Sometimes there are nuggets of extremely valuable information buried in the filings of publicly traded companies. As a close friend and fellow investment manager likes to say "people will do anything to avoid reading a 10-k". I highlighted an example of this in a previous article, where Osage Exploration (OTCQB:OEDV) had disclosed the need to raise significant capital to proceed with its plans. Since that article, Osage stock is down 18%.
I came across another hidden gem recently. In a conversation with the CEO of Gastar Exploration (GST), the CEO referred me to an SEC filing from May 7th, 2013 - a blanket disclosure of information made available to interested parties in the recently completed $200 million notes offering. What is interesting about this disclosure is that, unlike many 8-k filings, there was no press release mentioning it explicitly. Even more interesting, there was a press release that same day mentioning the proposed $200 million notes offering but not mentioning the release of additional information about the company.
I read through this 8-k with great interest, as I was concerned there might be "bones" buried in the document, similar to the Osage 10-k. My concern was driven by my ownership of Gastar stock. Fortunately, there were no observable significant negatives to be found in the document and instead, there was a valuable nugget that indicated previous articles might have understated Gastar's relative value.
The information of interest is a "normalized adjusted EBITDA" number for Q1 2013. Previously, the adjusted EBITDA number provided was $15.3 million, which implied a 2013 run-rate of a little over $60 million, which prior to the notes offering and Chesapeake (CHK) asset purchase worked out to a ~6.6x EV/EBITDA multiple, and pro-forma for the notes and Chesapeake deal worked out to a 8.3x EV/EBITDA multiple. This compared very favorably to multiples of Marcellus stars Range Resources (RRC), Cabot (COG), Rex Energy (REXX) and EQT (EQT), which trade in the 12-20x EV/EBITDA range.
With the normalized adjusted EBITDA of $22 million for Q1 2013, Gastar's implied EBITDA run rate is $88 million, which works out to be a 5.7x EV/EBITDA multiple, pro-forma for the notes and Chesapeake asset acquisition. This is particularly compelling when considering $300 million of Gastar's $500 million of Enterprise Value is comprised of notes and preferred stock, which makes Gastar quite levered and could make re-valuation particularly impactful to the equity value. For example, if Gastar traded to a 12x EV/EBITDA multiple (approximately REXX's current run-rate multiple, per its recent disclosure), it would trade at $12.60 per share, versus its current $3.10 price per share.
This discrepancy can be seen in the relative stock price performance of GST versus REXX, COG, RRC, and EQT. As can be seen in the below chart, GST has substantially underperformed each of these companies, despite achieving similar rapid production, reserve and EBITDA growth. GST has started to "catch up" but still has a long way to go to trade back in-line with these peers.
Obviously there are reasons why REXX trades at 12x and GST trades at 5.7x. However, Gastar's management is methodically ticking items off the list of reasons for Gastar to trade at a discount to its peers. Prior to last week, liquidity had been considered a big concern for potential investors and was cited in investment bank research reports as a concern. One of these banks published a report today saying that this concern has been alleviated now that the notes offering has successfully been completed.
Other items might have been poor execution, insufficient inventory, and uncertain drilling economics. Each of these has been refuted recently - yes Gastar had poor historical execution in East Texas, but it has sold off that property and has executed a highly successful drilling program in the Marcellus (so much so that its drilling contractor, Baker Hughes (BHI), actually used its work for Gastar in a sales brochure). Inventory concerns are being alleviated through successful (so far) down-spacing in the Marcellus and by Gastar's acquisition of a large acreage block in Oklahoma prospective for Hunton Oil. And drilling economics in the Marcellus are as strong as those of Marcellus stars like Range Resources, as discussed here.
Obviously this analysis is based on adjusted normalized EBITDA, not actual cash flow, so some discussion of the adjustment is necessary. The biggest adjustment is for midstream-related production issues. Gastar is projecting production will grow significantly in Q2, driven by those production issues starting to be reduced. Williams (WMB) owns the pipeline system and has spent hundreds of millions of dollars in capex to upgrade the system to better serve Gastar and other operators in the area. I can personally attest to these pipeline issues occurring and starting to be resolved - I own working interests in a field adjacent to Gastar's, where production in the past year had only been online for ~1/3 of the time, and now production is improving considerably.
There is some risk that infrastructure issues get worse again, or that Gastar has other problems either similar to past issues or unrelated to past issues. However, perhaps Gastar does not deserve to trade at less than half the multiple of its peers, particularly considering the recent steps Gastar has taken to "clean up its story". On the back of the recent successful equity offering, perhaps Gastar will close some of the valuation gap, which would disproportionately benefit the equity due to leverage. And it does seem likely that the market has missed the information provided in the 8-k, which could be one reason why the valuation gap has not narrowed more.
Additional disclosure: I am long GST and may buy or sell GST or any other security mentioned at any time without further disclosure