|Shares Out. (in M):||0||P/E|
|Market Cap (in $M):||465||P/FCF|
|Net Debt (in $M):||0||EBIT||0||0|
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We wrote up Gulfport Energy (Ticker: GPOR) in December of 2006 when the stock was $13.50. Our conclusions on value were either 1. Correct – since the stock went above $24.00 just ten months later or, 2. Incorrect – since the stock now rests at $10.50. In fact, we think the recent dramatic move down is mostly a function of GPOR moving from more of a growth story to a value story. We believe that once again GPOR represents very compelling value with 50% to 100% upside in 2008.
The Quick Version
The Story Behind the Weakness
Management recently reined in production guidance for 2008 which has taken some growth element out of the stock at least for 2008. And, GPOR decided to allocate this year’s Capex differently than investors had originally assumed. This has caused investors to worry about the areas to which GPOR is allocating less capital. Are the returns there as good as everyone has always assumed? As well, a recent acquisition (Permian deal) made in late 2007 had the appearance of performing very poorly – there are reasons for this that are quite easy to understand but the optics were terrible. While investor concerns are somewhat justified we believe the valuation more than accounts for recent challenges.
Market Cap = $450mm ($10.50 x 42.9mm shares out)
Net Debt of ~$65mm
How to Value
Asset Valuation Method of Core
Multiples Valuation Method of Core
Value of Oil Sands Investment: GPOR owns 25% of Grizzly Oil Sands – a major lease holder in the Canadian oil sands. This holding will be described at length later. For the time being, it is worth noting that Grizzly is likely to sell a small portion of the company this year – probably ~10%. This will provide greater clarity to investors as to what GPOR’s 25% ownership is worth. The more conservative analysts suggest Grizzly is worth $5.00 per share to GPOR whereas others use as much as $9.00 per share. Comments from management would indicate somewhere in the middle of that range. Trading and transaction comparables (none of which are perfect) give a value of $4.00 at a minimum to $10.00 or higher. For purposes here we use $5 to $7 per share and will validate that value later in this write-up.
Value of GPOR’s Other Holdings: These other holdings (
Oil Sands (Grizzly) $5.00 $7.00
Other $0.00 $0.75
Total $16.30 $27.25
Premium to Current 55% 160%
Catalysts in 2008
Risks and Concerns
The information given above is the quick story and investment thesis. Below we provide more color/detail and attempt to validate our assumptions.
The Longer Version
Organized as Follows
At WCBB GPOR drilled 26 wells in 2007 and 27 in 2006. Analysts figured GPOR would drill roughly the same number of wells in 2008 as they had in previous years. But, management surprised the Street when they recently said the company will only drill 8 to 10 wells in WCBB in 2008 while reallocating capital to other areas. They claimed they’d had a few disappointments with some of the wells in 2007 and felt like they were pushing the drilling too hard. Management basically said that they believe they can drill a smaller number of really high quality wells per year but drilling too aggressively will lead to declining success rates and lower well quality. This really caught investors by surprise – some raised concerns whether GPOR had ‘picked all the low hanging fruit’ at WCBB and that in reality the well quality/returns were declining. Comments from management suggest the last four or five wells at WCBB have been quite solid.
While we share the concerns of other shareholders, we believe GPOR will ultimately drill and produce their existing PUD locations (albeit somewhat slower) and more locations as yet unbooked. We also believe they will drill, book-up, and produce locations which are not in the PUD inventory – they have been doing this successfully for some time (think of it as booking and shipping something that never makes it through backlog – in this case PUDs are the backlog). But, to be conservative at this point we only give them credit for the PUDs and currently producing reserves and not any additional unbooked locations. Having said that, our conversations with other coastal salt dome players suggest that there are probably many prospects that GPOR will ultimately exploit at WCBB and that are not in the current reserve report.
What has become clear since that time is that the wells in the water at Hackberry fell of as quickly as they came on. It was believed that once the gas was produced off the top, behind that would be oil (typical pattern at WCBB and other successful Hackberry wells). In fact, for the most part there was gas with little oil. This means that the water part of the play at Hackberry may be a lot less significant than thought – it also means that the production barge may have been unnecessary (installed cost was $9mm). GPOR drilled 9 wells in the water at Hackberry in 2007 and will only drill one in 2008.
