- The cold reception for GeoPark (GPRK) last week following a smaller than planned IPO provides an opportunity for long term investors to buy one of the fastest growing E&P companies in Latin America.
- Moreover, GPRK should receive greater visibility after switching to the NYSE from the Alternative Investment Market (or "AIM") in the U.K. and as investors learn more about its unique and attractive growth story.
- The downside is limited by the low absolute EBITDA multiple and high insider ownership while expected significant production growth provides upside potential.
GPRK is an independent oil and gas E&P company operating in Chile, Colombia and Brazil.
Cold market reception creates "underpromise and overdeliver" opportunity
GPRK may be regretting coming to America after the poor first day performance (e.g. the stock fell 7.9% as the SPX rose 1.3%) following its IPO, even after significantly reducing the size and price from 20 million shares at $8-10 per share to 13.5 million shares at $7. While going back home (in this case to the AIM) always looks appealing after you've moved someplace new and unfamiliar (our stock is down therefore no one likes us), eventually GPRK should make new friends (investors) as domestic investors learn more about its story. GPRK is "burning all of its boats" by planning to cancel trading on the AIM on 2/19/14 and de-register from the Santiago Offshore Stock Exchange "as soon as practicable".
The story in this case is of a strong management team with significant skin in the game who built one of the fastest growing E&P companies in Latin America and a portfolio of under-exploited and undervalued assets.
Although acquisitions are responsible for much of the growth since its founding in 2002, GPRK is not running the standard growth through acquisitions playbook for two reasons. First, risk is significantly reduced by acquiring a diverse mix of assets (e.g. producing and non-producing) and by entering into strategic partnerships such as with Korean conglomerate LGI. Second, the focus on under-exploited assets (e.g. abandoned fields that can be turned into productive assets through new drilling techniques or constructing new pipelines) results in less chance of overpaying in a bidding war.
For example, the first acquisition of upstream assets from AES included a working interest in the Fell block in Chile, which at the time had no material production or reserves and resulted in GPRK being the first non-state controlled producer. Since becoming the operator in 2006, 72% of the ~92 wells drilled became productive and this block is now the single most valuable asset for GPRK with >10.2 mmboe of net proved reserves and an average production of 7,013 boepd YTD.
More recently, in May 2013 GPRK acquired Rio das Contas for $140 million, which provided a 10% working interest in the BCAM-40 concession. This included the shallow-depth and currently producing Manati Field operated by Petrobras, which is the largest non-associated gas field in Brazil. This field provides steady cash flow (e.g. 2012 EBITDA of ~$37.2 million) given its fully developed status and low capex requirements while there is significantly less commodity price risk due to a long-term off-take contract covering 75% of proven reserves.
There should continue to be plenty of attractive assets to acquire going forward given that the trend of countries rich in resources but poor in investment opening up is especially evident in Latin America as the fear of going from a net energy exporter to importer (e.g. Indonesia is a cautionary tale) overcomes the reluctance to give up* its national treasures. The few remaining regions with large reserves are less attractive for various reasons (e.g. Iran is opening up but offering unattractive terms).
Unlike many companies employing the growth through acquisitions strategy, GPRK is not left with a crushing debt load as shown in the chart below. Moreover, only ~19% of its long-term borrowing is variable rate due to a recent refinancing that extended the maturity from 2015 to 2020.
These acquisitions provide a platform for organic growth. For example, since acquiring Winchester, Luna and Cuerva in 2012, average production increased 89% to 6,075 boepd in Colombia while net proved reserves for new discoveries increased reserves by an additional 2.4 mmboe (100% oil). Furthermore, GPRK identified >200 low-cost drilling locations that should provide predictable production.
*This fear is a textbook example of "when it comes to politics - facts don't matter". A treasure of any kind is for all intents and purposes worthless if it is unable to be accessed, much less monetized. For example, the NPV of oil and gas reserves (using any discount rate) is zero if the country lacks the operating expertise, labor or equipment (or all three) to extract it.
Although GPRK is not the cheapest Latin American E&P company as shown in the chart below, it does trade at a discount to the median deal multiple of 4.83x. The ~3x multiple paid by Pacific Rubiales Energy for Petrominerales in September 2013 does not necessarily mean GPRK is overvalued as this multiple was based on forward rather than trailing EBITDA. The consistent EBITDA growth over the past five years for GPRK would produce a lower forward multiple as well (e.g. YTD annualized EBITDA of ~$198 million is 17% higher than the 2012 level and 3.1x the 2011 level). However a seemingly expensive relative valuation does not detract from the attractive absolute one, especially given the strong growth prospects.
The following are the primary risks to the investment thesis, in order of importance:
- A decline in oil and gas prices would result in lower revenue, a decline in the amount of oil and gas that could be economically produced and a decline in the value of reserves. Moreover, GPRK has not historically hedged production.
- GPRK must continually replace its reserves through a combination of acquisitions or increased production given the reserve life ratio of 4.1 years (as of 12/31/12).
- There are inherent risks of operating in the oil and gas industry including the risk of dry wells, rising costs for labor/equipment and uncertainty regarding reserve estimates.
The multiple used for the target price is not as aggressive as it appears given the previously mentioned median deal multiple and the fact that it assumes no EBITDA growth.
Using a stop based on the past trading history is impossible as there is only one trading day. However, investors should use any further short term weakness as an opportunity to scale into a long term position while using a standard stop based on individual risk preferences. The time frame is 18-24 months as the trend of increasing production is more of an intermediate term story. Furthermore, it will take time for GPRK to build its new investor base.