Venoco's Management Drama Overshadows Monterey Shale Opportunity

Oct.21.11 | About: Venoco, Inc. (VQ)

Ask average investors about oil and gas shale, and they'll mention stocks tied to Marcellus, Bakken and Eagle Ford. In 2012, however, investors may be talking more about the Monterey Shale in California. But the conversation may center more on Venoco Inc. (NYSE:VQ) rather than the formation's vast reserves.

The Monterey Shale is five times larger than Eagle Ford, and the EIA believes 15.4 billion barrels, equal to about 64% of all recoverable shale oil in the continental U.S., can be extracted. It runs from Northern California down to Los Angeles. As one of the oldest active formations, it's home to existing exploration and production infrastructure.

Yet, despite its size, investors often overlook it. The majority of players operating in Monterey aren't small independents. Instead, they're majors like Occidental Petroleum (NYSE:OXY), which controls over 1 million acres and has a market cap of $68 billion, or Canadian Natural Resources, which has 70,000 acres and a $35 billion market cap. Drop down a little and you also have Plains Exploration & Production (NYSE:PXP), which has 86,000 acres and a market cap of $4 billion.

While Monterey may not have a lot of wildcatting independents ripe for take-over, it does have Venoco Inc., a company that has been riddled with drama over the past decade.

Timothy Marquez and Rod Eson started Venoco back in 1992, reportedly using credit cards to acquire their first California well. Today, the company has 304,000 gross acres in Monterey alone, making it the biggest independent play in the Monterey Shale.

Despite its vast exposure to the formation, Venoco's back-story has given investors pause. In 1998, Enron acquired a 26% stake in Venoco for $60 million, an ill-fated decision that created C-level chaos a few years later when Enron, struggling to sell assets to avert its self-inflicted Armageddon, attempted to sell the stake back to Venoco for $65 million. According to the book Parts per million: The Poisoning of Beverly Hills High School by Joy Horowitz, the offer to sell back to Venoco nearly ended in brawl, as Enron officials cursed co-founder Marquez for his unwillingness to buy back shares and saddle his firm with debt.

Marquez's co-founder Eson, however, was more willing to work with Enron. This created an untenable situation, resulting in Marquez firing Eson and CFO Bill Wineland, only to have that decision later invalidated and reversed by a Delaware court. Once Eson and Wineland returned to Venoco, Marquez was instead forced out. Marquez, however, kept his shares and remained on the board.

Marquez returned to Venoco in 2004, buying out Eson's and Enron's stake for $14 million. Venoco was taken public in 2006, with Marquez retaining 50.3% ownership in a deal which proved very profitable for him. At its high in June 2008, Venoco's market cap topped a billion dollars, as shares traded north of $22. Today, shares trade around $9.50.

This past August, Marquez offered to take the company private again, offering $12.50 per share. On September 26, Venoco's board hired Bank of America Merrill Lynch (NYSE:BAC) to consider the offer.

Long-term investors are unimpressed. While above recent lows of $7.43, the deal values the stock at less than it has traded for most of the past 18 months. If you bought at less than $3 back in 2009, you're happy. But for many the offer smacks of an attempt by Marquez to double-dip at shareholders' expense. Perhaps instead its aim is to wake up shale hungry competitors, such as Chesapeake (NYSE:CHK) and Berry Petroleum (BRY), rumored to be locking up Monterey acreage. More likely, it’s a sign of frustration on Marquez's part -- he has watched shares rise markedly for other shale plays with seemingly less production upside than his company.

For the right price, it would seem a savvy buy. The stock will earn nearly $0.80 per share this year and analysts forecast earnings at $0.84 next year. And, that number could go higher thanks to approval for Venoco's new pipeline to its 2,000 bbl/d South Ellwood Field, which may boost Venoco's realized prices by $5-7 per barrel.

In addition to the $87 million in revenue last quarter, the acquirer gets 60,000 Monterey acres held by production. They'll also benefit from Venoco's $250 million in 2011 capital spending, nearly half of which is funding Monterey E&P and could add production next year.

Whether Marquez offer is a starting bid remains to be seen. He controls over 50% of the company, which means an acquirer will need his approval. Only his family can know his intentions and willingness to keep the company. But we do know that he's in his early fifties, has grown children and has become more active in philanthropy near his Denver home, which isn't exactly next door to Venoco's Cupertino, Calif., headquarters.

If he isn't ready to give up the reins, investors could still reap a 30% return if the board accepts his offer. Clearly, investors are skeptical, since shares are trading at a steep discount to the offer. For aggressive investors, taking Venoco with a stop-loss may provide significant upside, assuming one can handle the likely drama. If not, those interested in Monterey should keep a close eye on competitor's earnings calls to see if any new Monterey acreage is reported.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in VQ over the next 72 hours.