Interestingly – the land wells at Hackberry have been better. 3 wells were drilled on land in 2007 (2 successfully) and 4 to 6 will be drilled on land in 2008. The land wells at Hackberry were pretty decent and the company hopes to repeat that success on the part of the structure that underlies the land. We should hear about two of the new land wells at Hackberry by mid-summer. Given these wells’ proximity offsetting other successful wells in the area and the fact they are drilling into sands known to be productive, there is a reasonable expectation of success. Evidence of this should restore faith that Hackberry will be a nice growth driver although not likely at the levels once hoped for. A total of 17 wells are in the permitting process with the State of
Despite the fact the Permian will by definition grow meaningfully in 2008 (if you Capex – it will grow) this asset gave investors a big scare around the time of the 4Q call. This was due to management’s admission that their Permian assets will produce roughly 550 barrels / day in the first quarter of 2008. This seems pretty terrible since when they bought this asset in late 2007 it was producing 800 barrels / day. Rightly so, this struck people as a meaningful decline and created concerns over management’s understanding of what they’d bought.
But, there was a good explanation for the decline although this was not fully communicated to the Street. The basic explanation is this: A well in the Permian is first drilled (~20 days), then fractured (pump a bunch of fluid into the formation to fracture it - ~14 days), then when production comes on you must first produce all the frac fluid mixed with some oil (another 90 days). Thus, it takes a while to get a well drilled and on line and at peak performance – typically at a level of about 100 barrels / day. This rate declines relatively quickly and eventually more or less flat-lines for a long period of time at roughly 30 barrels / day. These early declines mean that if you stop drilling wells for a period you’ll see some steep declines in the overall field. GPOR (really Windsor) did just this during the final month of the deal and for two months after (Nov, Dec, Jan). Not drilling and fracing new wells meant that the field showed meaningful declines. I imagine the decision seemed rational to management at the time. They wanted to buy the asset and at the same time slow things down for a short period to assess how they were going to Capex the field. This may have been a good decision operationally but it created terrible optics and made investors rather nervous.
We are still not sure if the Street really understands how this will change over the course of the year. GPOR is quickly ramping up drilling at Permian and they will move from one rig currently to three rigs by May. Exit production rates at Permian should be close to 1300 to 1400 Boepd up from a low of 525 Boepd in January. Expect 35 to 45 new wells in 2008.
In our view the stock price reaction is well overdone. The valuation has moved down to levels where GPOR is trading at a significant discount to the value of the known hydrocarbons in the ground (ignoring upside from other things like unbooked reserves and Grizzly).
Yes – the oil sands are dirty, hard to extract, require lots of infrastructure and energy, etc, etc, etc. But, seeing as this is one of the last great reserves people are now scrambling to get their hands on acreage. Recent oil sands buyers include not only large independents like Conoco Phillips and
Before these properties became as coveted little Grizzly Oil Sands was actively leasing up acreage. The company was funded 25% by GPOR and 75% by Wexford private equity funds (the relationship between these two parties will be explained more later). By now, Grizzly is the #2 holder of land among independent development stage oil sands companies – they hold over 500k acres.
They have good data from their 2006/2007 winter drilling campaign (2007/2008 winter data is not quite available yet). This data only accounts for about 1/3 of their acreage. But, in this acreage alone they have ~12bn barrels of Original Bitumen in Place (OBIP). (As measured by bitumen that is over 10 meters thick – this is the current cut-off for economic recoverability.) Current estimates suggest about a 1/3 recoverability factor which means that over a very long period of time Grizzly could extract 4bn barrels of bitumen.
I know, I know – that’s a lot of bitumen. Wait – what the heck is bitumen? If light sweet crude oil is a cup of coffee, bitumen is the wet grounds discarded at the bottom of the trash can. It takes a lot of energy, processing, and miles of transportation to turn bitumen into oil or other refined products but with much effort the coffee grounds can produce quality coffee.
So the question is what is the 4bn of recoverable bitumen worth and more specifically what is the 1bn net to GPOR worth? It is interesting to note that all of the value we were discussing earlier relating to GPOR’s
The M&A comps are a bit tricky to understand because what someone will pay per recoverable barrel of bitumen is dramatically influenced by where a company is in its development path. An independent with very little data and no current plans for a facility might get 15 cents per estimated recoverable barrel. A company with significant core samples and a permitted facility might receive closer to $1.00 per recoverable barrel. Given Grizzly’s progress they are moving off the low end of this range. Currently they are just completing their second year of core samples and are working to submit plans in 3Q 2008 to get a permit for a facility.
