The Solv-ex Scam?
The Solv-ex Scam?
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[EDITOR'S NOTE: Today, Rogue looks at Solv-Ex, a company that has been racked by scandal in recent months. Is the company just a hype stock? Have shareholders been deluded?] "You've Probably Never Heard of Us. You Soon Will Because Our Technology Will Reduce American Dependence on Middle East Oil." This bold ad for Solv-Ex (SOLV) appeared September 18th in THE WALL STREET JOURNAL. And according to many short sellers and at least one disgruntled investor who recently filed a class action lawsuit, the claim is nothing but hype designed to keep afloat a shady company that has consistently misled investors about its prospects. Buffeted by both positive and negative analyst reports, news that the FBI was investigating trading in its shares, and deep suspicions regarding the company's financing, Solv-Ex's stock has ricocheted from $8 last November to $38 in January, back to $6.25 in late March, then to $28 in late May. In early September the shares dropped as low as $9 before recovering to $20 and now settling back to the mid-teens. The stock's volatility has followed the dramatically different views of Solv-Ex's prospects held by investors at different times. Based in Albuquerque, New Mexico, the company holds leases on two tracts of land in the Athabasca River region of Alberta, Canada. The company hopes to mine these lands for oil and minerals using what it claims is a proprietary technology. Specifically, the company hopes to extract a tarlike residue known as bitumen from oily sand, processing it into synthetic crude oil. Solv-Ex claims that it can produce oil at more than competitive costs using this method. More important though, the company also says that it can recover raw aluminum and other minerals in the process that are worth three times as much as the oil. The company's critics counter that other, much larger companies such as Suncor and Syncrude Canada Ltd. have similar technologies and that there are other extraction methods now available that are even more efficient and economical. Moreover, they claim that Solv-Ex has made material misstatements about its business prospects and financial arrangements at every turn. They say it's unlikely that the company will complete its first oil sands plant in Alberta in the first quarter of 1997, as planned, and that the failure to do so will jeopardize the lease arrangements. There have also been reports of possible criminal wrongdoing surrounding the company's $70 million in recent Reg S private placements. Such stock offerings are designed to facilitate the process by which companies raise capital overseas. Though the SEC has recently taken action that would force companies to make a more thorough and timely accounting of such private placements to their current shareholders, the existing Reg S rules allow firms to skirt the basic SEC filing requirements relevant to conventional secondary offerings of public stock in the U.S. Reg S placements are often made by companies who find it impossible or inconvenient to raise capital through conventional channels. The recent shareholder lawsuit filed in United States District Court, Southern District of New York asserts that Solv-Ex has made over 20 private placements since 1990, many of them pursuant to Reg S. According to the British press, Peter Young, a money manager at Morgan Grenfell Asset Management, is said to have violated British securities laws by using several shell companies, including Young's own investment vehicle Russ Oil, to purchase essentially all the shares offered by Solv-Ex in three placements earlier this year. British authorities are currently investigating the matter, but the implication is that both Morgan Grenfell and Young personally benefited by agreeing to purchase these Solv-Ex securities, either by receiving shares at a deep discount to the current market value or through direct bribes from either FIBA Nordic Securities, the company placing the shares, or from Solv-Ex management itself. The charges have yet to be substantiated, however. But it is known that Charlie Maxwell, managing director of Morgan Grenfell, had previously worked for Solv-Ex president Jack Butler at Mobil Oil. Maxwell issued a strong buy recommendation on Solv-Ex on January 26, 1996 in a paper titled: "Classic Growth Stock of Our Generation." According to an article in the FINANCIAL POST (February 3, 1996), Maxwell failed to disclose that he personally owned 100,000 shares of Solv-Ex at the time. Along with Richard Geist, author of "Richard Geist's Strategic Investing," Maxwell has continued to be one of the company's strongest advocates. In a conference call earlier this year, Solv-Ex CEO and chairman John Rendall at first said that he wasn't aware that Morgan Grenfell