|Shares Out. (in M):||50||P/E||0.0x||0.0x|
|Market Cap (in $M):||10||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||6||EBIT||0||0|
Gale Force Petroleum (GFP CN)
Gale Force Petroleum is a Canadian-traded roll up of conventional oil properties in the US, primarily in East Texas, Oklahoma and West Virginia. It is off the radar, rapidly growing, trades at a discount to its proved reserve value and to its peers, and is opportunistically executing new deals to continue its production and value growth.
GFP has approximately 50 mm shares outstanding. At 20 cents per share, its market cap is $10 mm. It has net debt of about $6 mm, for an enterprise value of $16 mm. As of the end of 2011, it had over 275 boepd of production, 90% of which was oil. GFP is targeting 350+ boepd of production by the end of June 2012 from the properties it owned as of the end of 2011.
Why do I care about a $10 mm company? It is very rare to find a small publicly traded oil company that is:
Trading at a discount to its PV-10 value – GFP’s last reserve report indicated a proved reserve value of approximately $40 mm, implying a $0.68 stock value (net of debt), 240% higher than the current price of $0.20. This reserve report includes neither the impact of recently increased production nor the Marcellus deal – proved reserves could increase by $5 mm from those factors, implying a potential stock value of $0.78 (net of debt), almost 290% higher than the current price!
This reserve report was prepared by Harper & Associates, which has provided reserve engineering to Ultra Petroleum and Range Resources among other clients, and was filed with Canadian securities regulators as a 51-101 report. It seems reasonable to expect the reserves to increase markedly in the next reserve report as this report was from June 2011 and production has increased substantially since then. Also,
Trading at a discount to its private market asset comps – GFP’s current 275 boepd has a private market value. In the areas its fields are in, production with low decline rates and high % oil to gas ratios currently sell for over $70,000 per flowing barrel. This implies an over $19 mm transaction value for the year end 2011 production, or an over 30% premium (net of debt) to the current $0.20 stock price. Additionally, with minimal capex Gale Force should be producing between 350 boepd and 400 boepd by the end of June, which implies an over $24 mm transaction value, or an 85% premium to the current stock price. This doesn’t include the value of the Marcellus deal or of future deals Gale Force may enter into.
Free cash flow positive – Unlike most small oil companies, Gale Force generates significant free cash flow beyond its maintenance capex and overhead costs. I estimate the current run rate free cash flow at over $1.5 mm per year. This implies a low trailing free cash flow multiple, particularly when considering the rapid growth rate. Another way to look at this is that GFP could pay a $0.03 per share dividend with 100% cash flow coverage, just from year end production levels, a 15% yield relative to a $0.20 stock price.
Low decline rate – Many oil companies have production bases that are rapidly declining, in some cases at 40% or more per year. In order to grow, they first need to replace that production. Gale Force doesn’t have that problem – management estimates that the properties that constituted the production base at the end of 2011 have less than a 5% decline rate. This means that incremental production at Gale Force almost immediately goes towards production growth rather than replacing depleted production; this will allow Gale Force to grow more rapidly and less capital intensively than its peers.
Well managed – The comparatively high free cash flow levels and concomitant low overhead and maintenance capex is indicative of bottom-line focused management. This is rare in the growth-at-any-price oil and gas exploration and production industry, especially among smaller companies. It helps provide some comfort regarding downside protection – management is unlikely to squander cash flow from the properties, which makes asset-level valuation metrics more relevant and reliable.
Also, management has so far earned excellent returns on deals, and has shown discipline in only entering into deals that offer both exceptional returns and comparatively few risks. The strategy is inherently lower risk, in that it is focused on acquiring proved reserves for low prices, not engaging in wildcat exploration or the recent fashionable approach of land speculation in unconventional or shale plays.
Growing rapidly – on a per share, debt adjusted basis, GFP is growing faster than almost all of its peers. This past summer it was producing around 150 boepd, and it is on track to be producing 350 boepd this summer, or a 233% growth rate. Obviously it is impossible to continue to grow indefinitely at this rate, but with the recently announced Marcellus deal having closed and with other deals in the pipeline, it is possible Gale Force can continue to grow more rapidly than its peers, building off its low-decline production base and financing a substantial portion of its growth with free cash flow and low cost bank debt.