Toward the end of 2007 Grizzly apparently tried to sell a small piece of the company. They said they wanted to raise $150mm and this would account for 8% to 12% of the company (I believe it was the GPOR 3Q call that they discussed this). The middle of this range would suggest a value of $1.5bn or about 37.5 cents per recoverable barrel. This also foots with rumors of Grizzly targeting a valuation of 35 cents per recoverable barrel. They did not get a deal done by the end of 2007 and scrapped the deal until 2008. The rumor was that Wexford wanted to mark the investment to market so they could book (or at least talk about) the return to LPs – this may just be Street conjecture rather than fact. Once it was clear that a deal was not going to get done quickly, the company figured they would simply wait. This was primarily because they expect Grizzly to be more valuable in 2008 than late 2007 because they’ll have the results from the 2007/2008 winter drilling program. The real key is that the owners of Grizzly would like to raise money for the entity so it can self-finance Capex rather than GPOR and Wexford having to continually fund the program. In the near term Capex is not too meaningful but ultimately a production facility will cost around $325mm – at that point Grizzly will clearly need financing from outside equity.
Thus, while we are unsure on timing, all indications from GPOR are that Grizzly will sell some portion of itself in 2008. We use $0.20 per recoverable barrel at the low end of our valuation range and $0.40 for the upper end. Quite frankly we do not think that Grizzly would take less the $0.20 since Wexford and GPOR could always fund them for another year. And, although some people have suggested the price could go higher than $0.40 we do not think comps warrant a higher price at this time. $0.20 per recoverable implies at $800mm value for Grizzly - $200mm net to GPOR or $4.65 per share and $0.40 per recoverable implies $1.6bn for Grizzly – $400mm net to GPOR or $9.30 per share. (Remember – this valuation is based on core data from only 1/3 of Grizzly’s land)
As well, trading comps also validate this valuation. They suggest values of $0.15 per recoverable barrel of bitumen for the least developed independent oil sands players. Companies further along in their development path might fetch as much as $1.00 or more per recoverable barrel of bitumen. (The Grizzly presentation available on their website has trading and transaction comps at the end.)
Sanity Check: From the 10k we know that GPOR has only put ~$30mm into the Grizzly through 12/31/07. Doesn’t it seem like lunacy that in just a few years this could be worth ~25x this amount on the low end? These types of return are of course very rare but not all together unheard of. In fact, such returns are occasionally generated by E&P companies that are first to a new and significant play. Take for example the Barnett Shale – the earliest players there could lease land at just a few cents on the dollar of what land costs today. Another example is the case of Suncor – a Canadian oil sands player. According to a presentation given (I think by Wexford) at the 2007 John S. Herold Pacesetter conference Suncor is trading at 45x their contributed equity. These are just examples but suggest it is possible in this space for early movers to generate very high returns. The oil sands set up perfectly for this and the early players are benefiting dramatically from moving first and leasing up acreage. If you look at a map there is basically zero acreage left for lease – those who want in now have to buy their way in.
In practice, when valuing E&P companies PV-10 is often seen as a base case – simply the value of what is known to be in the ground. In some cases E&P stocks trade at meaningful multiples of their PV-10. This is often true in the case where a lot of future reserves are as yet unbooked. GPOR’s
There is probably no person with a better understanding of the value of GPOR’s underlying assets. It is worth noting that when GPOR raised money in Jan of 2007 Chuck bought 530k shares at $11.92. Then in May 2007 when GPOR needed money to expand their drilling programs Chuck bought 700k shares at $16.00 – that is roughly 50% higher than today and oil was in the mid-$60 range at the time. We suspect he has good sense of the underlying value of GPOR’s assets and we are encouraged that he was buying at meaningfully higher prices.
When the stock was in the $20s Chuck did file a registration statement for his shares. This made some investors nervous as they thought he might become a seller. At current prices we are not worried about this. If the share price returned to the mid $20s we suspect he might seek partial liquidity – really just a guess.
The exploratory risk is relatively low and all of the assets are based in
Charles Davidson (the guy who probably understands the value best) was a buyer at meaningfully higher prices.
Finally, there are decent catalysts for 2008 with a sale of a portion of Grizzly, summer news of Hackberry land wells, evidence that the Permian will be a growth driver once the field production catches up with current Capex, and finally additional core data out of Grizzly will begin to delineate the other 2/3 of their land.
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