Description

The market is pricing in a near-term bankruptcy filing by ATP Oil and Gas (ATPG).  The stock has fallen 40% in the last two days since Bloomberg reported that a group of bondholders was interviewing advisors.  The bonds in question are The ATPG 11.875% second lien notes of 2015, which currently trade at 38.5.  I believe these notes are attractive at this level for a number of reasons:

• The assets more than cover the notes at par, and even a draconian valuation suggests only a 25% loss of principal from this level
• I think the notes would trade up on news of a Chapter 11 filing
• If the company doesn’t file, the large coupon provides buyers at these levels with a current yield of 31% while they wait

The enterprise value through the notes, as currently priced, is roughly $2.1 billion dollars.  The 2011 year-end PV10 value of the proved reserves alone is $4.2 billion, but for a number of reasons that provides little comfort to the bondholders – and not without good reason.

REASONS FOR UNDERVALUATION:

ATP’s entire capital structure has always been “cheap” as compared to the PV10 value of its proved reserves.  The company’s business model is to acquire undeveloped offshore reserves that are non-core to larger companies and develop them.  The idea is that ATPG won’t have to spend money on risky exploration and can create a lot of value by bringing forward production from these discoveries.  There are a number of problems with this model - and this company - that have led to a perpetual “undervaluation” when compare to the value of the reserves.

• The majority of the PV10 value is in proved undeveloped reserves (PUDs).  This means there is a lot of operational risk and capital cost involved in actually bringing these reserves onto production at some point in the future
• The company operates primarily in the North Sea and in the deep water Gulf of Mexico, which adds another layer of operational risk as well as regulatory risk
• Management is either very unlucky or they are not good operators 
• The Chairman/CEO and founder, Paul Bulmahn owns 12% of the stock.  He has resisted any attempts to reduce leverage at the expense of diluting his ownership
• Bulmahn stepped down as CEO two months ago and Matt McCarroll from Dynamic took the job . . . for about a week before resigning after “failing to reach an employment agreement”

Bondholders are rightly concerned by these risks.  The biggest danger to bondholders may be that Bulmahn runs the company into the ground trying to maximize the value of his substantial shareholding (which is down 95%).  Rather than issue equity, the company has funded their substantial capital needs by selling net profits interests (NRIs), overriding royalty interests (ORRIs), pipelines and other infrastructure.  Not only do these obligations substantially muddy the capital structure, but they are senior to the 2015 notes.  Rather than continue to be subordinated by complex and expensive methods of financing, I think holders of these notes should welcome a Chapter 11 filing.  Despite my favorable view, the notes traded at an all-time low today. 

VALUATION:

The company’s assets consist of offshore oil and gas reserves as well as substantial infrastructure which is used to produce these reserves.  In addition to the proved and probable reserves in the Gulf of Mexico and North Sea, ATP has an exploration prospect in the Israeli deep water that may contain a trillion cubic feet of gas net to them.

 Reserves:

At year-end 2011, ATP had proved reserves with an SEC PV10 value of $4.2 billion (66% oil).  Adding probable reserves takes this number to $7.3 billion.  I break this down into three categories:

• Proved Developed Producing (PDP) reserves: As the name implies, these are reserves that are in production.  This is essentially an income stream that is easy to value and is subject only to operational hiccups.
• Proved Undeveloped (PUD) reserves: These are reserves that have been discovered, but someone needs to complete (and possibly drill additional) production wells and hook them up to a production facility (which may or may not be in place).  The PV10 value of these reserves is the present value of the project if you spent all the money to bring them onto production, everything goes roughly as planned, and you have a 10% cost of capital.
• Probably reserves: These are just like PUD reserves, except that they may not exist.

Obviously some haircut is needed for the PV10 value of the PUD and probable reserves.  The good people at JP Morgan have been nice enough to provide a PV10 at the current oil and gas strip for the proved reserves broken out by category.

At the current strip, the PV10 value is not what it once was due to falling oil prices.  The leverage to oil prices is one of the bigger risks to this investment and has a huge impact on the PV10 value.  The values above are as good of a snapshot as we are going to get, but they are by no means exact.  If you think oil is going to $70, stop reading now.

ATP also has substantial probable reserves that have real value.  They have sold the deep rights on a number of their leases for tens of millions of dollars and could likely sell probable reserves.  I value these at zero to be conservative, but I will note that management does have a decent track record of converting probable reserves to proven.  I also value their Israeli prospect at zero, but note that their first well encountered 62 feet of natural gas pay.  There is some optionality to these assets, but I don’t think either is worth betting on or paying for.

Infrastructure:

                ATP owns two large offshore production platforms in the Gulf of Mexico; the ATP Titan and the ATP Innovator.  They have  a third facility, the “Octabuoy” under construction in China with deployment in the North Sea planned for 2014.  They also have other minor infrastructure, pipelines, and an interest in 14 offshore platforms. From the 10k:

“The floating production facilities have longer useful lives than the underlying reserves and are capable of redeployment to new producing locations upon depletion of the reserves. Accordingly, they are expected eventually to be moved several times over their useful lives.”

