I sat down at my computer today, ready for another day spent searching for undervalued securities, and was surprised with some welcome news. Actually, surprised is not a good choice of words, because my Unconventional Investment Plan fully expected the news that I received. I just didn't know when that news was coming, and to which company it would relate.
Regular readers will know that my Unconventional Plan has involved building a portfolio of light oil producers that are focused on unconventional shale and tight oil plays. I believe that the stock market greatly under-appreciates the value of the acreage that these unconventional players control.
I've focused mainly on the smaller, oil-weighted players because I believe they offer the most upside. I expect this upside to be realized either through future production and cash flow growth that the stock market must eventually acknowledge, or through bigger companies coming in and gobbling my undervalued juniors.
I'm indifferent as to whether the value gets realized over the long term as production in these unconventional plays grows, or in the short term through acquisition. The upside is likely higher if these companies can grow production over the long term, but takeovers are also nice because that brings in cash that can be reinvested elsewhere.
As you might have guessed, the news I received today was that one of my "Unconventionals" was being acquired by a larger player. The company in question is Midway Energy which is being bought by Whitecap Resources for $4.85 per share which is a healthy premium from my acquisition cost of Midway last fall.
When I bought shares in Midway, I did so knowing that in all likelihood the company would be acquired within a couple of years. I didn't know that because I can see into the future; I knew it because I can read. By that I mean, when I first discovered Midway I read about this history of its top executive and the oil and gas companies he had bought and sold:
1) Campion Resources Limited
- Founded in 1998 with $5 million in equity
- Sold in 2002 for $35 million
2) Java Energy Limited
- Founded in 2002 with $2 million in equity
- Sold in 2004 for $22 million
3) Pilot Energy Limited
- Founded in 2004 with $13 million in equity
- Sold in 2008 for $76 million
Midway Energy would now be the fourth addition to this list. Midway was founded in 2009 with $96 million in equity, and sold this week for $550 million. How long do you think it will be until the Midway management team starts working on number five. I'll be watching for their next venture.
Midway is a perfect example of why I like to focus on the junior oil producers. These companies are often run by serial entrepreneurs who have a lot of skin in the game and are trying maximize, and then quickly realize value for shareholders. Objective number one is maximizing the share price for management's own benefit. Fortunately their benefit is directly aligned with the best interests of shareholders.
Contrast that with the top management of a big oil company. These guys are typically career employees who have never started a business or risked their own capital. They work for a big paycheck, not because they founded and own a big chunk of the company.
It is the aggressive management teams of these small oil companies that have reinvented the oil business in North America through the application of horizontal drilling and multi-stage fracturing to previously uneconomic shale and tight oil resources. These small aggressive companies have also led the industry and put together large amounts of acreage in these unconventional shale and tight oil plays.
Now the bigger boys who are late to the party are starting to come along and buy up the juniors. Today it was Midway Energy that got taken out. Who is up next? It is impossible to know for sure, but I've got three candidates that I bet don't last too long as independents.
1) Second Wave Petroleum (OTC:SCSZF) - Second Wave is one of the few remaining ways that a bigger company is going to be able to gain entrance into the emerging and prolific Beaverhill Lake light oil play. Second Wave estimates that it has a drilling inventory of 130 Beaverhill Lake oil wells and an additional 650 wells in the Pekisko. Look for Penn West (NYSE:PWE), Penngrowth (NYSE:PGH) or Crescent Point (CSCTF.PK), all of which operate in this area, to be the big fish that swallows this one.
2) Arcan Resources (OTCPK:ARNBF) - Arcan is like Second Wave, but has even more exposure to Beaverhill Lake where Arcan estimates that it has 400 drilling locations. Arcan and Second Wave are the only two remaining publicly traded companies that offer pure exposure to the Beaverhill play. I believe both will be acquired in the near term as the play has been greatly de-risked and appears very attractive. The longer the big boys wait, the more expensive the price.
3) Spartan Oil (OTC:SRTNF) - Midway's most attractive assets were in the Alberta Cardium. The Cardium is also the primary focus of Spartan Oil. Spartan believes it has between 200 and 300 drilling locations in the Cardium as well as significant potential in the Bakken in Saskatchewan. Spartan, like Midway is run by a management team with a history of creating shareholder value. The Spartan management team own almost 30% of the company which provides tremendous incentive to grow the company quickly and then create a value-realizing event.
Now I would caution that after oil has run up well over $100 per barrel and the stock market has had a nice run there is likely no rush to buy these companies today. I think their current share prices are likely attractive, but at some point in the next couple of months a pullback in the stock market or oil prices seems quite possible.
Disclosure: I am long PWE.