Odyssey Marine Provides Amazing Risk/Reward As Environmental Approval Nears

Posted on Oct 24, 2015


Summary

Odyssey Marine controls the rights to one of the largest phosphate deposit in the world.

Upon approval, we believe the Don Diego project alone is worth a multiple of the current Odyssey Marine stock price.

Approval of the Don Diego project appears inevitable, backed by Mexican billionaire Alonso Ancira.

Stock was heavily shorted on liquidity concerns, which have been eradicated, but short sellers have yet to cover. Short interest is 14.4 million shares, an amazing 78 days to cover.

Summary

Odyssey Marine Exploration (NASDAQ:OMEX) is in the final innings of a transformation that will make them one of the largest phosphate producers in the world. The company has backed away from their shipwreck exploration roots, and is focusing on the much more stable and profitable business of mineral mining. We believe that their Don Diego mineral deposit will receive environmental approval from the Mexican government in the coming weeks. When that happens, we believe we will see contracts from some of the largest phosphate producers in the world to secure their supply of this limited resource. This phosphate business should generate a steady stream of cash flows. In our discussions with management, we believe production of 2 to 5 million tons of phosphate processing per year is achievable, which would provide $ 200 to $ 500 million of revenue at 40% EBITDA margin. With the stock trading below $ 0.40, this provides a significant call option, with the opportunity to make a multiple of your investment before year-end.

Company Transformation

Historically, OMEX has been the top ocean exploration and recovery company in the world. Not only do they have the largest shipwreck database, but they are the best at locating and extracting treasure from the wreckage. The problem is, that is a very difficult business model for a public company. After pulling gold, silver, or other treasure from a shipwreck, the loot will sit in a warehouse for years while the court battles play out to determine who has legal claim. This results in uncertain revenues, long stretches of negative cash flow, and very impatient shareholders.

Over the past couple of years, OMEX realized that this business model is very difficult to execute, and started looking for a way to leverage their core competency to stabilize their cash flows. OMEX’s core competency is locating and identifying assets on the ocean floor. Instead of focusing on locating shipwrecks, the company now focuses on identifying large sea bed mineral deposits. Although we don’t know the exact number, OMEX has said that they have a database of deep ocean mineral deposits.

Sea bed mining has significant benefits over traditional land mining. While land mining requires extracting minerals from underneath the earth’s surface, which is both costly and environmentally hazardous, the mineral deposits identified by OMEX are laying right on the ocean floor. Extracting the material is done by dredging the minerals right off the surface, rather than digging, which is much cheaper, and poses no environmental risks. In addition, mineral deposits on land are becoming more depleted every year, with resources becoming more scarce. Because 2/3 of the earth is covered by water, and because very little mining has taken place, there are vastly more resources available to mine in the ocean.

Don Diego Mineral Deposit

OMEX is already in the process of monetizing their first mining project. Off the Pacific coast of Mexico, there is a phosphate deposit called Don Diego, one of the largest phosphate deposits in the world. In 2012, OMEX secured the rights to this deposit, and in 2013 they sold a minority stake for $ 27.5 million. Third party testing recently indicated that there are 588 million metric tons of phosphate ore in the Don Diego deposit.

OMEX has exclusive rights to mine this site for 50 years. With 588 million tons available, it will likely take longer than that before the deposit shows any signs of depletion. This steady stream of cash flows initially ranging from $ 100 to $ 200 million annually has been valued by numerous buy-side and sell-side analysts. Most estimates, including this one, value the Don Diego mineral deposit between $ 1.7 and $ 2.5 billion. Regardless of where your valuation falls in that range, this asset is clearly worth a significant multiple of the current stock price.

After monetizing some of the asset in 2013, OMEX now owns roughly 50% of the mineral deposit. In early 2015, OMEX received a substantial investment from Minera del Norte in exchange for shares and warrants, which if fully exercised will result in about 150 million shares outstanding. As a result, OMEX owns 50% of an asset worth roughly $ 2 billion. With the stock trading under $ 0.40, that’s a call option that provides enormous upside.

