, LLC were $55.4 million.” So, bigger capital expenditures are coming up for AMSO as it reaches the $100 million threshold.
It should be noted that this year AMSO has had trouble with tests before it could start on the pilot phase.
“In January 2012, AMSO, LLC conducted a fully integrated commissioning test of the above and below ground facilities to determine their readiness for pilot test operations. The test showed certain details to the facilities that must be corrected prior to proceeding with the pilot test and identified weaknesses in certain diagnostic equipment. The manufacturer of the underground heater is currently modifying its equipment to address issues that arose during the commissioning process and which were confirmed during subsequent factory acceptance testing. The modifications and improvements are intended to enhance the reliability of the heater during the pilot test and could be completed as early as this fall. If the proposed enhancements do not meet our performance standards, AMSO, LLC may elect to introduce a substantially modified design, which would involve additional delay, but would be expected to be beneficial in the long term. As a contingency, AMSO, LLC has begun initial engineering of possible alternative approaches.”
It is possible that if enhancements do not work, it could have a negative affect on the stock and the project.
IEI is the shale initiative in Israel. Genie owns 89% of IEI. IEI expects to start construction of the pilot phase in 2013 and expect it “require $25 to $30 million over the next three years.”
It is hard to value GOGAS, but besides Total’s investment, there have been the following investments:
- “In November 2010, an entity affiliated with Lord (Jacob) Rothschild purchased a 5.0% equity interest in GOGAS for $10.0 million paid in cash.”
- “Also in November 2010, Rupert Murdoch purchased a 0.5% equity interest in GOGAS for $1.0 million paid with a promissory note.”
Although, those transactions were small, they valued GOGAS at around $200 million in 2010. GOGAS is now closer to the pilot phase at both AMSO and IEI then they were in 2010. However, why would anyone pay that much now when all of Genie is valued at $169 million. Genie indicated in its latest 10Q that it may “finance our operations through sales of equity interests in GOGAS.”
As of June 2012, Genie has almost $100 million of cash, restricted cash, and marketable securities with no debt. If you add the $50 to $80 million valuation to the cash for IDT Energy, GOGAS (valued at $200 million in 2010) is essentially free. Genie is undervalued.
Preferred or Shares?
Stay away from the preferred shares!
- It is possible with the amount of capital expenditures that GOGAS is going to require over the next years, Genie might suspend the dividend.
- The 8.6% dividend yield is not worth the risk. There are plenty of stable REIT’s that offer above 7%. Check out our article on AIG debt, which offers almost 8% yield.
- If GOGAS’s shale initiatives pan out, preferred shareholders will not participate in the upside.
All signs point to a buy for the shares.
- Company is undervalued.
- Heavy insider buying especially from the Jonas Group.
- Start of the pilot phase at GOGAS.
However, investors should be warned that this is a risky investment with potentially high returns. IDT Energy is not a good enough business for investors to load up on the shares. If the shale initiatives don’t pan out and the company makes significant capital expenditures, the stock price could be cut in half.
Investors should also look at the March 2013 stock options as there are near term catalyst for this stock:
- Additional investment in GOGAS by outside investors.
- Start of the pilot phase at GOGAS. It is possible there could be hiccups, and options will limit the downside.
- Smaller float as a result of the preferred exchange.
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Disclosure: I do not own share of GNE, but may initiate a position in the shares or options within the next week.