You will thank Carl Icahn for ousting this energy-company guru

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Investors like to follow shareholder activists such as Carl Icahn to buy whatever they’re buying as they push for changes at companies.

But here’s another way to play this game.

Follow the top managers those activists push out because they disagree on strategy. If the excommunicated managers are any good, they’ll set up a new company. And you can get in on the ground floor for potentially big gains.

A great example of this is energy company Tellurian Inc. TELL, +0.99% You’ve probably never heard of this company. But I predict it will be a major U.S. natural gas (NG) exporter in a few years. If I’m right, this stock could rise to $55 from current levels of around $11 a share — a “five bagger.”

The Tellurian tale

Tellurian’s story begins in early 2015 when Icahn amassed a big position in Cheniere Energy Inc. LNG, +1.55% which buys cheap natural gas in the U.S. and freezes it into liquid natural gas, or LNG, for export. Cheniere sells LNG where natural gas is a lot more expensive than it is in the U.S., which pretty much means most of the world.

Cheniere founder Charif Souki and Icahn didn’t see eye to eye on strategy. Icahn wanted a bigger piece of potential cash flow. Souki, ever the entrepreneur, wanted to invest it. So Souki took a hike. He then launched Tellurian with help from much of his Cheniere team. They’re now setting up an LNG export plant called Driftwood near Lake Charles, Louisiana.

I’ve known Souki since 2003 when I wrote about Cheniere in an investment column. Afterward I bought the stock. The company was building plants to import LNG at the time. The stock did phenomenally well, rising above $40 by 2006, from $2 a share in the summer of 2003.

Luckily I sold just before trouble struck. The fracking revolution drove down the price of NG in the U.S., so importing LNG no longer made a lot of sense. Then the financial crisis tanked the stock market. Cheniere’s stock cratered to under $1 by October 2008. Souki ultimately decided to convert Cheniere into an LNG export company, and the stock rose into the $70 range by 2015 before settling in recently in the low-$40s.

The new playbook

Sadly, I missed that run. But now, Souki is setting up a similar company at Tellurian, and I’m on board. I’ve also suggested it in my stock letter, Brush Up on Stocks.

It’s early days, so there is uncertainty. But what’s important here is that Souki, Tellurian’s chairman, has an innovative playbook that will probably work in a global LNG market that has changed dramatically.

What’s changed? NG production has shot up around the world, and LNG prices have dropped sharply in Asia and Europe. LNG that once sold for $15 per million British thermal units (MMBtu) in Asia recently sold for just $6 per MMBtu or less.

Aware of these changes, LNG buyers no longer go for the large, 10- to 20-year contracts that used to be the mainstay of this business. Just a few years ago, Cheniere could rely on these mega-contracts, often from utilities, to drive up its share price so it could raise the huge amount of capital needed to build LNG export plants. Those days are gone. So now, Souki has a new plan that’s different in three key ways.

• Instead of selling LNG in long-term contracts, he’s angling to sell the lion’s share of the capacity at his Driftwood facility. He wants to keep about a third on behalf of Tellurian shareholders — which includes himself and his management team. They own over half of the company’s stock, which is a good sign. I like to invest alongside managers with big positions in their companies.

• Second, Tellurian is buying upstream NG assets to bring down its costs relative to competitors that have to buy in the open market. This tactic locks in his NG supply costs, another big advantage over competitors left to the vagaries of Henry Hub prices.

• He’s working with partners Bechtel, Chart Industries Inc. GTLS, +0.90%  and General Electric Co. GE, +0.25%  to create what will probably be one of the lowest-cost LNG plants in the world. Low costs are key in the new competitive world of LNG exports.

Walking through the math

So how is this going to push Tellurian stock up to $55, or more? Of course, there are no guarantees. But let’s drill down on some numbers.