purchased any of the company's Reg S shares. Yet some sources claim that Rendall himself discussed the sales with Young in Morgan Grenfell's offices. In an early September report in the British press, Rendall publicly defended Young as an outstanding individual. The British investigation apparently follows up on leads generated by ongoing FBI and SEC investigations into trading in the company's shares, which was originally announced in late March by Bloomberg Business News, CNBC's Dan Dorfman, and other financial media. Specifically, a Los Angeles grand jury was said to be looking into possible ties between Solv-Ex and international stock manipulators Thomas Quinn and Arnold Kimmes. The news that a grand jury was seeking indictments in the case caused the stock to lose two-thirds of its value in one day. The stock dipped to $6 before recovering to $11.75 the next day. Solv-Ex was and remains heavily shorted. Though there's no proof that company officials participated in any of these alleged wrongdoings, the company's track record is not a promising one. Solv-Ex has never been profitable. And the company's 10-K public filing for the fiscal year ended June 30, 1996 indicated that it had a loss of $0.27 per share on total revenues of $642,000. (The company has about 22 million shares outstanding, with about 6.5 million shares in the hands of company insiders.) Moreover, company officials have been involved in various debacles. For example, in 1983, the company received a letter of intent for $42 million in loan guarantees from Synthetic Fuels Corporation, a federal agency created to help the U.S. become less dependent on foreign oil. In exchange for the loan, Solv-Ex was supposed to build a fuel plant in New Mexico to refine oil from tar sands in New Mexico and Utah. On the strength of this agreement, Solv-Ex went public, selling $4 million of stock at a price of $4.25 per share. Yet the tar-sands extraction agreement fell through shortly after the public offering when it became clear that the quality and quantity of the mineral resources were much less than Solv-Ex had originally reported. In a congressional hearing, subcommittee chairman Mike Synar (Democrat from Oklahoma) charged that Solv-Ex had never tested its processing method on a commercial scale when the loan guarantee was approved. Others testified that before the stock sale, Solv-Ex received a report from an outside consultant indicating that the oil reserves were actually one half to two-thirds less than Solv-Ex had previously said. According to the WASHINGTON POST, Rendall said at the time that he believed that "the potential loss of these reserves was not significant." In addition, former Solv-Ex executive Sam Francis was convicted of fraud in the trading of penny stocks in 1993. The battle between the company and its critics has grown fierce. In February, Solv-Ex officials advised the company's shareholders to take possession of their shares from margin accounts in an effort to squeeze the short-sellers, who it claimed were trying to manipulate the stock by spreading untruths. It has since been revealed, however, that at the same time, Rendall himself had secured a loan of $1 million for Solv-Ex by margining his own Solv-Ex holdings. On August 12, 1996, the company filed a lawsuit against a group of short-sellers (Solv-Ex Corporation v. Parker Quillen et al) whom it charged with revealing certain confidential information about the company. This suit turns, in part, on the differences between a purported audit of the company's feasibility study conducted for the company by Houston-based Pace Consulting, of Jacobs Engineering Group, and a technical due diligence report completed on March 29, 1996 by Vancouver-based Weir-Jones Engineering Consultants for a group of short-sellers. Though there's a lot of intrigue around the stock and the various investigations into the company's financing arrangements, the principal points of dispute involve an endless number of material business issues, which critics charge company officials have consistently and willfully misrepresented in their press releases, conference calls, investor relation packets, and other public filings and comments. And these two competing studies by respected consultants highlight the meat of the dispute even as they contribute central points for the charges made in the class action suit filed earlier this month on behalf of Alfonso L. Sedita and others who owned Solv-Ex during the class period February 15, 1995 to September 30, 1996. This lawsuit names Solv-Ex, company executives Jack Butler, Herbert Campbell II, and John Rendall, and Morgan Grenfell as the defendants. The company's critics charge that Solv-Ex essentially misrepresented the Pace report as a thorough third-party audit of the company's feasibility study. Yet Pace