Has a hedging program – Gale Force currently holds some puts on oil production in 2012 and has indicated that it intends to hedge out the majority of its “PDP” (proved developed producing) production for the next two years, locking in a high oil price and reducing risk to cash flows in case oil prices fall. Hedging is potentially a value-added strategy because Gale Force could potentially monetize hedges at a sufficiently low oil price and use the cash to buy back low-priced stock or acquire distressed assets, creating more value for shareholders.
Recent deal – ongoing value creation
On January 31st, Gale Force announced the financing of a liquids-rich Marcellus shale project. Gale Force purchased a 0.255% working interest in several producing wells, producing approximately 20 boepd (50% liquids) net to GFP. In addition, GFP will have a 1.125% working interest in 50-100 additional wells drilled on the 10,000 gross acre lease. 50% of GFP’s working interest is reversionary to the seller after a 25% IRR is achieved.
This Marcellus deal is indicative of the types of deals Gale Force has executed and highlights the company’s ongoing value creation across several dimensions.
Low cost of entry - Gale Force paid nothing upfront for very valuable leases – in the area, leases have recently sold for in excess of $10,000 per acre. And the reversionary interest is substantially better than industry standard – a 25% IRR hurdle before a 50% split is much better than the typical “1/3 for 1/4” deal and joint venture deals.
Cost advantaged operations - The operator of the property is a multi-billion dollar public company that was able to leverage its large Gulf of Mexico oil service contracts to secure discounted drilling and completion services, leading to a $6 million well cost, versus $7 million for nearby operators.
Excellent economics – The liquids rich Marcellus shale in Wetzel County, West Virginia, is one of the most highly economic new fields in the country, despite its high gas content and low current natural gas prices. Wells drilled in the area exceed a 30% IRR at $3 gas and $90 oil. Obviously there is substantial upside potential in the case of a natural gas price recovery. Also, early production numbers are indicating the first wells may be twice as good as expected, which should flow-through to even higher than expected well economics, returns and production growth for Gale Force.
Risks – Obviously GFP is a risky investment. GFP is an illiquid stock, its growth strategy is dependent on capital markets, and its revenue, cash flows and intrinsic value could be negatively impacted by lower commodity prices, particularly oil, which could be somewhat mitigated through an active hedging program. There is also execution risk, although that is somewhat mitigated by an excellent execution track record to date.
There is also the risk the company stays below the radar, the equity stays cheap, and the company isn’t able to use the equity as currency for acquisitions. This came up in conversations with the CEO – I think in that case the company would likely sell off assets and either use the proceeds for acquisitions or distribute them to shareholders. Also, being off the radar is largely a function of size, and the company is rapidly growing into the “radar zone”.
Additional questions and answers – color from the CEO
I circulated the above thesis among a small circle of investment manager and investment banker friends. The following few questions came up, which I passed along to the CEO of Gale Force and to which he responded. Please find the questions and his responses below. Obviously, like the rest of this thesis, I believe this is not material non-public information, but rather color around information already found in public filings, highlighting certain aspects and risk factors of Gale Force.
1) Are these low cost / mature well opportunities recurring or “one-off” deals?
Initially, GFP’s business plan was written for a 18-24 month opportunity to access undervalued/underdeveloped properties as a result of (a) the financial crisis 2008-09 that resulted in numerous over-leveraged companies and general lack of access to capital causing property prices to decline significantly, and (b) higher oil prices making fields in mature basins economic again (i.e. $20 netbacks at $60 oil), and (c) new technologies allowing for cost-effective recovery of additional reserves. We are in a secular bear-market, and we believe the opportunities are in place for 5 years, as far as the eye can see.
2) How concentrated is the production at the wells? (I.e. do you get 90bbl from one well and 10bbl from 9, or is it spread out)
Spread out. Largest well currently does 25 bbls per day plus some gas. New wells coming on-stream in the next 12 months are expected to do 50 bbls per day plus gas.
3) How is the decline rate for these wells 5% while market is 40%? Is this sustainable?
Decline rate used by GFP’s third-party engineers is 8%.
4) In their presentation they have ~$50mm of prospective acquisition opportunities, which one project consisting of the bulk of that. Where does this $50mm come from?
GFP has dozens of acquisition opportunities, is currently in various stages of evaluation/negotiation on a dozen properties. The presentation only includes the next 2 likely to be purchased by the company.
Disclaimer: The views expressed are those of the author and do not necessarily represent the views of any other person. The information herein is obtained from public sources believed to be accurate, reliable and current as of the date of writing. The author will not undertake to supplement, update or revise such information at a later date. The author was not compensated to prepare this report but may have other commercial relationships with Gale Force or other parties mentioned. The author may hold a position in the securities discussed, and may add to or sell this position at any time.
