Robert William Laughlin
CEO of Playa Vista Capital Management
Chief Executive Officer
Ring Energy, Inc.
901 West Wall Street
Midland, TX 79702
Dear Mr. Hoffman,
Thank you for taking the time to read and consider the content of this letter.
It should be noted, firstly, that we continue to have the utmost faith in management’s ability to methodically execute on the production growth and acquisitions plan within the Central Basin Platform and Delaware Basin. We appreciate management’s commitment to protecting and growing shareholder value and think the modified dutch tender proposed by Cannell Capital on October 15th would directly align with those objectives.
As you and your team consider the implementation of the tender, I would like to make you aware of the results of an analysis we’ve conducted at Playa Vista Capital Management regarding the impact a tender would have on Ring Energy’s effective free float, as well as the positive impact we believe a share repurchase plan, of almost any kind, would have on long-term shareholder value, and how those two factors relate when considering the 7+ million share short position currently outstanding.
Starting with the 60.4 million shares currently outstanding, to find the effective free float, we first start by subtracting the shares held by index funds including, but not limited to, BlackRock, State Street, Vanguard, and other institutions utilizing an index or closet-index strategy. We think of these shareholders as essentially permanent holders of the shares, as adjustments are made to their holdings only when adjustments are made to the indices which they track. We estimate the total amount of shares held by such institutions to be approximately 36.7 million, reducing the effective free float to approximately 23.7 million. Next, we looked at insider ownership.
We are of the view that, if a modified dutch tender for any portion of the float is implemented, all insiders of the company should publicly commit to not selling any shares into the tender. Assuming this is the case, we note that insiders, collectively, own approximately 3.4 million shares of common stock, not including beneficial ownership via unexercised options, or restricted stock. When added to the permanent shareholder category, we have a new effective free float of 20.3 million.
Based on separate discussions we’ve had with individual retail shareholders, as well as investment advisors who represent them (but who not listed as 13F filers), we estimate that approximately 90% of the retail shareholder base, who we estimate own approximately 5 million shares, will not sell into a tender offer, even at a substantial premium to current pricing levels. We attribute this, in large part, to the extent to which such shareholders believe Ring Energy is undervalued, as well as the expectation that Ring Energy will eventually be sold at a much greater valuation to a larger institution, just as Tim Rochford and Stan McCabe did with their previous company, Arena Resources. Based on the results of this research, we add an additional 4.5 million shares to the permanent shareholder category, further reducing the effective free float to 15.8 million.
Additionally, we anticipate that, of the largest active institutional shareholders, a substantial majority of them will not sell into the tender offer, even at a substantial premium to current pricing levels. We came to this conclusion by studying the duration of time each of the top institutional shareholders have held securities in the past relative to their current holding period for Ring Energy, as well as their stated investment strategies, respectively, and our conception of Ring Energy stock’s fair value relative to a multitude of share repurchase pricing scenarios. As a result, we hypothesize that a very small minority of those large active institutions would actually sell into a tender offer, even at a substantial premium to current pricing levels, which would mean the effective free float, conservatively, would be further reduced by at least another 10 million shares, making the final effective free float approximately 5.8 million shares.
A tender for up to 19% of the outstanding shares would equal a maximum repurchase of 11.48 million shares, which, if only partially subscribed, would essentially eliminate the remaining effective free float, making this company extraordinarily closely held.
We believe this will create an unforeseen volume and supply problem for the short sellers who have borrowed, in aggregate, approximately 7.4 million shares. As the effective free float declines, the costs short sellers incur by borrowing stock to maintain their short position should increase, materially, likely creating a scenario in which, for economic reasons, short sellers will be forced to cover into a very unaccommodating liquidity environment.
We note the trading activity on October 2nd to October 4th, the week when Seaport Global released their research report, Ring Energy’s stock traded down from $10.65 to $7.80, a decline of 26.76%, on total volumes of approximately 11.1 million shares. If a modified dutch tender is able to further reduce the effective free float relative to that which was present during that October event, we anticipate a much more meaningful and sustained move to the upside, especially considering that the company is now back on track from an operations perspective and since the company’s realized commodity prices have increased materially in the 4th quarter due to the Midland WTI spreads rapidly diminishing.