                The Titan is encumbered by a secured loan facility, and the Innovator has been dropped down into a joint venture called ATP infrastructure partners (ATP-IP) or which ATP owns half and GE purchased the other half for $150 million.  The company has spent about $492 million on construction of the Octabuoy and will need to spend another $210 million to complete it (payment of the remainder is not due until 2013-2014).  I value these assets as follows:

• The ATP Titan and its related infrastructure have a net book value of $1,105.9 million as of year-end 2011.  I value this asset at 55% of net book, or $608 million.  There is a secured loan facility attached to this asset with the full amount of $318 million borrowed against it (which I deal with in the liabilities section) which I think is a very conservative low-case value
•  I value ATP’s 51% interest in ATP-IP (The ATP Innovator) at $150 million just like GE did
• I value the Octabuoy at half of the $492 million that has been spent thus far, as a rough approximation of what it could be sold for at this point

In my “bear case”, I haircut all of these assets a further 50%:      

                Valuing the Probable assets at zero in both cases, I think that the “base case” below is both reasonable and conservative.  I have a tough time imagining the assets could be worth less than my “bear case” numbers unless Brent Crude falls another $20 (and ATPG is decently hedged for the next twelve months).

Liabilities:

                ATP has a $362 million first lien term loan and another $312 million borrowed in the “ATP Titan Facility”.  The company also has $594 million in “Other Long-term Obligations”, as well as a working capital deficit and asset retirement obligations that all come before the Second Lien Notes.  The “Other” obligations are as follows:

• The net profits interests (NPIs) are basically debt backed by current oil and gas production.  ATP promises the investor (or vendor in some cases) a specified rate of return on a specified principal amount, to be paid out of a specified percentage of the production from certain PDP assets.  If the wells are shut-in or production otherwise stops, the juice keeps running, but the company has no obligation to make payment.  These are generally short term and $190 million was expected to be repaid in the next 12 months as of March 31
• The dollar-denominated overriding royalty interest (DDORRI) is essentially the same thing.  These are similar to credit card debt in both payment terms and the implicit interest rate.  $160 million of this was expected to be repaid in the next 12 months as of March 31
• The Gomez pipeline was sold for $74.5 million in 2009.  ATP agreed to continue to use the pipeline with set fees and monthly minimums.  The purchaser has the options to return the pipeline (and any related asset retirement obligation) to ATP at the end of the useful life.  This is considered a financing transaction due to these terms, but I believe this was really a sale and that a much smaller liability (for potential monthly minimums, above market rates and eventual retirement) is appropriate.  In my “base case” I discount this liability by $50 million
• The Vendor deferrals are pretty self-explanatory.  Some of their vendors allow them to delay payment until first production.
• The “current maturities” show up in the working capital deficit

I assume that of the $350 million of NPIs and DDORRIs expected to be paid by March 31, 2013, $100 million has already been paid.  Under this assumption, “other” obligations fall to $494 million.  In my base case this falls an additional $50 million for the Gomez pipeline:

                Below the Second Lien Notes in the capital structure, there is $35 million of convertible unsecured debt (added June 20^th from one investor), $311 million face value of 8% convertible preferred stock and then the common.

A NOTE ON THE PREFERRED SHARES:

Interestingly, my base case suggests a 34% recovery for the convertible preferreds.  The convertible preferreds (ATPGP) carry an 8% dividend payable quarterly in cash or stock. They have never missed a dividend payment, and the last 10Q stated that they expect to continue paying these dividends in cash.  The preffereds traded down to $6.00 per share today (they are $100 par value) and the next dividend is in two months.  I think this is too cheap:

• Bulmahn seems hell-bent on preventing dilution and will likely do anything in his power to prevent a Chapter 11 filing
• If he is successful in raising more funds through royalties or a sell-down of the infrastructure assets, I believe they will keep paying the preferred dividend
• The current yield is 133% at $6.00 per share, and just one or two quarterly dividends will substantially reduce the cost basis if purchased here
• There is clearly a valuation argument to be made for the Prefs if they do file, and this “nuisance” value would likely be worth the current price

It is worth noting that the preferred share issue has a face value of $311 million and now has a “market cap” of only $19 million, while the common stock has a market cap of $73 million.  The preferreds convert to 4.5 shares of stock – a conversion price of $1.33, which is lower than where the common shares closed today!

While you probably cannot borrow the stock, you can sell Jan 2013 $2.50 calls (these were $0.22 bid at the end of the day).  Doing this would recoup an additional $1.00 per preferred share without any risk.

                Additionally, for those investors who can purchase term loans, I believe the First Lien term loan is trading in the high 90s and carries an interest rate of 9%. One half of 1% of the principal must be paid down quarterly.  I think this is a very safe ~10% yield.

LIQUIDITY:

                The company essentially has no liquidity, which is why the bondholders have hired an advisor. The company will either need to creatively raise money, or they will not make it past the next interest payment on the notes at the end of November – if that long.  They have discussed selling down either the Octabuoy, the Cheviot field it is destined for, or both.  They should have material production coming online in October or November, but they will still need to raise money elsewhere. 

I beleive purchase of the preferred shares in tandem with the 2015 notes provides and interesting hedge against the company staving off Chapter 11 once again.

If anyone is more familiar with the name and has a thought on the assets or liabilies, let me know.  I have heard grumblings about the consultants who value their reserves, but I think that is priced in.  Apologies for any errors, it's getting a little late.

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