|Shares Out. (in M):||0||P/E|
|Market Cap (in M):||1,323||P/FCF|
|Net Debt (in M):||0||EBIT||0||0|
ATPG has been repriced by the market over current production run rates. The market’s near term focus has created a tremendous value opportunity to purchase ATPG at less than 2x 2009 cash flow, or under 1.6x 2010 cash flow.
ATPG is an oil and gas development company operating in the Gulf of Mexico and North Sea. Both areas are politically stable for oil and gas operators, negating the risks associated with more far flung companies operating in West Africa or the Middle East. ATPG has a fairly unique business model of developing acquired assets with logged, probable, and proven reserves. This is not a company engaged in virgin exploration, but rather a company exploiting the assets that either don’t fit a former owner’s strategic plans, or a former owner’s lack of capital resources for the development process. As a result, ATPG has a 98% success rate in bringing its undeveloped properties to commercial production.
ATPG’s strategy is focused on a system of ‘hubs’, which bring synergies to the cost of exploiting surrounding leases. ATPG will have its own leases around such hubs, but can also process oil and gas for third parties.
Terminology: Mcf is 1000 cubic feet of gas. Mcfe is the 1000 barrel of oil equivalence to 1000 cubic feet of gas…multiply the number of barrels of oil times a factor of 6 to reach an Mcfe number. MMcfe is million cubic feet of gas equivalent. Bcfe is billion cubic feet of gas equivalent.
The present problem:
ATPG made a great deal of noise about achieving a daily rate of 300MMcfe/day of production by the end of 2007. Part of this was driven by expectations of a near 60MMcfe/day run rate for the W-1 Wenlock gas well located in the North Sea. ATPG announced the W-1 well was online as of December 6, 2007 and had tested in July at 58MMcfe/day, with production rates expected near or even above that level. On December 13, ATPG announced the Kilmar K-3 gas well was completed and tested at 45MMcfe/day. On December 20, ATPG announced it had reached and exceeded its company-wide goal of 300MMcfe/day production rate for yearend 2007. The market ended the year with ATPG stock priced at $50.54/share.
Through January 17, ATPG fell a little over 7% to $46.85, in line with overall market weakness. On January 18, ATPG announced that it had achieved record Q4 and full year 2007 production. It mentioned that 2008 YTD production rates were around 260MMcfe/day, and that Wenlock W-1 was running at around 40MMcfe/day due to an unknown issue. The tone was clearly indicating run rates versus peak production, and the market was not happy with this shift, as the prior emphasis on production ‘goals’ apparently led many to assume a peak level of production equated to sustained production. The market took ATPG down 11.5% on the 18th alone, and it has now settled 21% lower in one week at $36.87. On January 24, company officials in an investor presentation did not rule out a reservoir issue with the W-1 well, but believe a more likely problem is somewhere in the hole or subsea equipment. Time is needed to further evaluate the situation, and more information will likely be available by the end of February.
Yes, one can fault the company for pushing the 300MMcfe/day figure too hard, and one can remark on the market’s foolishness of dinging the company 21% on a 13% drop in daily production. But in its haste to punish ATPG over these near term issues, the market is ignoring the company’s understated assets and future production increases that WILL occur in the next couple of years.
ATPG shares are now priced below where they were two years ago when full year 2005 results were announced. Back then, the full year 2005 production was 19.9Bcfe of oil and gas. For 2007, production is 63.5Bcfe. In 2005, gas sold during the year averaged $7.46/Mcf, and oil sold during the year averaged $41.90/barrel. Converting the barrel price to a Mcf equivalent, shows the company averaged a realized price of $7.37/Mcfe on all production in 2005. By contrast, in 2007 the price realized per Mcfe is $9.30. In the two year interim, ATPG went from 31.13MM fully diluted shares to 37.27MM fully diluted shares. So, the share count is up 19%, but production is up 219%, realized revenue is up 303%, and the stock in two years is down 6.5%.
