New Source Energy Takes Its Chances With An IPO

| About: New Source (NSE)

New Source Energy (NSE) is a oil and natural gas company looking to join the small number of energy companies that have managed to go public in the past couple months. The company is offering 9.1 million shares at a price range of $10.00 to $12.00 per share, and it is expected to start trading the week of 5/7/12. New Source is looking to raise about $100 million, and the deal would give the company a market cap of just under $363 million. The managers and co-managers of the IPO are BMO Capital Markets, KeyBanc Capital Markets, SunTrust Robinson Humphrey, Johnson Rice & Company, and Baird.

New Source Energy's Business

New Source Energy is a newly formed company, created just last July, to acquire and develop oil and natural gas properties. In August of 2011, New Source acquired oil and natural gas liquids assets from Scintilla and other sources for $60 million in cash and 21.2 million shares of stock. New Source Energy is what's known as a non-operator, and the acquired assets will continue to be operated by New Dominion as they have been for the past 12 years.

Both Scintilla and New Dominion are privately held companies and are both owned and controlled by David Chernicky who is also a primary shareholder at New Source Energy. The companies are known for unique methods of recovering oil using a process called de-watering. The process removes all the saltwater, liquid and gaseous hydrocarbons from the target production zone, allowing for a higher recovery of oil than a lot of other traditional drilling methods.

New Source is a tiny company, with just 11 employees. It will also be classified as a "controlled company" by the New York Stock Exchange. This simply means there are different regulations concerning the companies board of directors and controlling shareholders. Specifically, a "controlled company" is defined as a company in which any individual or group of shareholders owns more than 50% of the shares of the company. After the offering, David Chernicky and his companies will own 61% of New Source Energy.

New Source Energy Financials

New Source's revenue stream comes from production of its properties located in Oklahoma. For the year ending December 31st, 2011, it had an average net daily production of 3,725 boe/d (barrel of oil equivalent per day). The companies revenue for last year was a little under $50 million, $35 million of which was from natural gas liquids sales. Overall it recorded a net loss for the period of ($645,000).

Prior to August of 2011, New Source Energy had no history of revenue. So included in the historical financial data is Scintilla's operating history along with the history of "Other Contributed Assets". The asset's described had been profitable in 2009 and 2010. The loss for 2011 was due to administrative costs incurred by New Source Energy related to starting the company and acquiring assets.

How To Trade New Source Energy

A positive for New Source is that it has a profitable business, as long as production can be maintained and proven resources data is accurate. However, it is a tiny company and other larger corporations have significantly more resources. In the oil and gas business a company doesn't make money with every hole dug and small companies have trouble weathering the expense of dry holes.

New Source Energy also states in its S1 filing that it plans to use the proceeds to pay down indebtedness and general administrative expenses. I would prefer to see the company acquire more natural gas assets while the market for both natural gas and oil is soft.

The energy industry is subject to a lot of government regulation which could hurt New Source Energy's exploration and production. In addition, its non-independent board may not always align its interests with other shareholders. Considering those facts along with the low natural gas prices, I don't see a reason to participate in the initial public offering.

Sources: Interview, Deal Lawyers Blog, Nasdaq Market and New Source Energy S1.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.