Well, it's been quite a ride hasn't it?
The markets have experienced if not the worst top to bottom collapse ever, almost certainly the second worst.
Meanwhile, oil and gas prices have without a doubt had the fastest and most painful top to bottom collapse ever.
And debt of any kind has become completely terrifying.
So if you were ever going to find absolutely insanely undervalued stocks,do you think that highly leveraged stocks in the energy sector might be a place to look?
I think I've got one in ATP Oil & Gas (ATPG).
It’s trading at $6 and I believe it might be worth over $75 with today's energy prices. Imagine then what it might be worth in the future if we are headed for an oil and gas rebound.
ATP is a development company (notice the absence of the word exploration) that purchases proven oil and gas reserves that are not attractive to other companies for a variety of reasons and develops them.
Since starting the company in 1991, Paul Bulmahn and group have a 98% success rate in developing properties.
Because they don't have the exploration risk of other E&P companies and because they are very confident in their ability to turn the properties into cash flow (98% success rate), Paul has been willing to use a lot of debt.
And that is the big question. Can they handle the debt?
So let’s discuss.
Last spring, out of frustration over the stock price not reflecting the value of the company’s underlying assets, ATP management decided that it would sell of portions of various properties. The intention was to help the market understand what the entire puzzle was worth by selling off pieces of it. At the same time, they would take to proceeds and reduce leverage. I’ll look at the results of this later.
The debt itself as of last reporting on December31, 2008:
- Tranche B-1 $1.05 bil maturing 2014.
- Tranche B-2 $ $326 mil maturing 2011.
So no near term maturities that are pressing. They have reduced the $326 mil facility to $296 mil in early March. No rollover risk.
How about payment terms?
- The$1.05 bil tranche requires a payment of $2.63 mil per calendar quarter until September 2013, and payments of $249.4 mil thereafter.
- The $326 mil (now $296 mil) requires no payments other than interest until maturity.
So the payment terms are very friendly as well. I won’t spend a lot of time on it, but with $200 mil of cash on hand(plus another $90 mil from a March transaction) and likely another $300mil of cash flow in 2009, they won’t have any trouble making their required debt and interest payments (ATP has only 64 employees, so other expenses, including lease expenses, are also quite manageable). Starting in 2010, cash flow is going to increase in a big way as their largest field is brought on production.
And the real key is that they operate 100% of the properties so they can reduce capex as necessary to match cash flow and capex. So there is no risk of not making debt and interest payments.
Nowwe know they have no near term maturities to worry about and no problems making scheduled payments, the last thing to consider are the debt covenants. These covenants are:
- Minimum Current Ratio greater than 1 : 1
- Net Debt to EBITAX Less than 3 : 1
- EBITAX to Interest Expense greater than 2.5 : 1
- PV10 of PDP (using strip pricing) to net debt of greater than 0.5 to 1
- PV10 Proved plus 50% pre-tax Probable of greater than 2.5 to 1
What is management’s take on the covenants?
Ihave heard Al Reese (CFO) publicly state twice that they fully expect to be in compliance with covenants through all of 2009. So that provides some comfort, but let’s have a look at these.
- Minimum Current Ratio Greater than 1 : 1
At year end, they had current assets of $375mil and current liabilities for debt covenant purposes of about $300mil (excludes derivatives, asset retirement current ltd), well in compliance. This should be very safe in Q1 as the company sold for $150 mil a 50% interest in a floating production facility. Much of this cash will stay on the balance sheet. More on the transaction later.
- Net Debt to EBITAX less than 3 : 1
In prior quarters, the company was not anywhere close to missing this one due to the high commodity prices. This year will be a little closer due to lower energy prices. One thing to note that is going to help on this is the $119 mil gain on the sale of UK gas assets in Q4 2008. This is going to be included in this calculation for the next 3 quarters (uses a rolling 4 quarter EBITAX figure). By my calculations, this one could be close by Q4; however, once this gain on sale is out of the numbers.
However, I’m not factoring in any further debt reduction, and as discussed later, more is coming. There is also a pretty good chance that we see another gain on sale in the coming months, which will again help with this covenant.
- EBITAX to Interest Expense Greater than 2.5 : 1
The prior covenant will trip them up before this one does. By my calculations, they should be fine on this one, so refer to the prior covenant for the bigger concern.
- PV10 of PDP (using strip pricing) to net debt of greater than 0.5 to 1
Not an issue. You can look at the numbers but the have no problem here.