The Near Future:
So on current run rates ATPG is substantially cheaper than two years ago, but what is the future outlook? The market was enamored with the thought of advancing production rates year over year past 2010. The confusion appears to be over what numbers one should use for those rates. ‘Peak’ production rates became adopted as average rates and may have led to overestimating the future. Real world experience for ATPG includes the occasional hurricane which can temporarily curtail production, low prices in the summer for gas in Europe which can result in voluntary curtailment of North Sea gas production, suspensions of production while facilities are being upgraded, decrease in flow rates of existing wells as they age, delays in achieving production, and yes, the possibility a well won’t flow at an expected rate at a given point in time. So the future outlook needs to use a conservative view of average daily production rates.
With respect to price, there are the opposing forces of supply and demand, global economic expansion and higher energy use, or perhaps some recessionary downside in consumption. There is the threat of supply disruption in politically unstable Africa and the Middle East. I can’t predict absolute prices 2 years out, but in subjectively weighing these forces, it isn’t difficult to conclude that price is more likely to run in a $60-100 price for oil, than fall back to $40, and gas is more likely to run $7-10, than fall back to $5.
ATPG hedges the cash flow from future production with substantial forward sales, and a backstop of puts for a floor on some additional production. For 2008, based on a 250Mcfe/day average rate of production, or 91.5Bcfe for the year, ATPG has already sold 61.4Bcfe on forward contracts, at an average price of $10.03/Mcfe. That’s 67% of probable 2008 production (using guidance from the January 24 investor presentation) locked in at a price nearly 8% higher than that realized in 2007. So, one should expect an above average financial performance relative to the effect of conservative production volume increases.
I’ve spent some time on a verbal description of now versus two years ago and the coming year simply to show ATPG is cheap on previous valuations of the company. But an investor is buying the longer term future. That story has always been based on growing production volumes as the dominant theme. The market seems to think the recent news throws all of those expectations in to question. The market has it wrong.
Production volume step increases remain in the cards over the next several years. Al Reese, the CFO, and lead person in communicating the company’s story, strongly suggested an average daily production figure of 250Mcfe/day was appropriate for 2008 in an investor presenatation on January 24th. ATPG has many opportunities to build on that level of production going forward.
Assuming smaller projects (like those on the continental shelf and smaller hub areas) will offset production declines from existing wells, the key areas for future production step-ups are the Telemark and Canyon Express hubs in the Gulf of Mexico, and the Cheviot field in the North sea.
Telemark will first come on line in late in 2008 or more likely early 2009 (Things happen in complex projects.) The production facility, called a ‘MinDOC’, being installed in the northern part of this area will have an initial capacity of 25,000 barrels of oil/day and 50MMcf gas/day throughput. I assume 50% of this capacity will be used in 2009, for an increase of 36.5Bcfe production for 2009 from this source alone. Then by mid 2010, a second MinDOC will enable production from the southern portion of this hub in the AT63 lease block.
The timing on incremental production in the Canyon Express hub I’ve held off until 2010. ATPG plans to have a rig onsite by 2009, but could accelerate this into 2008. I assume no production increase until 2010.
The Cheviot Field in the North Sea will not likely come online until late 2010 or early 2011, but as this is the single largest reserve for the company it is out there as a further substantial step-up to production.
Throughout the next two years, there will be further well development in the Gulf shelf areas, as well as the Tors and Wenlock hubs in the North Sea. Third party production will added in 2009 at the Gomez hub in the Gulf, the company’s largest current production site.
So in modeling the next few years I use 91.5Bcfe of production in 2008 based on the numbers from the January 24 presentation, add only the 36.5Bcfe of production from Telemark to reach 128Bcfe in 2009 (351Mcfe/day), and ramp production for 2010 to 155Bcfe (425Mcfe/day) based on likely additions at Telemark, Canyon Express, and the North Sea during the year. These rates are 15% lower than daily rates I’ve seen in the past from a variety of sources. This reflects the reality of the business occurrences described earlier. I’ve not incorporated any upside for recent acquisitions during 2007 lease auctions, nor do I assign any value to the likely substantial increase of proved and probable reserves (based on acquisition and development activity in 2007) to be reported for year end 2007 on February 29th.