GFP is off the radar, rapidly growing, trades at a discount to its proved reserve value and to its peers, and is opportunistically executing new deals to continue its production and value growth.
|Subject||RE: RE: RE: RE: RE: deal flow|
|Entry||02/10/2012 02:59 AM|
A friend asked me tonight why they're cheap, and I'm not sure I gave a great answer in the writeup.
Gale Force did an equity offer early in 2011, and then basically showed no progress to the market, other than one small acquisition, until recently. By the time they told the market they'd doubled production in 7 months, no one was paying attention anymore. The stock was totally illiquid, the company had 0 coverage (still does) and micro caps had gone way out of favor. Its a great investing situation - a high growth, very profitable company at a deep value stock valuation.
Gale Force will have to keep showing growth to cycle in growth investors and a growth multiple, but they've proven their ability to do so and have good asset value backstopping the current price - in the current market for 320+ boepd fields that are 90% oil, I estimate a $25mm+ sale value, which increases every day as production continues to grow. (vs a $17mm EV, of which $6mm is debt)
|Subject||RE: Recent deal and financing|
|Entry||04/22/2012 11:07 AM|
Yes - they issued shares at a big discount to buy a property at a much bigger discount. Texas Reef is conservatively worth $10 million before drilling results and could be worth $50 million+ if development drilling is successful.
It was a distressed acquisition - they bought it from 14 different parties who were in the process of suing each other. Yes, it is hard to find attractively priced oil deals in the current market, but this is one of the most attractive deals I've seen in the space - they should be at 150 barrels of oil per day just from the one property in a few months, with only $250k in capex. And they think they can get to 500 barrels of oil per day just from the one property by the end of the year with maybe $7 million in capex (which they now have enough dry powder to accomplish, between the recent equity raise and a recent increase in their revolving credit facility from $6 million to $10 million).
The CEO was recently at the IPAA conference. He didn't present, but we had a dinner with a few fund managers and some sell side guys. One interesting discussion at the dinner was around royalty trusts. If you look at SDT, PER and others, they trade for a valuation in excess of $250,000 per flowing boe. Gale Force should be producing in excess of 800 boepd by the end of the year, and could be at 1000 boepd by the end of the year. They are serious about converting that production into a royalty trust, and could achieve a significant valuation uplift if they do so. And yes, a $250 million trust is sufficiently large to get done at high valuation metrics. And it would obviously lead to a huge valuation uplift. If successful, Gale Force could be valued at 10x its current valuation.
|Subject||RE: RE: RE: RE: Recent deal and financing|
|Entry||07/13/2012 01:11 AM|
Sugar, any recent thoughts? Any idea what is driving the sub .30 sellers?
|Subject||RE: RE: RE: RE: RE: RE: Recent deal and financing|
|Entry||07/13/2012 09:33 AM|
Any idea what time frame you would expect results?
|Subject||Sugar, what is the news?|
|Entry||07/31/2012 01:14 AM|
Any updated datapoints?
|Subject||Sugar, any updates?|
|Entry||10/04/2012 09:23 AM|
I know they are issuing units for the latest deal (stock and warrants for .30), but if the free cash flow is really there, why continue to dilute? ANy color you can provide would be much appreciated.
|Entry||11/01/2012 02:33 PM|
Tyler, here's an update - Gale Force just released its updated financials and an updated NI 53-101 (reserve report). It almost doubled its proved reserves, and now as a proved pv-10 of over $60 million. The stock has been left for dead while the company has continued to grow rapidly.
|Subject||RE: reserves doubled|
|Entry||11/01/2012 03:00 PM|
Thank you. Any thoughts on the latest deal or why it has been so weak? You were pounding the table on this stock and then went completely silent. Any change at all to your thesis?
|Subject||RE: RE: reserves doubled|
|Entry||11/01/2012 03:26 PM|
I got restricted in the stock until today, when they announced they're working on divesting some non-core assets (its in their md&a and I think also in the reserve report). The business plan is working, albeit more slowly than expected. The nice thing about growing by 300% a year is if you only grow half as fast, its still incredible.
|Subject||RE: RE: Discount to PV10.|
|Entry||11/05/2012 11:07 AM|
Thank you Sugar.
|Entry||05/22/2013 03:27 PM|
Sugar, what do you make of this? I get that Iroquois is frustrated, but the company's response is pretty reasonable. This seems insanely cheap.