We hurried the article about Manas out last night because we had a feeling the rally wasn’t about to suddenly reverse, and indeed it didn’t, up another whopping 24%! We also promised to dig deeper into it’s finances, as that is where, apart from drilling disappointments, the most potentially destructive element in these kind of stocks are potentially terrifyingly diluting financing arrangements. Let’s look..

The latest SEC filing is the Q308 (calender year), called the 10-Q, filed Nov, 14:

On the balance sheet in the 10-Q, there are:

• Bank loan                                           1,220,000
• Contingently convertible loan            1,698,849
• Debentures                                         3,810,000

All three of them are new in 2008, as they didn’t feature in the end of year 2007 filing. There is nothing wrong with the bank loan, and on first sight, both the contingently convertible loan and the debentures are too small to cause really significant dilution. The debentures were issued on April 30, 2008. These have a mandatory redemption date of April 30, 2010.

However, that’s not the end of it:

• Our cash balance as of September 30, 2008 was $10,457,063, of which $9,115,000 has been restricted for a bank guarantee for the first phase of our work program in Albania (covering the seismic and geological and geographical (“G&G”) costs in Albania) and two escrow accounts for the first phase of our work program in Mongolia (covering the seismic and G&G costs in Mongolia), leaving a balance of $1,342,063. The Group’s net losses since inception were $31,206,789. Based on our expected monthly burn rate per month, we estimate that we have sufficient working capital to fund operations for two months. Given the turbulences on the global equity markets, we now anticipate that the planned financing of up to $80,000,000 will take place from now until 2009.
• In order to continue to fund operations for the next twelve months and implement the geological work program for our projects particularly in Central Asia and the Balkan Region as well as to finance continuing operations, the Group will require further funds. We expect these funds will be raised through additional equity and/or debt financing. If we are not able to raise the required funds, we would consider farming-out projects in order to reduce our financial commitments. [10-Q p.F6]

Well, farming out they did, with Santos for $54M for a 70% stake in the 570K acres property in Kyrgyzstan, and Santos has an option for a second, similar deal for $50M in Tajikistan, although we have a feeling that farm-out deal preceded the statement in the latest 10-Q quoted above, as:

• DWM Petroleum, a subsidiary of Manas, and Santos International Ventures have entered into an agreement under which Santos has a unilateral option to elect for the parties to execute at a later stage a farm-in agreement for a 70% interest in DWM’s Novobod Tajikistan license and a proposed North Tajik license. [Rigzone, December 12, 2007]

It’s pretty clear that Santos has lifted that option, but when remains a bit of a mystery, so we’re trying to find dates

• We previously sold a 70% interest in South Petroleum JSC to Santos International Holding Pty Ltd. As part of this sale, Santos agreed to undertake a work program on these licenses in two phases, the first of which has already begun. [10-Q August 14, 2008]

So the state of affairs is likely that they will either rely on the second farm-in deal with Santos, or have some kind of financing deal. However, this is still not the end of it. Somebody from a normally very civilized message board called the company:

• As to Albania, they are in negotiations for a farm in on all blocks, A,B,C,D, and 1 and 2. He said they were talking to a number of farmees and one negotiation was in late stage. I wasn’t clear and failed to ask, if they were going to farm all the areas to the same farmee, sorry. He didn’t give a time frame on that, but he said late stage negotiations, so that may mean relatively soon. You can define “soon” and “relatively” for yourselves. 🙂
• Mongolia is in early seismic and will be a ways off as to farming in or drilling.
• He said there was no plan for more equity financing, and that it would be nuts at these levels. So, we are safe from dilution at these levels anyway. He said the costs now are quite low, just an office and a few employees. I got the impression they could hunker down until money starts flowing. [Investorvillage April 3, 2009]

Since they have farm-outs on two out of five properties (and a third pending) and no major activities taking place in the other two, we would be surprised if they needed the $80M mentioned in the Q308 filing anytime soon. So we think this statement of affairs is basically correct.

