I recently wrote a "top idea" on Seeking Alpha (link) discussing the investment prospects of AusTex Oil (OTCQX:ATXDY), an undervalued publicly traded oil company. I got great feedback from the Seeking Alpha community, and many more shares of the stock traded than average in the days following the article. However, when I shared the article with friends outside of the finance community, their response was generally "this sounds great, but what does all this mean?" Below I will walk through a plain-language investment thesis for AusTex Oil:
AusTex Oil is a company that produces oil and natural gas from wells it drills in Kay County, Oklahoma. It has been around since 2007 and has been actively drilling in this particular field since 2011. It has drilled 29 wells so far, most of which are currently producing oil and gas (and which it is selling for approximately $40 per barrel, after taxes and other relevant fees).
AusTex's 29 wells are currently producing over 1,000 barrels of oil and gas per day. The company has announced and analysts who work for investment banks and follow the stock have projected that AusTex will drill enough new oil wells that they will be producing 3,000 barrels of oil and gas per day by the end of 2014.
Licensed reserve engineers, who professionally evaluate oil fields to determine how much oil is likely recoverable from the fields, and who then calculate the value of the fields, determined that AusTex's fields are worth approximately $250 million.
Based on the number of shares outstanding, AusTex is currently valued in the public market at approximately $100 million. If AusTex had 100 million shares and every share cost $1 to buy, multiplying the number of shares AusTex has by the price per share determines the public market value of the company. (the $100 million takes into account debt and stock options, but I won't get into specifics about those here).
Oil companies are valued in the public market based on a number of factors, but two seem to affect their valuations more than any others. One is that they tend to be valued higher than their proved reserve value. And the other is that they tend to be valued at least $100,000 per barrel of oil and gas they produce per day. So if they produced one barrel of oil per day and had $120,000 worth of oil in the ground according to reserve engineers, they might have a public market value of $120,000 or more.
I own AusTex because, assuming it grows as much as its management and the investment bank analysts think it will grow, it trades at approximately $30,000 per barrel of oil and gas it will be producing at the end of 2014, and it trades for about 1/3 of the value outside engineers said its reserves are worth. This means that, if things go as planned, AusTex's stock could triple in the next year.
As an example in my "top idea" article, I pointed out another company that produces oil and gas and that is growing rapidly. That company is Synergy Resources (SYRG). Synergy produces about 3,000 barrels of oil and gas per day, and has about a $900 million public market value. This means that it is trading for about $300,000 per barrel of oil and gas it is currently producing per day. In the previous paragraph I mentioned AusTex is trading at $30,000 per barrel of oil and gas it will be producing per day at the end of the year. This difference between $30,000 and $300,000 means AusTex stock could potentially go up a lot if it were to trade at a valuation similar to Synergy.
Another point I made in my "top idea" article is that there is a new person involved with AusTex who could make a big difference in how the company is managed. Also, because he is involved, the stock could trade higher because investors might have more confidence that he will help make sure the company performs well for its investors.
That person is Michael Stone. He is famous in the finance community for taking a large, controversial company, Herbalife (HLF) private in 2002 (think Richard Gere in Pretty Woman) and then taking it public again in 2004. In just that one investment, co-investors and clients made up to $1 billion in profit, which is a lot of money with not a lot invested.
Unlike with Herbalife, it looks like Michael Stone invested his personal money in AusTex, and he bought over 30% of the company. This is a good sign that he thinks AusTex is very undervalued. He probably did math similar to the math I did above (albeit much more complex) and realized that AusTex was one of the cheapest oil and gas stocks available in the entire market.
Another interesting aspect of Michael Stone's investment is the timing- around the time Michael Stone started investing in AusTex, Herbalife stock was trading at a multi-year low. There are likely few people who know that company better, and instead of buying Herbalife stock, he was buying AusTex stock. Herbalife has traded up 180% since then -$1 invested at that time would be worth $2.80 now. AusTex stock is only up about 40% since then, implying that there could be substantial upside to AusTex stock if it is assumed that an investor could have done equally well buying Herbalife at its low or buying AusTex stock at that time.
Perhaps the Huge valuation difference between AusTex and oil publicly traded oil and gas companies like Synergy is one reason Michael Stone chose to buy such a big part of AusTex. Or perhaps AusTex trading at a low price compared to the value of its oil production or the engineering value of its reserves, despite rapid growth in both, might have been why. Regardless, Michael Stone's participation and ability to appoint 3 out of 7 board members can likely give investors comfort. A sophisticated investor and proven private equity manager may lead to substantial value realization (the stock price going up a lot).
One other aspect to the investment is that AusTex is growing its oil and gas production and reserves at a time when large oil companies are spending more money than they are making, and despite that, are still shrinking. I pointed out in another recent article that Shell Oil (RDS.A) had a very disappointing quarter, earning only 1/4 of the profit it had earned the previous year, due to failed exploration projects and other problems. It is possible that investors in large oil companies like Shell may be selling their stock and looking to buy companies that are growing faster but are still trading at low valuations. Stocks like AusTex could benefit in this environment, as investor dollars move away from companies that are disappointing investors, like Shell, and towards companies that are pleasing investors because of their rapid growth, like AusTex.
And finally, I started the article with an explanation of why investors might be interested in reading what I wrote. This was my third "top idea" article on Seeking Alpha. My first "top idea" was to buy a stock, Gastar Exploration (GST) which, since that article was published 7 months ago, went up more than 150% ($1 invested would now be worth over $2.50). And my second top idea was to short a stock (bet that it would go down), which two months after I wrote about it, had gone down ~15% despite the market going up 5% in that time. So basically, my only two "top ideas" at that point had done very well. This did not mean my third "top idea" would necessarily do well, but it did mean that it might be worth paying attention to.
Hopefully this "plain language" walkthrough is helpful in understanding this "top idea". Please don't hesitate to ask me questions about it, and I will try my best to respond to comments or messages that are sent to me. Below is an important disclaimer.
Disclaimer: Opinions expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment adviser capacity. This is not an investment research report. The author's opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies' SEC filings, and consult a qualified investment adviser. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice.
Additional disclosure: I may buy or sell any stock mentioned at any time with no further notice