- PV10 Proved plus 50% pre-tax Probable of greater than 2.5 to 1
This one scared the pants off me in Q4 2008 as prices were plunging. As it turned out, they were fine on this covenant. ThePV10 for the reserves for this covenant was $3.7 bil, net debt now isdown close to $1 bil now, which would mean the PV10 for this only needs to be $2.5 bil. They have lots of clearance.
To summarize the covenant issue, I believe that the one EBITAX covenant could come close in Q4 if commodity prices stay low for the entire year. However, there are several things happening that will likely make this into a non-issue:
- The company is in the middle of a continuing and already successful (even in this environment) asset monetization program which is likely to further reduce debt.
- Further gains on sale in the monetization process will increase the EBITAX number involved in the covenant calculation.
- The company is going to be current with all payments, has ample assets as security for the loan and has a game changing field coming on production right at year end, so I think even if they did miss this one covenant a lender would be silly to act on it. Why do something when there is no risk of non-repayment?
More monetizations and debt reduction coming:
As noted above:
- No near term debt maturity issues
- No cash flow issues with respect to making debt/interest payments
- Covenants appear to be ok
There is more to consider with respect to the debt.
The company, as an employee challenge, had a goal to reduce debt by $600 mil before July 2009. As recently as March of 2009, I saw an interview with CEO Paul Bulmahn in which he indicated that the company still expected to have this goal achieved by the end of 2009. This would leave them with only the one tranche still outstanding, which is not due until 2014. And this would obviously improve debt covenant ratios.
So how are they going to raise this cash? Through the monetization process that they started last spring. They have been very successful with this program even in this horrible environment.
Here is what they have monetized so far:
- They sold an override that involved 0.5% of the company’s proven reserves for $80 mil in the summer of last year (at their Gomez property).
- They sold 9% of proven reserves to EDF for $400mil last October. This was a UK gas asset.
- They have sold a 50% interest via an MLP in their floating production unit, the ATP Innovator, to GE for $150 mil. This closed in March of this year.
So they have raised $630 mil through this process since it began. And the really impressive part is that the company's 2P reserves stand exactly where they were when the process began as they more than replaced production and these asset sales. And I should say all of these were sold for very good prices in this very difficult environment. The North Sea gas assets were for over $6.50 per MCF, the Gomez override was right at the top of the market and therefore was at $100 plus oil,and the Innovator interest was for 50% of what had been spent on it.
And here is what is currently being considered for further monetization:
- ATP Titan – their second floating production unit that is meant for their new Telemark field. It has cost $500 mil plus. I have great confidence that they can do an Innovator-like transaction for this one as well which would mean $250 mil cash back to the company. This alone would almost retire the remaining 2011 debt maturing. Why the confidence? Al Reese said at the most recent company presentation that he is extremely confident that this would happen, and that it was a matter of when, not if. Further, there is an interview with GE Energy Capital after the Innovator deal where the GE executive involved indicates that they are interested in further transactions with ATP. Al has CEO Paul also indicating that they are speaking with other parties about this in addition to GE. Expect this late in the year as Telemark nears production.
- Gomez Pipeline – cost of $80 mil. ATP is looking to also monetize the considerable value they have in pipeline infrastructure. Per the last company presentation Al mentioned that they were actively working on this pipeline right now for monetization. Paul Bulmahn has also been quoted that we can expect pipeline monetization to occur before the Titan deal is done.
- Telemark Pipeline – cost $160 mil. They will likely do the same with the new Telemark pipelines as well.
- Canyon Express Pipeline – replacement cost $200 mil. This one is the only current interconnect to the Eastern Gulf of Mexico where new discoveries have recently been announced. It has significant value and ATP will be looking to do something with it as well.
- Telemark partner – ATP has enlisted Scotia Waterous to help them find a partner on this soon to be producing field. It is scheduled to commence production near the end of this year. Has about 70 mil BOE and will have peak production in 2011 at a 30,000 BOE per day. ATP has asked for bids of $100 mil to $460 mil, with the bidder to name the working interest they want for the amount bid.
- Cheviot partner – ATP’s other world class field that is further away from producing than Telemark. Scheduled for 2011/2012. Al mentioned in their last presentation that they are looking for a partner in this field in addition to Telemark. At least 50 mil BOE of 2P reserves here so it is large.
