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Echo Energy – Bizarre funding arrangement, share price must drop, mustn’t it?

By Cynical Bear | Friday 21 April 2017

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from ShareProphets). I have no business relationship with any company whose stock is mentioned in this article.

I’ve been scratching my head over the funding plans announced by the newly re-named Echo Energy (ECHO) earlier this week as there is an unusual aspect to it and can’t believe that the share price won’t drop in the short term as a result. Let me explain.

On Tuesday, Echo provided an update on its strategy and funding plans and, in part, it is very encouraging as James Parsons has set out details of a regional onshore gas play in Central and South America. Having recently completed the placing and open offer, it also announced some chunky financing plans that looked great at first glance but merit a closer look.

The detail is set out below:

“In anticipation of the Company's first asset acquisition, the Company has today signed non binding heads for further institutional investment of approximately £23 million, before expenses.  It is anticipated these funds, net of expenses, will be deployed to evaluate, drill and develop any acquired assets. 

The institutional investment will, subject to approval by shareholders, consist of a £10 million placing of new equity to Spartan Fund (a Bahamas based energy specialist institution) priced at or around market on the date of signature of binding agreements (the "Issue Price") with a 10% commission payable by the Company.  The investment will also include a €15 million five year bond from the Company's cornerstone investor, Greenberry plc.  The bond will carry an 8% coupon, a 10% fee and will be issued at 80% of par.  The debt issue is expected to complete around mid-May 2017. The institutional investment will also have warrant coverage.  Pursuant to the equity fundraising there will be warrants over 50% of the number of shares issued and will be exercisable for five years at 150% of the Issue Price.  Pursuant to the bond there will be warrants over 100% of the number of shares purchasable by €15 million at the Issue Price, exercisable for five years at 150% of the Issue Price.”

Let’s start with the simpler aspect, namely the debt.

Greenberry, Echo’s largest shareholder, is providing a €15 million five year bond. However, it will be issued at 80% of par and there is a 10% fee, so I calculate that Greenberry actually only hands over €10.5 million and the 8% coupon actually works out at 11.4% on the funds invested.

Fair enough, I guess, pretty expensive bearing in mind there is in effect a 40% premium on repayment but it is not without risk so it is what it is to a certain extent. It does mean that despite all the recent cash raised and that payable from future warrants, the net cash/debt position is pretty flat once this debt instrument is in place.

What I can’t get my head round though is the equity investment.

Spartan Fund has apparently agreed to invest £10 million (less 10% commission) “at or around market price” on the date of signature of the binding agreements. That is very strange.

As I write, the share price is approximately 0.45p, valuing the equity at £26 million (and closer to £40 million on a fully diluted basis). This is largely hope value as has been commented on previously by Tom Winnifrith (HERE).

Assuming for one moment that Spartan Fund is an independent institution with a business-like approach to investment, has it really agreed to put in a net £9 million at an unknown price. One should bear in mind, and I’m sure it has, that Greenberry acquired its initial 30% less than two months ago for £650,000 (and has put a bit more in in the open offer) at a price of 0.065p.

What if the retail investor exuberance continues to bid up the price; would Spartan Fund pay 0.5p or even 0.65p – ten times everyone else’s buy-in price.

I doubt it very much. I imagine it has agreed to put the money in but if I’m in its shoes, I’m not signing a binding agreement until the “market” price is much more attractive. It is putting £10 million into a business with no real assets, about €15 million of debt and about the same potentially in cash, and I would want a majority shareholding for that, not 20% or less. Taking a step back, it would be rather odd if it ended up with about the same number of shares as Greenberry having invested ten times as much.

I am assuming that James Parsons appreciates the issues here and understands that it would be helpful if the share price was managed downwards and hence why the RNS reiterated the point that the Italian and Egyptian assets are deemed to be worthless and perhaps it was also assumed that punters would be selling off their open offer shares dropping the share price.

To be fair, this seemed to be working on Tuesday and Wednesday; however, the share price has performed strongly since.

The alternative approach by Spartan would be to short the shares or, more likely, forward sell its placing shares to drive the share price down in the short term and guarantee a profit as and when it gets its shares, although I imagine it could well be restricted from doing do.

Until this funding pricing issue is resolved, I would be very wary of buying in the market and, personally, would take advantage of the frothy price to lock in a profit.

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