By Eric Jackson
June 2, 2008
Barnwell Industries (BRN) should get an award for having the most moving parts for such a relatively small business.
It is a $100 million company with natural gas holdings in Western Canada, a land investment business on the Big Island of Hawaii, and water contract drilling business. It’s based in Honolulu and employs 65 people.
If that’s not a hodge-podge company, I don’t know what is. Yet, despite that mis-mash of businesses, this is an attractive activist investment from a number of perspectives. I’ve built up a position in it in the last quarter and just recently launched a “friendly” activist campaign targeting the company to unlock shareholder value.
Its diverse set of businesses has confused investors over the years, but, at heart, Barnwell is a natural gas play (95% of its oil and gas revenues are from natural gas). Seventy-three percent of the company’s $47MM in revenues last year came from the gas business – while only 13% came from the water contract drilling business and 12% from the land investment business.
Barnwell’s productive wells dropped in 2007 versus 2006 and its revenues and operating income took a hit as a result. The stock was cut in half from $24 to $12. Further pressuring the stock was a large holder (Mercury Real Estate Advisors LLC) cutting its position in the company. A couple of months ago, the stock hit $8 – just above its book value per share of $6.87. Since then though, news that Barnwell’s productive wells have staged a comeback along with first quarter revenues has helped the stock snap back nicely closing just under $14 last Friday.
Natural gas prices have moved up sharply in the past year. The price per MMBtu is at almost $12 today, versus $5 – 6 a couple of years ago. As a result, pure-play natural gas companies like Chesapeake Energy (CHK) and Encana (ECA) are up 40% and 33% respectively year to date. Barnwell, by contrast, is only up 13%.
Barnwell has been around since the 50s, but it only recently got into the land investment business. It has taken some of the ample cash flow from the natural gas operations and bought up land in and around the Four Seasons Resort on the Kona-Kohala coast of the Big Island of Hawaii. The Four Seasons Hualalai is simply stunning and the surrounding area has fast become a magnet for second homes of Silicon Valley entrepreneurs and Hollywood celebrities. Even though we are going through a soft period for real estate in general, this location remains highly desirable for its target rich-and-famous audience and this will only increase as it gets built out. Barnwell just received a $2MM option payment for developing the land around the Four Seasons resort, with another payment due later this year.
A final attractive aspect of the company is that 5 insiders have recently purchased shares in December and January, when the stock price was around $9 – 12. They clearly see something attractive in Barnwell’s pricing. Who can blame them when you see its Enterprise Value – EBITDA ratio for the last 12 months at 5, while Encana’s is at 9 and Chesapeake’s is at 10.3?
Barnwell’s board and management clearly have to take responsibility for the low multiple for the company. That’s why I recently launched an activist campaign targeting them. In addition to simply writing a letter to the current CEO and COO (Morton Kinzler and his son, Alexander), I’ve put my draft points of a plan in “wiki” form on the Web so that other investors can edit and comment on the plan (it’s located at http://shareowneractivism.wikia.com/). I’m a big believer in the idea that the community is smarter than any one individual. Hopefully, other Barnwell investors will be inspired to get involved and improve on these points below for how the company can better unlock shareholder value.
Here are the prescriptions for Barnwell:
Simplify Corporate Structure
Barnwell’s three businesses (oil and gas, contract water drilling, and real estate/land investment) have no synergy. A simpler corporate structure would better allow the market to bid up the underlying value of the oil and gas business to reflect the doubling of the commodity pricing in the last year. Barnwell should sell its water drilling business, which is small and shrinking in revenues and earnings. If the company received 1x its revenues, its cash reserves would nearly double to $14MM, allowing a stock buyback and/or upping the dividend. Selling or spinning off the real estate business might also make sense to focus Barnwell as a small natural gas pure-play.
Reduce SG&A Costs
Over the last year, SG&A costs have gone up 50% to $3.2MM. Yet, revenues and gross profit only increased 28% and 27% respectively over that same period. Barnwell is growing its costs at twice the rate of its sales and profits. As they say in Business School, that’s not sustainable. It’s also not acceptable for a 65 person company. Selling off the water drilling business, which contributes little profit, is a step in the right direction to improving things here, but much more work is needed.
Do a Stock Buyback
The company did agree to pay out a 5 cent dividend recently. Hopefully, that will attract a new group of investors to the stock. However, a stock buyback is both prudent, given that the cash position has increased over the last year and the strength of gas and land development businesses, and would make the company more attractive by lowering further its price-earnings ratio.
Bring in Some New Blood to the Board
Barnwell’s board is large and long-tenured. RiskMetrics awarded Barnwell a Corporate Governance Quotient (CGQ) score that is lower than 70% of other energy companies. The board’s composition is part of the problem. Seven of the 11 directors are older than 64. Four of the directors have been on the board for more than a decade.
It makes sense to change the composition of the board. Some of the longstanding directors should step down now to make way for some new blood, but some of them shouldn’t be replaced. An 11-member board is too large for a $100MM company. Having fewer than 10 directors would lead to faster meetings with more participation and debate.
Better Align Executive Compensation with Performance
Executive compensation policy has also likely contributed to Barnwell’s lower CGQ score. Last year, the CEO was paid $1.2MM. He explained this by pointing to how the company’s profits increased by 200% that year, yet the stock price dropped in half over that same time.
Barnwell needs to better spell out its executive compensation policy and ensure that it links in part to stock performance.
I also am not a fan of stock options. I would much rather see Barnwell with a policy that encourages both officers and directors to buy stock on the open market with low interest loans from the company. In my experience, this creates much more of a “skin in the game” mentality than options, which benefits corporate performance.
Barnwell Industries is an off-the-beaten path company and clearly there’s risk here that management and the board do not perform and take a status quo approach. In such a small company, with so many different kinds of businesses as moving parts, that’s a big concern.
But, this is a great candidate for activism. There is fundamental strength in the core natural gas and ultra-luxury Hawaiian land holdings, which can defy recession. With some improvements in the areas outlined above, along with continued strong quarterly performance, this stock can move quickly – as it has already almost doubled since mid-March.
It’s also nice to know that the father and son who lead the company still own 20%. They were both recent buyers of the stock in the open market. They’re incented to do the right thing for stockholders and hopefully will be open to constructive dialog that activism brings.
[Disclosure: At the time of publication, Jackson was long Barnwell (BRN)]
Eric Jackson is founder and president of Ironfire Capital, LLC, and the general partner and investment manager of Ironfire Capital US Fund LP and Ironfire Capital International Fund, Ltd.
Monday, June 02, 2008
By Eric Jackson