- Remaining 20% interest in Wenlock – on the last conference call, COO Leland Tate mentioned that discussions are still ongoing about potentially selling the reminder of this interest. At the prior transaction value, this could be worth $100 mil.
The company is only looking to reduce debt by the remainder on the $600mil tranche, which is just under $300mil as of today. You can see by the value of the assets that are under consideration for monetization that this debt retirement should not be difficult. The Titan, in my opinion, is a lock to happen, as is the Gomez pipeline.
Once this additional $300mil of debt is retired, there should be plenty of room from their debt covenants.
So once more to conclude on the debt:
- No maturity issues. Next one is 2011 and that debt is going to be gone before then end of this year. That leaves the next maturity in 2014.
- No problems with making debt and interest payments. Very strong cash balance of $200mil plus and operating cash flow in excess of $300mil. Also important that they control capex completely and that monetizations will supplement cash on hand and cash flow.
- Debt covenants look ok. Company has said they will be in compliance. More monetizations should make it a non-issue.
I feel pretty good that they can handle this debt. It is the issue you have to get your head around.
So let’s look at what the shares might be worth as that is actually the easy part.
3 Ways to Look at Value
Net asset value estimates:
1) PV 10 of Proved and Probable
Perindependent 3rd party Dec 08 analysis, ATP has $4.7 bil of proved and probable reserves. Less estimate of tax to be paid on sale of these reserves $1.6bil. Add to that $1 bil in infrastructure and deduct$1.1bil of net debt
Total is $3.0bil / 36 mil shares = $84 per share.
Now imagine if oil and gas return to $90 and $8. This $84 figure is going to be way too low.
2) Acquisition rule of thumb.
Common rule of thumb in the industry is that value per barrel of oil is $20. ATP has 250 mil barrels of oil equivalent.
$20 times 250mil = $5 bil. Take off $1.6 bil or so of taxes on this.
Plus $1 bil of infrastructure, less $1.1 bil of net debt.
Total is $3.3 bil / 36 mil shares = $91 per share.
3) Value based on recent company asset sales
We have two of these to work from. Most recent is the sale to EDF of 9% of ATP's oil and gas reserves for $400 mil.
- If 9% equals $400 mil then 100% of oil and gas reserves would be worth $4.4 bil.
- Value of oil and gas $4.4 bil.
- Take off $1.6 bil or so for taxes.
- Value of infrastructure $1 bil.
- Less net debt ($1.1bil).
- $2.7 bil / 36 mil common shares = $75 per share.
The other transaction was last July when oil prices were peaking. The sold half of one percent of their reserves for $80 mil. This would imply that at these prices the total value of reserves is $16 bil. I'm not going to quantify that in per share terms, but you get the idea.
Conclusion on Value
There are 3 different estimates all of which result in over $75 in value. The stock price is $6 by the way.
I’m trying to be realistic here. My estimates on the reserves are all from independent and verifiable sources. The infrastructure is going to turn in to cash so it can be verified as the monetizations occur.
And the real interesting thing is what is going to happen to value here if there really is an oil spike coming due to production destruction and assumption of demand? ATP is 55% oil, 30% GOM gas and 15% UK gas.
So you have to go back and think about the debt a few more times. The value is obvious.
Game Changer Coming in 6 Months
There is a big change coming to ATP at the end of the year as their second world class field (Gomez is the first, Cheviot the third) Telemarkbegins production. As soon as year two, it will be hit peak and be producing almost 9 million BOE in a year (76% oil) so it could add almost $500 mil in cash flow or double where ATP is currently running. In 2010 it will add hundreds of millions in cash flow.
Every member of ATP’s staff owns stock. The CEO owns almost 20% of the company and the CFO has almost his entire net worth in company stock. They are aligned with shareholders. CEO Bulmahn recently purchase 80,000 shares in the open market after being quoted in an article saying the shares were grotesquely undervalued.
20% of the shares are sold short. It could be piling on as various hedge funds had to sell during the great collapse. At this point though, with a fairly obvious NAV of 10 or 15 times the current share price, it could get pretty scary to be short here if the monetizations keep on coming and energy prices rebound. And don’t forget how significant Telemark is going to be to this company’s cash flow.
In my opinion the value is the easy part and can’t be disputed. Thedebt requires some thinking but it seems to be something the company can handle, especially considering how many levers they have to pull to monetize assets.
By 2011, with oil much higher and natural gas at a more normal level, Telemark and Cheviot producing………………….
Disclosure: I am obviously long ATP Oil & Gas