And they also conducted a private placement:

• On September 4, 2008, the Company conducted a private placement in which it sold 4,000,000 units for $2,600,000, or $0.65 per unit. Each unit consisted of one share of common stock, one warrant and an interest in rights granted to us by the Mineral Resources and Petroleum Authority of Mongolia with respect to certain production sharing contracts governing areas in Mongolia referred to as Blocks 13 and 14.  The Company agreed to cover the unit holder’s share of the exploration costs on Blocks 13 and 14 through exploration phases 1, 2 and 3 herein after referred to as the Participation Liability.
• Each of the 4,000,000 warrants granted under the Securities Purchase Agreement is exercisable for two years at $0.95 per warrant. The warrants carry “tag-along” registration rights such that if a registration statement (other than on Form S-4 or S-8) is filed, the holders may demand that the shares underlying their warrants be included in such registration statement.  If no such registration statement is filed by January 4, 2009, the Company has to undertake its best efforts to file a registration statement for the shares underlying the warrants by May 4, 2009.  There is no financial penalty in the agreement should the Company fail to file a registration statement.
• Of the aggregate proceeds received of $2,600,000, $430,571 has been allocated to the warrants based on their estimated fair value, $320,000 has been allocated to the Participation Liability and the balance has been allocated to the Shareholders’ Equity.
• The amount allocated to the Participation Liability was determined in the same manner as the Participation Liability arising in connection with the Loans described in Note 13. [10-Q p.F13]

There has also been a small promissory note finance ($540K) on Dec. 8 2008.

Another possible source of dilution is stock based compensation (both to insiders and outsiders):

• On February 1, 2008, the Company granted 1,000,000 stock options to officers at a price of $2.10 per share. The strike price represents the closing share price on the grant date. These stock options vest over 36 months with 1/12 vested per quarter. Compensation cost, being the fair value of the options at the grant date, is calculated to be $1,127,410 of which $93,951 will be expensed every quarter as the remainder vest.
• The fair value of all of the options was determined using the Black-Scholes option pricing model using a 6-year expected life of the option, a volatility factor of 50%, a risk-free rate of 5.0% and no assumed dividend rate.
• On March 3, 2008, the Company granted 150,000 shares to employees in Albania and 1,219,893 shares to consultants as payment for services (market price at grant date $2.05 per share). Compensation costs are calculated to be $2,808,281. Of this charge, $307,500 and $2,500,781 were recorded in personnel costs and consulting fees respectively.
• For the nine months ending September 30, 2008, Manas recorded a total charge of $8,058,814 in respect of the equity awards granted under the stock compensation and stock option plans ($1,760,617 for the third quarter of 2008). Of this total charge, $5,175,379 and $2,883,435 were recorded in personnel costs and consulting fees, respectively, for the nine months ending September 30, 2008 (or $1,633,065 and $127,551, respectively, for the third quarter of 2008). [10-Q p.F9]

Here is detailed info about the debentures:

• On April 30, 2008, the Company successfully negotiated a mezzanine tranche of bridge financing and raised $4,000,000 through the issuance of 4,000 debenture notes (Debentures) of $1,000 each and 1,000,000 detachable warrants. The warrants are exercisable to purchase the Company’s unregistered common shares at $2.10 per share at the option of the holder and will expire on April 30, 2010. The net proceeds after paying finders fee were $3,790,000. The Debentures bear an interest of 8% per annum payable twice a year (June and December) and are due and payable in full two years from the date of issuance (April 30, 2010).  The Debentures can be prepaid along with any unpaid interest at the Company’s request without prepayment premium or penalty. The Debentures can be converted into unregistered common shares at any time on demand of the holder at a conversion price based upon the average price of the 20 days trading price prior to conversion and subject to a floor of $1.00 per share. Interest can be paid in the equivalent amount of unregistered common shares of the Company. If the Company issues shares for proceeds in excess of $40,000,000, then up to 50% of the proceeds are required to be used to pay down the Debentures.
• The aggregate proceeds received have been allocated between the detachable warrants and the Debentures on a relative fair value basis.  Accordingly, $240,000 was credited to additional paid in capital with respect to the warrants.
• At the date of issuance the conversion price determined in accordance with the Debenture agreement was less than the actual share price on the issuance date. This resulted in a beneficial conversion feature of $557,989, which has been immediately expensed as part of interest expense because the Debentures are immediately convertible at the option of the holder.
• Debt issuance costs of $210,000 were incurred and will be amortized over the term of the Debentures using the effective interest rate method. For the nine months ending September 30, 2008, we have accreted the Debentures for the discount that relates to the current period ($50,000). [10-Q p.F10]

