Upcoming Litigation Award
OMEX is currently in the final stages of its NAFTA litigation against the Mexican government with an award announcement set to be revealed in Q1’24. If the company wins and the award is anywhere within the range of the filed claims, OMEX shares will be a multi-bagger. If the Mexican government prevails, OMEX is a donut. The odds seem to be in OMEX’s favor, but the award amount is uncertain. Thus, this is an option like bet with a catalyst in the coming months.
A brief background on the pending litigation: Since 2014, Mexican regulators have repeatedly denied OMEX an environmental permit for its world-class phosphate deposit (Don Diego mine) located off the coast of Mexico. Eventually, in 2019, OMEX’s subsidiary, which owns the project, filed a NAFTA tribunal claim, asserting that permit rejection by regulators was solely driven by political reasons and lacked any scientific grounds. The gross claim ranges from $1.4bn (without interest) to $3.1bn (including accrued interest), compared to the current market cap of $60m. Several arguments suggest OMEX is likely to win, including a ruling by the Mexican that annulled regulator’s environmental permit rejection, deeming it unfounded. For more background on the litigation case please refer to this write-up on VIC from Mar 2022 and Green River Asset Management’s blog from Sep 2021 (the latter includes a detailed analysis of why OMEX is very likely to win this arbitration). The final hearing took place in May’22, and closing arguments were submitted in Sep’22.
Since early 2022, OMEX’s share price has halved, reflecting dilutive financings to fund operations/litigation as well as investor fatigue due to the extended tribunal decision timeline. During this time there were minimal/no updates neither from the company nor the tribunal (aside from the note of brief delay due to Covid).
That is changing now. The setup is finally approaching the finish line and OMEX’s main shareholders/litigation funders have just injected fresh funds into the case. Here is the latest:
- In Oct’23, OMEX received a letter from ICSID (the administering body for the litigation) stating that “the Tribunal is well advanced in the drafting of the Award and expects to issue the Award in the first quarter of 2024”. Not only is this a strange choice of words (does it mean OMEX won arbitration?), but also marks the first time that either the tribunal or OMEX’s management has publicly announced a specific timeline. Although it might seem that the tribunal’s decision is long overdue, the timeline so far is quite close to the 425-day average it has historically taken ICSID arbitration to reach the decision (counting from the final hearing date).
- In early December, OMEX announced a new debt financing agreement ($6m) with a group of parties, including its largest shareholders FourWorld Capital Management (owns 14%) and Two Seas Capital (10%). As part of the financing package, the parties were also given out-of-the-money warrants to purchase 1.6m shares, with exercise prices of $4.25 and $7.09 (vs $3.0 today). The two hedge funds appear to be highly experienced in the litigation space. Two Seas focuses exclusively on litigation investments, while Four World invests in event-driven situations, with a focus on tax, legal and regulatory catalysts. OMEX’s litigation funder, Drumcliffe, also participated in the latest round through its buyout fund DP Special Opportunities. The investment from these firms shortly before the expected tribunal decision seems to be a strong vote of confidence in OMEX’s litigation prospects.
- Then going back a bit, in Sep’23 the company approved a special bonus to its employees payable upon a successful NAFTA arbitration outcome. The bonus will depend on the net proceeds received by Odyssey and might “equal up to 250% of each eligible employee’s salary”.
- In Mar’23, OMEX reached an agreement with its legacy debtholder, AHMSA, a Mexican steel company, to eliminate its debt in exchange for cash and common shares. Prior to the agreement, OMEX was in default on the debt and had pledged all of its shares in the phosphate project to AHMSA. Even in a successful litigation outcome, this might have led to new disputes given AHMSA’s shady history. So the agreement seems to have removed a major overhang which had previously been one of the key risks to the thesis.
So how large of an award can investors expect?
Figuring out the potential upside here is a bit of a guesswork. As Green River said “We don’t know whether the ultimate award will be $500 million or $3 billion”. The litigation claim (as of Sep’22) is at $1.355bn (without interest) or $3.138bn (with 13.95% annual interest) or $1.065bn and $2.468bn after Mexican taxes respectively. These values are mostly derived based on DCF valuation of the Don Diego mine to which OMEX was denied the permit, i.e. foregone value that OMEX was not able to earn. OMEX owns 65%-70% ExO subsidiary that would receive the award (stake varies due to convertible debt owed by ExO).