The final step before the mining beings is environmental approval. As I mentioned above, OMEX made a strategic partnership with Minera del Norte, a Mexican mining company backed by Mexican billionaire Alonso Ancira. This relationship is critical for three reasons; Minera del Norte’s expertise in mineral mining, Ancira’s relationships with the largest phosphate producers in the world, and his relationship with the Mexican President and other government officials.

We believe the Mexican government will approve the project for a number of reasons:

1. The vast majority of food in Mexico is imported, because only 11.9% of their land is arable. Mining phosphate would significantly increase fertilizer production, which means more farmland.

2. President Nieto ran on a platform of reducing hunger in Mexico. More farmland means more crops, which will reduce hunger.

3. Ancira, through his subsidiaries, has agreed to make an initial investment of $ 14.75 million as a line of credit to the company. In addition, he has agreed to invest up to $ 101 million over the next 3 years at a price of $ 1.00 per share, a nearly 200% premium to the current stock price. He wouldn’t make that kind of investment if he wasn’t confident that the project would get approved.

4. Ancira is very well aligned with the current Mexican government, including President Nieto, who has spoken very highly of Ancira in the past.

5. In addition to the agricultural benefits, Mexico would benefit economically, by creating jobs, and becoming a net exporter of phosphate, where they currently import nearly all of their phosphate.

OMEX has completed all of the environmental impact studies, proven that there will be no detrimental impact to the ocean, seabed, plant life, or wild life, and shown that this project is much more environmentally friendly than mining on land. They’ve also made significant partnerships with people and companies that are accustomed to working with the Mexican government. This project provides much needed agricultural and economic benefits to the people of Mexico, with no environmental impact. Based on everything we know about this, there doesn’t appear to be a reason for the Mexican government not to approve it.

While environmental approval is the catalyst that investors have been waiting for, it is actually only the first of many. Phosphate is a limited resource globally, and getting more scarce by the day. Global agriculture companies are concerned about where their supply will come from. Upon approval, OMEX will likely partner with one or more of these phosphate producers, allowing them to monetize a portion of the asset up front.

Also, OMEX has mentioned several times that they have a database of sea bed mineral deposits. Once they have the Don Diego project approved, they will begin securing the rights to another site, with similar economics to the Don Diego project.

Short Interest

I went over the issues facing OMEX when they were a shipwreck business. These cash flow problems were noticed not only by investors, but by short sellers as well. OMEX is one of the most heavily shorted stocks on the market. The reason the stock is heavily shorted is because of liquidity concerns. Not current liquidity concerns, but liquidity concerns in the past. Prior to making their strategic partnership with Minera del Norte, OMEX had a poor balance sheet. Years of operating as a shipwreck business with uncertain cash flows started to take its toll on them.

The short selling started a couple years ago, when the stock was $ 3.00. Although it turned out to be a great short with a 90% return, most short sellers have held their positions rather than cash in. As of 9/15, the short interest on OMEX is 14.4 million shares, representing almost 20% of the float, and 78 days to cover. With the investment from Ancira, OMEX has no liquidity concerns and the short thesis has played out. While there doesn’t appear to be any downside to the stock at these levels, the short sellers are holding out for every last potential penny of profit. While this is a small part of the thesis, the lack of covering leaves the stock artificially depressed, and allows investors to buy the stock at a great value.

Conclusion

OMEX is putting the finishing touches on a transformation that will make them a cash flow machine, with a huge pipeline of potential projects. It’s a story that is under followed and misunderstood. As a result, it is significantly oversold on liquidity concerns that no longer exist, has a multi-billion dollar mineral asset that is very close to approval, and a chance for investors to make a multiple on their money.

Editor’s Note: This article covers one or more stocks trading at less than $ 1 per share and/or with less than a $ 100 million market cap. Please be aware of the risks associated with these stocks.

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