We are quite happy with that floor of $1 on the conversion, without that, the holder would have had an incentive to short and convert into an as large amount of shares as possible, but with that floor, the dilution is minor even at the floor. That is a very wise inclusion! Other companies could take example.

Contingent convertible loan

• On August 18, 2008, the Company issued contingently convertible loans (the “Loans”) with a principal amount of $2,000,000 and disposed of 8% of its interest in its operations in Mongolia related to Blocks 13 and 14 for aggregate proceeds of $2,000,000.  The net proceeds after paying finders fee were $1,860,000.  The Company is responsible for the Loan holder’s share of the exploration costs attributable to Blocks 13 and 14 through phases 1, 2 and 3, hereinafter referred to as the Participation Liability.
• The Company has allocated part of the gross proceeds to a Participation Liability for the exploration costs related to the 8% interest in Blocks 13 and 14 in Mongolia provided to the unit holder.  The Company has estimated that there is a range of costs that could be incurred through exploration phases 1, 2 and 3.  The total minimum estimated spends for phase 1, the only phase that is currently probable, is $4,000,000 and therefore, a Participation Liability of $320,000 has been recorded.  This liability will be reduced as expenses are incurred.  The liability will be re-evaluated in future periods and any change will be recorded immediately in the statement of operations.
• The Loans carry an interest rate of 8% per annum and all principal and accrued interest is payable in full two years from the date of issuance (August 18, 2010).  The Loans are secured by the Group’s assets in the Kyrgyz Republic.
• The principal and any accrued but unpaid interest on the Loans are convertible, in whole or in part, at the option of the holders if the Group conducts a public offering at the prevailing market price.  The conversion feature represents an embedded derivative that is not indexed to the Company’s own shares because it is convertible at a variable price.  Accordingly, it must be recorded as a liability at fair value with changes in fair value recorded in the statement of operations.  At inception and September 30, 2008, the Company has estimated the fair value of the conversion option at zero.
• The initial carrying amount of the Loans of $1,680,000 will be accreted to the redemption amount of $2,000,000 over the term of the loans using the effective interest method. [10-Q p.F12]

Not too much to worry about either.

The listing through DMW

• On April 10, 2007, the Company completed the Exchange Transaction whereby it acquired DWM pursuant to an exchange agreement signed in November 2006 whereby DWM shareholders received 80,000,000 shares of the Company’s common stock, which is equal to 72.9% of Company’s outstanding common shares in exchange for 100% of the shares of DWM. On April 10, 2007, as a condition of closing, the Company completed a private placement of 10,330,152 Units. The Company received USD 10,330,152 less costs and expenses for the sale of the units. Each Unit consisted of 1 share, Series A warrant exercisable at USD 2 per share, and Series B warrant exercisable at USD 4 per share.
• The Company also has an obligation to issue 500,000 shares of its common stock over time to the former DWM stockholders for every 50 million barrels of P50 reserves net to the Company from exploration in Kyrgyzstan and Albania up to a maximum of 2.5 billion barrels of P50 oil reserves. At the Company’s option, this obligation may be extended to additional properties that are acquired through the actions of the former DWM stockholders. [10QSB/A June18, 2008]

We think the 500K dilution for every 50M barrels in P2 reserves is not a problem, to put it mildly…

All in all, it seems quite manageable, it could have been a lot worse, so we give this one the green light. Other people seem to have done so today as wel…