Based on market feedback, Souki thinks he can sell his Driftwood plant capacity for around $1.5 billion per millions of tons per annum (MTPA) of throughput. If he sells 60% of the planned 27.4 MTPA capacity, or 16.5 MTPA, that will raise over $24 billion. Since the Driftwood plant and related pipelines will cost roughly $20 billion, that would leave around $4 billion for other investments.

A lot of this money will go toward the purchase and development of more upstream natural gas assets. This is a key differentiator for Tellurian. Tellurian recently bought natural gas assets in the Haynesville Shale. This gives it access to NG delivered to its plants for about $2.25 per MMBtu, compared to the current market prices of around $3 per MMBtu for competitors, plus whatever delivery costs they pay.

Add on processing costs of about 75 cents per MMBtu to run the NG through Tellurian freezers at Driftwood, and Tellurian can deliver LNG for around $3 per MMBtu to loading docks on the Gulf. LNG currently sells for around $6 per MMBtu there, so Tellurian basically has a 100% mark up. That’s not a bad business model.

Assuming Souki keeps around 9.5 MTPA of capacity at its Driftwood plant, Tellurian will produce about $1.4 billion a year in cash flow at current LNG prices of around $6 per MMBtu in the Gulf. And the company will be debt-free. Put a multiple of 10 on this cash flow, which isn’t a stretch for a company like this, and this points to a market cap of $14 billion. Given that Tellurian’s current market cap is $2.3 billion, this suggests the stock can go up over six-fold to $65, from recent levels of around $10.90. I’m discounting that by $10 to be conservative, which is how I get a price of $55.

A potential kicker

All of this assumes LNG stays at $6 per MMBtu forever. But it could easily go much higher. True, right now, there’s excess LNG production capacity. But investing is all about the future. Global economic growth will continue, which will support LNG demand growth. China, in particular, wants to use more natural gas instead of coal, because of its pollution problem. But it is not the only one.

“Natural gas will be the fossil fuel of choice in an environmentally conscious world,” said Jefferson Clarke, the head of LNG research at the energy shipping consulting firm Poten & Partners, at a Marine Money conference in New York.

Estimates are all over the map. But based on research by Wood Mackenzie, Tellurian and Cheniere, it looks like there will be an LNG export capacity shortage by 2022, which is when Tellurian thinks it will begin exporting LNG.

Last winter we already saw signs of a tight market, Tellurian CEO Meg Gentle pointed out. A cold snap in Asia drove LNG prices there up to $9-$10 per MMBtu, a sign that the LNG market may be tighter than people think.

Investors won’t have to wait until Tellurian starts shipping LNG in 2022 to see big stock gains. Souki thinks the company will have plant capacity sales and related financing in place by next summer when it breaks ground on its Driftwood plant. This will take much of the risk out of the story and attract a lot of investor interest.

Will he actually sign those deals? He thinks so, because LNG buyers like the price of NG in the U.S. And he’ll probably be offering some of the best prices because of his efforts to keep costs down.

“It’s a good deal for our partners because it’s the cheapest gas they can get their hands on,” Souki said.

One worry is that a long line of competitors will launch LNG export projects and flood the market. But this is a complicated business. Sempra Energy SRE, -2.22% for example, recently announced LNG project delays. My bet is that Souki and his team won’t have those problems for a simple reason: They have a lot of experience. As a team, they’ve created a fifth of the current LNG export capacity in the world.

So is Souki bitter at all toward Icahn because the activist investor pressured him to step aside at the company he founded, Cheniere? If so, he’s not letting on.

“Within 10 minutes of meeting him, he told me ‘I really did you a favor,’ ” Souki said.

Souki doesn’t seem to disagree.

“You can always take a bunch of lemons and turn them into lemonade,” he said.

At the time of publication, Michael Brush held shares of TELL. Brush has suggested TELL in his stock newsletter, Brush Up on Stocks. Brush is a Manhattan-based financial writer who has covered business for the New York Times and The Economist group, and he attended Columbia Business School in the Knight-Bagehot program.