In modeling financial performance I use the hedged revenues reported on January 24 in the appendix of the investor presentation and make price assumptions for the unhedged production at a $9.00/Mcfe level. (That is 10% below 2008 hedged prices. Gas runs lower than $9.00, but this is equivalent to $54 oil. ATPG has already hedged some 2010 and 2011 oil over $68.) One of the underlying keys is EBITDA margin. As production volume and price have both increased, and volume will continue to increase, I expect EBITDA margin, which likely hit 73.8% for all of 2007, to move to the upper 70s in the years ahead. This is critical as essentially I’m modeling to determine cash flow. Management has indicated the strong possibility of placing some of the floating production infrastructure into an MLP or similar deal that would free up capital. I don’t explicitly utilize such an event, but I do believe it is reasonable to believe that along with cash generation from operations, this event would provide a cushion to suggest no additional debt is likely to be added. This stabilizes cash interest expense in the model. Cash taxes are a challenge. ATPG has NOLs both here and in Britain, and with the vagaries of oil industy taxation may continue to be a deferred tax payer in the US. I include some modest cash tax payments in 2009 and 2010.
The results of this approach shows ATPG generating EBITDA of $634MM, 934MM, and 1098MM in 2008-2010. Cash flow from operations (ex working capital changes) of $522MM, 718MM and 870MM is realized in 2008-2010. This is $13.99, $19.28, and $23.35 per fully diluted share in each of those years.
This is not a free cash flow story as development costs are substantial likely ranging from 600MM to 775MM in each of the three years. Still, ATPG should likely reach positive after tax free cash flow by 2010 on this very conservative set of assumptions. In the meantime, cash balances will fluctuate, but debt should be stable. I reiterate, the stock presently prices at less than 2.0x 2009 cash flow.
Stock Valuation and Return:
If one uses a cautious 4.5x EV/EBITDA valuation on the above generated EBITDA numbers, then EV in 2008-2010 will be $3076MM, $4189MM, and $4941MM respectively. Net debt varies, but clusters around 1300MM. The actual market caps produced from specific net debt levels each year are 1765MM, 2829MM, and 3686MM. On a fully diluted share base of 37.27MM, we get a share price of $47.37 for 2008, $75.90 for 2009, and $98.90 for 2010. The stock closed at $36.97 on January 25.
The market is focused on a near term ‘disappointment’ on production rates. But as is so often the case, this permits those with a long term view to profit handsomely when Mr. Market regains his senses.
Disclosure: the author may buy, sell, or hold securities in ATPG at any time.
|Subject||Does the management's constant|
|Entry||01/28/2008 10:32 AM|
|Does the management's constant pumping of the stock worry you?|
I like ATPG's assets and wrote it up a little more than a year ago. I did get a little tired of company issuing press releases every time they meet investors.
Also the latest equity issuance at $47 was a little negative with the CEO selling shares.
But Mr. Market has been downright nasty to ATPG.I have started buying again.
Great write up - hopefully ATPG management focuses on generating cash flow and stops raising capital debt/equity and focuses more on production than press releases on meeting investors.
|Subject||Edit to typos|
|Entry||01/28/2008 11:58 AM|
|Sometimes it is difficult to keep track of the 'M's in MMcfe.|
Please change Mcfe/day to MMcfe/day in:
para three, sentence two under 'The Near Future'..."For 2008, based on a 250MMcfe/day average rate of production..."
para two, sentence two under 'The Numbers'..."strongly suggested an average daily production figure of 250MMcfe/day was appropriate for 2008..."
para eight, sentence one under 'The Numbers'..."add only the 36.5Bcfe of production from Telemark to reach 128Bcfe in 2009 (351MMcfe/day), and ramp production for 2010 to 155Bcfe (425MMcfe/day)...."
My apologies for any inconvenience. The math is correct!
|Subject||Hi Bruno, I appreciated you|
|Entry||01/28/2008 12:37 PM|
I appreciated your write up a year ago.
What is the correct balance on public dcompany communications, LOL? I hold some businesses that I wish would get out and tell their story! They're languishing in part due to an information vacuum.
With respect to ATPG, I understand your comment...volume of releases does not correlate to effectiveness of communciation. I don't mind announcements of investor presentations as long as I can freely access them. That's a useful service. I think a fair criticism is that particularly over the last half of 2007, all the message was "we're going to get to 300MMcfe/day", with little tempering that maybe 300MMcfe/day was not a near term average run rate. That overbuilt expectations leading to the present stock price crunch. The actual story is good enough that it didn't need hype.