Below is a pay-off waterfall from VIC pitch (Mar’22) with rather optimistic award amounts. Today’s fully diluted share count is around 34.6m, comprised of 20m outstanding + another 14.5 from options and warrants. The exercise of these derivatives would bring in a total of $60m in cash. Adjusting the table below for the new figures results in a $12.6-$23.6 value per OMEX share. That’s materially above the current prices, but for my uneducated eye, these seem to be very aggressive award amounts, which might be difficult to collect from the Mexican government.
OMEX also has $242m in federal NOLs and $88m in foreign income NOLs – these could at least partially shelter the company from the US tax burned on the award.
Let’s reverse engineer the same calculation – what kind of award would be required for OMEX net proceeds to be worth the current price of $3/share? At this level, there would be no dilution from options/warrants as these have exercise prices of $3.35-26.4/share. With 20m share count, litigation funding of $185m, and assuming zero US taxes due to NOLs, the award would need to come at $310m after Mexican taxes or $440m gross.
I am using $185m for ‘Litigation Funding’ and any other ExO subsidiary-related costs, as that seems to be the minimum expense based on the info derived from the Sep’23 8k. I am assuming the $200m award mentioned below is after any Mexican taxes, as in the claim OMEX argues that no taxes should be charged on the award.
…the aggregate net cash payments received by Odyssey, after payment of or reservation of cash for all legal and other expenses, including litigation financing for the Arbitration, and all of ExO’s outstanding liabilities, equal at least $10 million. Odyssey has estimated that the amount of a monetary award or settlement amount would need to be at least $200 million for this condition to be satisfied.
Given that OMEX would most probably trade at a discount to the net proceeds figure due to potential collectability issues and unclear capital allocation strategy going forward, the actual probability-weighed award that the market is currently discounting is probably closer to $600m. That is half of OMEX’s claim before any interest accruals.
Interestingly, the new bonus plan requires “net payments to Odyssey equal at least $400 million” for the employee bonuses to reach 250% salary levels. This amount of net proceeds to OMEX would be approximately equal to the base case in the table above. Hard to tell if this is something that management realistically expects or if this is a blue-sky scenario.
So that’s the bet:
- Multibagger – if OMEX wins and the award is somewhere in between the $1.4bn – $3.1bn that the company claims.
- Breakeven – if OMEX wins and the gross award is around $600m.
- Zero – if OMEX loses or if the award is $300m or less.
The catalyst appears to be around the corner – we will most likely see a significant share price movement in one direction or another upon the announcement of the award over the next couple of months.
Why permit denial was unlawful and why OMEX is likely to win?
- Initially, Mexican Secretariat of Environment and Natural Resources (SEMARNAT) was ready to approve the project before the ministry’s eventual decision to deny the environmental permit for the Don Diego mine. Two witnesses from SEMARNAT have claimed that they found no environmental concerns.
- In 2018, a Mexican court (TFJA) annulled the ministry’s decision to deny the permit, claiming it was unfounded. The ruling was unanimously in favor of OMEX. But SEMARNAT still refused to grant the permit.
- Court filings show that OMEX has had several witnesses from SEMARNAT who agreed that the rejection was due to political reasons rather than any scientific grounds.
- SEMARNAT has previously approved several comparable projects with seemingly worse environmental concerns/lower risk mitigation efforts. These include ESSA Project, Laguna Verde Project, Sayulita Project, Veracruz Project, Matamoros Project, Santa Rosalia Project.
Several other points
- Even if OMEX prevails in the litigation, enforcing the award against Mexico could be challenging and time-consuming.
- Aside from the pending NAFTA arbitration case, OMEX holds several exploration-stage subsea mineral projects. Apart from SG&A expenses, a substantial portion of the company’s cash burn (net losses of $5.7m in Q2’23 and $10.9m in Q1’23) have come from operational and research costs associated with its deep-sea mineral exploration projects. For valuation purposes, I assume these have zero value.
- OMEX’s management has an 8% stake (or 5% on a fully diluted basis), currently valued at $4.8m. This compares to the $2m in total compensation that the top three executives received in 2022.
- While these stats are not likely to impact the chances of OMEX win, a glance at claims against Mexico under UNCITRAL arbitration rules (the same as in the Odyssey litigation) shows that out of 10 resolved disputes since 2010, only two rulings were in favor of the investor, with five decisions in favor of Mexican state (the remaining 3 were discontinued).