(Editors' Note: This article covers a stock trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.)
- FieldPoint Petroleum (NYSEMKT:FPP) is an overlooked and attractive beneficiary of the fracking boom in the fast growing Permian Basin.
- The lack of analyst coverage results in little investor awareness of two key catalysts: The expected significant production growth and the possible sale of the company with the recent hiring of a bank to pursue strategic alternatives after the founder passed away last year.
FPP is an E&P company with varying ownership interests in ~360 wells located in Oklahoma, Louisiana, New Mexico, Texas and Wyoming. FPP operates 80 of the wells while the others are operated by independent operators.
Production decline likely marks bottom than top
The YTD production decline shown in the chart below should not be taken at face value for three reasons.
First, the production trend is clearly up and to the right with the "up" years being multiples of the "down" years. Second, a production increase in the mrq as well as a projected increase during the next two quarters due to additional drilling in New Mexico are encouraging signs that production growth has resumed its historical trajectory.
Second, FPP plans to drill up to 12 horizontal wells this year with partner Riley Exploration Group, which along with a revitalization of existing vertical wells could result in significant production growth as this is the largest project ever undertaken. Riley is already proving to be an excellent partner after it allowed FPP to participate in a well that was drilled prior to the agreement becoming effective. Moreover, the East Lusk property in New Mexico continues to show positive results as partner Cimarex is preparing to drill a fourth well (PDF alert).
Third, new drilling techniques such as horizontal drilling can provide access to reserves that were previously uneconomical. For example, in October 2012 FPP sold its interest in the South Vacuum field for a gain of $204,000 after the property had been fully impaired.
Moreover, FPP has cost effectively hedged about half of current daily production (PDF alert) via a costless collar with an $87 floor and $108 ceiling. This is a "positive expectancy" trade as the losses prevented should be valued higher than forfeited gains due to its limited resources compared to larger peers.
From tragedy to opportunity
In June 2013 the founder, president and CEO Ray Reaves died in an automobile accident. While the loss was tragic on multiple levels*, the loss was minimized as the board had a succession plan in place.
Less than six months later FPP hired Stephens to "evaluate strategic alternatives for enhancing shareholder value". A sale to a larger strategic acquirer would almost be poetic as FPP was formed after a merger (Bass Petroleum and Energy Production in 1998).
Many companies regularly engage the services of banks in the pursuit of strategic alternatives - almost to the point of diluting the effectiveness of this in terms of stock price appreciation as more than an insignificant number of them decide to continue business as usual for a variety of reasons (e.g. no one wants to buy them period or at least not at a "reasonable" multiple*). However this does not appear to be the case with FPP for three reasons.
First, and related to the above, the estate (who now owns ~38% of the stock) is less invested from a sweat equity standpoint and may be more willing to sell.
Second, the current bullish operating environmental likely represents the peak in terms of valuations at least for the foreseeable future. For example, the emergence of fracking removed many of the previous production constraints facing smaller domestic companies. Moreover, the strong rebound in gas prices (despite significant production growth due to fracking) and still high oil prices should result in a multiple near the upper end of historical deal comps, especially as the growing activist presence in the industry highlights the value opportunity (not that FPP needs an activist as the board continues to focus on maximizing shareholder value). Furthermore, FPP deserves a premium given that it operates in the fast growing Permian Basin with 92% of its revenue YTD generated from oil sales.
Third, FPP would be a perfect fit for any one of the many larger companies trying to replenish reserves, much less grow them. This can be accomplished more easily through "buying American" in the form of a fast growing, smaller domestic company as opposed to buying international assets with significantly more risks (e.g. unfriendly government, unfavorable partnership agreement). The phrase "if you can't beat 'em, join 'em" comes to mind when evaluating the increasingly competitive bidding environment for quality properties. While FPP should be able to thrive as a standalone company, the previously mentioned search for growth by larger companies raised the bidding floor price for everyone, which may disproportionately affect FPP given its relatively limited resources. In general, it's much better to receive a high multiple as the seller than pay it as the buyer. Moreover, although G&A declined 10% YTD, it is still at a ~$1.5 million annual run rate and expected to remain stable or increase slightly. A larger company would be better able to shoulder this expense (which seems high in relation to the asset base).
In addition to going long the common, more aggressive investors may purchase the warrants. In March 2012, FPP issued warrants to shareholders as a dividend that may be exercised at $4 for six years (from the record date) and may only be called if the common reaches $6. This should go without saying but I'll say it anyways. The inherent risk in the warrants is significantly greater than the common. Investors can reduce the risk on an absolute dollar basis by purchasing fewer aggregate warrants (e.g. at least 50% less) compared to an investment in the common.
*Let me be perfectly clear on this issue as sincerity is often lost (or not readily seen) in print. In no way am I minimizing the loss of the founder, which obviously greatly affected his family, friends as well as the company. I am simply discussing this in the context of the stock.
**I put this word in quotes because often an acquirer will make what it thinks is a reasonable bid (e.g. 10x EBITDA) while unrealistic expectations by the board (e.g. "our peer trades at 15x so we should too") often result in no deal as the acquirer usually has shareholders to answer to as well (and increasingly activist ones).
The following are the primary risks to the investment thesis, in order of importance:
- While a decline in oil and gas prices would obviously have a negative effect on FPP, this risk is reduced due to the previously mentioned hedging program.
- Production may be less than expected while drilling costs may be greater than expected, especially due to the inherent risks present in the E&P industry (e.g. dry wells, blow-outs). Moreover, there are additional challenges unique to fracking (e.g. requires large amounts of water and sand, which must be properly disposed of).
- Oil and gas reserves may be less than expected (especially proved undeveloped reserves compared to developed reserves) due to a decline in oil and gas prices that would most likely result in not only a lower value of proved reserves but also the amount that could be economically extracted.
While the current dip in production results in a not meaningful 14.8x EBITDA multiple, this should come down due to the previously mentioned production growth. This catalyst, along with the very real possibility of a sale of the company should provide at a minimum a 20% increase in the price of the common. The time frame is 12-18 months given that the resolution for these two catalysts should come during this time frame. The stop loss should be placed below the recent support at ~$4 or ~7% below.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.