A 20% Arbitrage Opportunity With Venoco

| About: Venoco, Inc. (VQ)

Venoco, Inc. (NYSE:VQ) is an oil and gas exploration and production company operating primarily in California. Its main assets are natural gas properties in the Sacramento Basin and oil assets in Southern California. It produces over 17,000 barrels of oil equivalent per day and holds oil and gas reserves previously valued at over $1 billion. Venoco has a market cap of $646 million.

For the last few years, Venoco has been touting the potential of its significant Monterey Shale assets in California. Occidental is another large player in the Monterey Shale and is also optimistic about its potential. So far Venoco has only had limited success in the Monterey Shale, although Venoco continues to call the data encouraging. Natural gas drilling in the Sacramento Basin is not profitable at current natural gas prices, so Venoco curtailed new drilling in the Sacramento Basin in the first quarter, in favor of continued development of its oilier assets in Southern California.

CEO Timothy Marquez owns 50.3% of Venoco stock. On January 16, 2012, Marquez entered into an agreement with Venoco to buy out the remaining shares of Venoco at $12.50/share in order to take the company private. On June 5, 2012, a majority of the minority shareholders approved the merger agreement. Marquez will need to secure financing in order to complete the merger, which may be difficult in current market conditions. On June 12, 2012, the Board of Directors agreed to extend the time for Marquez to secure the necessary financing until July 20, 2012.

Christopher Helman of Forbes has a nice article on Marquez and Venoco here which will give the investor a better understanding of Marquez and Venoco. Some investors have questioned why Marquez would want to take Venoco private. My opinion is that the reason Marquez wants to take Venoco private is simply that he understands that the company's assets, long term, are going to be worth far more than $12.50/share. Another view recognizing the underlying value of Venoco's assets, by Devon Shire, may be found here.

With a stock price currently around $10.50, Venoco presents a lucrative arbitrage opportunity for investors, nearing a 20% gain in just 1-2 months. The downside risk is that the merger does not go through, in which case the stock could easily fall below the pre-announcement price below $8. If the Monterey Shale turns out to be unprofitable, and natural gas prices stay at current levels or decline, Venoco's future would be bleak. However, I find this scenario unlikely.

In summary, I am optimistic on Venoco's future. The most likely result of an investment in Venoco now is a 20% gain within a short period of time. The downside is mitigated in that Venoco retains great value (and much greater eventual potential upside) even without the merger. Indeed, I see the stock as being worth more than the $12.50 offer by Marquez. I therefore consider the stock a BUY.

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

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