has no specific expertise in evaluating oil reserves in the ground or the cost of oil production. The firm accepted a number of the cost assumptions that Solv-Ex provided, only reviewing the methodology by which this raw data was generated. And the raw data for the feasibility study itself is said to have come from laboratory tests of Solv-Ex's extraction technology rather than tests under field conditions for commercial mining. The critics also charge that samples used by the company were of uncommonly good quality, which would distort the results in Solv-Ex's favor. Given the starting assumptions, though, Pace concluded that Solv-Ex's extraction plant could generate oil at $5.21 per barrel at a planned capacity of 14,000 barrels a day. If West Texas Intermediate were trading at $19 a day, the company's often discussed but unsubstantiated agreement with Gibson Petroleum, an oil distributor based in Calgary, would lead to operating cash flow of $7.50 per barrel before debt service. Furthermore, the Pace report placed the cost of building the oil extraction plant at $97.4 million. Though Solv-Ex has raised less than this in its the various Reg S offerings this year, the company now says it has enough financing and that the plant construction is ahead of schedule. Yet a story in the March 16th issue of THE FINANCIAL POST revealed that Pace believed Solv-Ex was indeed misrepresenting its study. Pace vice-president Dan Foley is quoted as saying, "We reviewed a feasibility study they prepared; audit is their term. We only commented on a US $2.25 portion of the US $5.21. We're not used to our name being kicked around in these kinds of circles. We weren't hired to give opinions for the public market... Throwing a number out without backup on what those numbers mean can be misleading to the public." The Weir-Jones report asserts that Solv-Ex underestimated difficulties and overestimated expected revenues at every turn. For example, Weir-Jones placed the cost of the oil plant facility at $125 million, or nearly $28 million more than the Pace study estimated. Weir-Jones also concluded that annual production costs would run $19 million more than Solv-Ex estimated and that net revenues would be substantially lower as a result. The firm also figured that debt-service would run nearly $5 million more per year than Solv-Ex had estimated. In short, Solv-Ex's Bitumont tar sands project would not generate enough cash flow to cover the company's debt service. Since Solv-Ex is building its oil extraction facility prior to the mineral processing facility, the company must first make money off its oil. But the recent Sedita lawsuit raises serious questions about whether that is possible. Though Solv-Ex possesses a number of U.S. patents, all of those patents pertain to the use of solvents in extracting bitumen from the oil sands, the only means by which Solv-Ex has ever produced marketable oil. But the company does not intend to use solvents at the plant under construction. Solv-Ex officials say they have patents pending for the current processing methods. But no patents have yet been awarded and the company's critics doubt that they will be, given the fact that Solv-Ex's much larger competitors Syncrude and Suncor are currently using a similar extraction process. Moreover, the Solv-Ex figure of $5.21 per barrel is for raw bitumen before the cost of upgrading or transportation. The Sedita lawsuit asserts that the company's major competitors, using the same extraction process, currently can mine such bitumen for $2.92 per barrel, suggesting benefits of scale at the very least. In addition, these companies have developed subsurface "in situ" processes for recovering oil from sands that would lead to cost advantages over the process that Solv-Ex plans to employ. Given the fact that Solv-Ex does not now have relevant process patents for a process that is already in commercial use by Suncor and Syncrude, the company's critics are doubtful that Solv-Ex will be able to market its processing technology to other oil extraction companies. And the fact that Solv-Ex was apparently forced to raise money through Reg S placements suggests that no oil company that might stand to benefit from Solv-Ex's processing methods deemed the company worth investing in. Exactly what Solv-Ex can produce remains to be seen. And the company's own studies and the public statements from company officials suggest that at the very least, Solv-Ex will need additional financing to complete even its oil extraction facility. Since it has no earnings, but a market cap of around $300 million, the company's critics wonder exactly why anyone would deem Solv-Ex a worthwhile investment. -- Louis Corrigan (RgeSeymour), 10/18/96
Transmitted: 10/18/96 8:21 PM (media) |
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