It’s no secret that Ring Energy management is relatively conservative with respect to the usage of their credit facility. We think this strategy is an asset most of the time, but it can also be a flaw if a “too conservative” nature leads to missed opportunities, like being able to repurchase stock at times when the market capitalization of the company is dramatically lower than its intrinsic value. We believe it is abundantly clear that the company will have more than enough liquidity to finance the remainder of its current 2018 capital expenditure program, as well as a comparable 2019 capital expenditure program, considering the growing cash flows from operation and the company’s willingness to utilize a portion of the largely untapped $175 borrowing base, which is part of the $500 million credit facility.
Assuming free-cash-flow neutral means quarterly operating cash flows of $37.5 million or higher, we agree with management’s recent statement that the company could reach free-cash-flow neutral by late-2019. Should the company implement a version of the aforementioned tender offer, the percentage of operating cash flows spent on interest, assuming borrowing costs of 5% and total outstanding debt of around $100 million, would be minuscule and would decline significantly each quarter that operating cash flows increase thereafter. With your operational expertise and aggressive growth plan, we see this scenario being an extraordinarily high probability event. We hope you do, too.
Thank you for taking the time to review and consider; we look forward to hearing from you soon.
Important Disclosure Information
THIS LETTER INCLUDES INFORMATION BASED ON DATA FOUND IN FILINGS WITH THE SECURITIES AND EXCHANGE COMMISSION AND OTHER SOURCES. ALTHOUGH WE BELIEVE THAT THE DATA IS RELIABLE, WE HAVE NOT SOUGHT, NOR HAVE WE RECEIVED, PERMISSION FROM ANY THIRD-PARTY TO INCLUDE THEIR INFORMATION IN THIS PRESENTATION. MANY OF THE STATEMENTS IN THIS PRESENTATION REFLECT OUR SUBJECTIVE BELIEF.
THE INFORMATION CONTAINED ABOVE IS NOT AND SHOULD NOT BE CONSTRUED AS INVESTMENT ADVICE, AND DOES NOT PURPORT TO BE AND DOES NOT EXPRESS ANY OPINION AS TO THE PRICE AT WHICH THE SECURITIES OF RING ENERGY, INC. MAY TRADE AT ANY TIME. THE INFORMATION AND OPINIONS PROVIDED ABOVE SHOULD NOT BE TAKEN AS SPECIFIC ADVICE ON THE MERITS OF ANY INVESTMENT DECISION. INVESTORS SHOULD MAKE THEIR OWN DECISIONS REGARDING RING ENERGY, INC. AND ITS PROSPECTS BASED ON SUCH INVESTORS’ OWN REVIEW OF PUBLICLY AVAILABLE INFORMATION AND SHOULD NOT RELY ON THE INFORMATION CONTAINED ABOVE. NEITHER ROBERT WILLIAM LAUGHLIN NOR ANY OF HIS AFFILIATES ACCEPTS ANY LIABILITY WHATSOEVER FOR ANY DIRECT OR CONSEQUENTIAL LOSS HOWSOEVER ARISING, DIRECTLY OR INDIRECTLY, FROM ANY USE OF THE INFORMATION CONTAINED ABOVE.
Certain statements contained in this letter are forward-looking statements including, but not limited to, statements that are predications of or indicate future events, trends, plans or objectives. Undue reliance should not be placed on such statements because, by their nature, they are subject to known and unknown risks and uncertainties. Forward-looking statements are not guarantees of future performance or activities and are subject to many risks and uncertainties. Due to such risks and uncertainties, actual events or results or actual performance may differ materially from those reflected or contemplated in such forward-looking statements. Forward-looking statements can be identified by the use of the future tense or other forward-looking words such as “believe,” “expect,” “anticipate,” “intend,” “plan,” “estimate,” “should,” “may,” “will,” “objective,” “projection,” “forecast,” “management believes,” “continue,” “strategy,” “position” or the negative of those terms or other variations of them or by comparable terminology.