Atlas America (NASDAQ: ATLS), an E&P company based in the Appalachian Basin, is trading at a significant discount to its sum-of-the-parts value with several short to mid-term positive catalysts on the horizon. ATLS was taken public by its parent company, Resource America (NASDAQ: REXI) on May 11, 2004 at $15.50 per share. REXI sold 2.6mm shares (~20% with greenshoe) in the IPO and REXI plans to spin-off the remaining ~80% to shareholders by the end of 2004. Additionally, the CEO and CFO of ATLS as well as the CEO of REXI have been buying shares in the open market (in addition to the shares they bought in the IPO) as recently as mid-August. My analysis of valuation is below.
Current Capital Structure and Market Valuation:
Equity Value = $23.50 price x 13.3mm shares = $313mm
Enterprise Value (EV) = $313mm equity value + $36mm total debt = $349mm
ATLS has two main pieces of value; 1) the E&P business, and 2) 22% of the limited partner (LP) units and 100% ownership of the general partner (GP) of Atlas Pipeline Partners (NYSE: APL), a publicly traded master limited partnership (MLP). For simplicity, I will start with #2, the ownership interests in APL.
ATLS owns 1.6mm APL LP units (22%), which trade at $38.35, for a total value of approximately $60mm.
According to management, the GP interest is expected to earn $7-8mm in cash flow in ’05. The GP is currently in the 50% splits, meaning all incremental distributed cash flow at APL gets split 50/50 between the LP’s and the GP. APL recently made a $140mm acquisition that significantly enhanced the cash flow to the GP, and they will continue to make similar acquisitions and grow the GP cash flow accordingly. There are several precedent transactions that value GP cash flows between 12-30x, including GTM/Goldman Sachs, WMB/Carlyle and more recently SUG/OKE. Public comps include XTXI and KMI who trade at approximately 22x and 15x forward cash flow respectively. Using a range of 12-15x cash flow, the GP is worth $84-120mm. My DCF approach, assuming a modest acquisition forecast, gets value for the GP in excess of $200mm. For now let’s assume that $100mm is a fair valuation for the GP interest.
Total ownership interests in APL = $60mm LP + $100mm GP = $160mm
Therefore, you are currently creating ATLS’s E&P business at an EV of $189mm ($349mm EV - $160mm in APL value), which is approximately 3.4x ‘05E EBITDA. An overview of the E&P business and valuation is below.
ATLS drills for gas in the Appalachian Basin with a business model that is very different than your standard E&P company and is crucial to understanding the story. Instead of raising money in the debt or equity markets to fund its drilling, ATLS raises money through a network of retail brokerage relationships that attract LP’s to invest in drilling partnerships. Through the economics of the partnerships, ATLS effectively gets a 35% economic interest in each partnership by putting up only 12% of the cash. The retail investors get an immediate tax deduction on 90% of their investment, so every $100 they invest only costs them $70 or so net upfront (a pretty juicy deal for both parties!). ATLS recently announced that they have raised $112mm from LP’s this year for drilling activity next year. This business structure creates 2 streams of cash flow for the E&P business; 1) gas production cash flow, and 2) cash flow from drilling reimbursements and management fees. I detail the cash flows and potential value below.
Gas production EBITDA in ‘04 will be approximately $40mm. Onshore E&P comparables trade between 4-7x ‘04E EBITDA, and ATLS’s business compares well given its long reserve life and 90%+ drilling success rate. Using 5x on the low end, the production cash flows are worth $200mm.
ATLS also earns a 13% margin on all drilling activity on behalf of the LP’s as well as a management fee of $350/well/month. The stability & growth of this portion of the business is based solely on their ability to raise capital through LP’s. ATLS has increased their fundraising from $51mm in ’02 to $112mm in ’04 as it has built a larger infrastructure. This business deserves a higher multiple than gas production, given the lack of commodity price exposure and the stability/growth of cash flow. One public comparable is PETD, the only other public company who finances their E&P business in the same fashion. If you value PETD’s oil & gas production EBITDA at 5x, their current EV implies a multiple of 15x+ for the drilling and management EBITDA. Also, publicly traded drilling companies trade above 10x ’05 EBITDA. Given these data points, I feel comfortable using 8x EBITDA for this business. At 8x approximately $15mm of EBITDA (including $5mm in g&a expense) for drilling and management, these streams are worth $120mm.
Recap of the Sum-of-the-Parts:
LP units + GP interest in APL = $160mm
Value of gas production EBITDA = $200mm
Value of drilling & management EBITDA = $120mm
TOTAL EV = $480mm
Debt = $36mm
TOTAL EQUITY VALUE = $444mm
Shares = 13.3mm
IMPLIED PRICE = $33.40
UPSIDE TO S-O-P VALUE= 42%
1) Spin-off – REXI will spin-off its 80% interest in ATLS by the end of 2004. Given its thin float, which is tightly held, and its lack of liquidity, the spin-off should attract more investors. Also, the company is planning an extensive road-show concurrent with the spin-off.
2) APL Acquisitions – APL is constantly looking to acquire additional midstream oil & gas assets, which enhance the value of the LP units that ATLS holds and more importantly the GP cash flow.
3) Share Buybacks – management from REXI has a history of buying back stock and I expect that once the spin-off is completed, ATLS will be a buyer of its stock if the market does not value it properly.
4) ATLS Acquisitions – ATLS is considering acquiring additional lands for drilling, so they can significantly increase the size of their drilling programs from the expected $100-110mm in ‘04.