I've spoken to Al Reese several times and my impression is a straight shooter. He certainly seemed a little chastened in the January 24 presentation. He was back to a sentiment I'd heard before: "we do want to underpromise and we do want to overdeliver."
I was surprised by the equity offering as well, but it was significantly accretive to equity, and largely covers the cost (provides the opportunity) for the second MinDOC, with a 3-4x return on that specific investment. That seems pretty reasonable. [Please see slide 14 of the 1/24/08 presentation....it cites 10-15MMBbls of INCREMNTAL recovery with the second MinDOC.}
I can further understand your concern regarding Mr. Buhlman's commitment to provide shares in an overallotment. He committed up to 750K shares and actually sold 450K. However, in the context that he still owns 6,580,474 shares after the sale according to his 12/13/07 form 4, I can't really get too concerned. [His January 2, 2008 Form 4 shows an increase in his holding via restricted stock of 69,284 shares.) Management overall holds over 20% of the stock. I'm confident their interests are firmly aligned with mine as a shareholder.
Thanks for the compliment on the writeup.
|Entry||01/29/2008 05:56 PM|
|I struggle with valuing E&P companies on simple metrics like P/CF that don't take into account differences in reserve life. Gulf of Mexico companies with a 5-6 year reserve life trade at very low EV/EBITDA and P/CF multiples relative to longer-lived E&Ps. If you look at ATPG's peer group of shorter-lived offshore producers (EPL, SGY, WTI to name a few), they trade at 2.5-3.0x EBITDA (2008) and 1.5-2.8x P/CF. This compares to ATPG at 2.3x P/CF and 3.6x EV/EBITDA. However ATPG is significantly more levered which argues for a lower P/CF multiple. On EV/EBITDA, it trades at a meaningful premium to those other companies listed, perhaps reflecting 2009+ growth. |
I have always prefered NAV over P/CF measures b/c a DCF of the proved and probable reserves take into account reserve life.
Just a few thoughts.
|Subject||Re: Valuation Issues|
|Entry||01/29/2008 09:06 PM|
Thanks for the comments.
Some of my statistical sources have not yet caught up with the effects of the 227MM equity capital raise in November. Depending on whether your sources have caught up to this it could effect the equity portion of your D:E leverage numbers. The market cap component might also be understated in the EV calculation...though the cash 'missing' from the equity raise in the net debt piece is larger and in the opposite direction. So be careful of overstated EV and overstated D:E.
That said, ATPG probably still comes in at a small EV/EBITDA 'premium' to the three peers you mention. The October 18 Investor presentation contains slides (#28 & 30-32) that makes some comparisons to these specific peer companies. These slides show ATPG as the lowest full cyle cost producer, the highest realized product price recipient in H1 '07, and the highest full cycle cash margin for that period. In the latter category, ATPG is at 47%, while WTI is at 39%, SGY is at 35%, and EPL is at 33%. If ATPG is significantly more efficent as measured by margin, the premium may well be justified to its offshore brethren.
ATPG also presents slides (#19-21) comparing itself to companies in other basins: SWN, KWK, and GDP, in the Fayetteville Shale, Barnett Shale, and East Texas basins respectively. The comp here shows ATPG with a substantially higher 3 and 5 year CAGR for production, a sharply lower PE on 2008 First Call earnings, and a dramatically higher revenue per employee stat. These three also carry double digit trailing EV/EBITDA multiples.
I understand your concern about cross basin comps, but in both sets of peers ATPG is outperforming in absolute terms. It may not deserve onshore 'hot' basin multiples, but I don't believe it should be held to the limits of less efficient offshore peer multiples.
Growth is a valid reason for an expanded multiple. The Cheviot field is ATPG's largest reserve, and should be coming on line by or during 2011. That alone should provide substantial impact, let alone the additional opportunities that develop in the interim. So actual growth, and further growth potential are part of the ATPG story for the period 2008-2011.
On a TTM basis, since 2005, the price assigned ATPG on the day after quarterly earnings and production releases has never produced an EV/EBITDA multiple below 6.5x. At the $36.87 price at the time of this idea's posting, if my estimate for Q4 '07 results are correct, then ATPG is pricing at 5.8x EV/EBITDA based on 2007 EBITDA. Since my stock price prdictions are tied to TTM EBITDA, my use of a 4.5x multiple seems pretty reasonable.