OPEN RANGE ENERGY CORP ONR
October 18, 2011 - 6:56pm EST by
mm202
2011 2012
Price: 9.75 EPS $0.38 $0.00
Shares Out. (in M): 71 P/E 25.5x 0.0x
Market Cap (in $M): 690 P/FCF 9.5x 0.0x
Net Debt (in $M): 44 EBIT 40 190
TEV ($): 735 TEV/EBIT 18.4x 3.9x

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Description

I'm recommending a long position in Open Range Energy.  Open Range is an undervalued energy company with strong growth prospects, a large dividend and a strong catalyst at the end of the month.  Open Range has two business units: exploration and well fracturing.  These two businesses will be separated at the end of the month.  NewCo will represent the exploration business and Poseiden Concepts the fracturing.  After the split you will own .882 shares in Poseidon for every 1 share you own in Open Range prior to October 31, 2011. Both Poseidon and Open Range are going to be classified as Corporations and the Poseidon Concepts Corp. shares will pay a $0.09 dividend for every 1 share you own in Poseidon. We have a 12 month target north of $15 for the combined companies.

 Poseidon Concepts

The Poseidon system was conceived and designed in-house initially for use in Open Range's multi-stage fracturing operations at Ansell/Sundance. The proprietary and patented Poseidon system is a modular, easily transportable and insulated single tank with a very high capacity of 18,000 bbls or 2,900 m3 specifically designed for the larger fracturing jobs common at today's unconventional oil and liquids-rich natural gas plays across North America.  The Poseidon system takes only 4 to 6 hours to setup and typically saves customers 50% over traditional fracturing fluid storage systems.  

After proprietary testing, the first revenue-generating rental came in June 2010, and the industry's acceptance has been dramatic. By year-end tank 2010, rentals had generated $5.3 million in revenue and approximately 25 systems had been manufactured in southern Alberta and deployed in western Canada. By the end of February 2011 that figure had climbed to 65 systems in western Canada and the United States, where they have a third-party manufacturing facility building systems for that market. Open Range recently introduced an enlarged model, the "Atlantis", with 41,000 bbls (6,500 m3) of fluid storage capacity, more than double the Poseidon model's capacity. 

Currently 67% of their fleet is deployed in the US with 33% in Canada. Despite only being in operation since mid-2010, Poseiden Concepts has already captured 5% of the North American market.  50% of their capacity is backlogged through 2012.  Originally, the company expected to generate $45M in EBITDA in 2011, that figure is now $55M.  The estimate is $130M in 2012. 

Psodein's goal is to provide investors with a growing energy services company that pays a strong dividend.  Initially Poseiden will pay a dividend of $.09 per share per month.  Taking the share split of .882 that gives a dividend yield of 12.3% for a company growing EBITDA north of 100%.  We expect the payout ratio to remain constant going forward.

 

   

2012 Forecast

EBITDA (millions)

 

$130

Capital expenditures (millions)

 

$25

Tank rental fleet at June 30, 2012

 

240

Exit net debt (millions)

 

$25

Debt-to-EBITDA ratio

 

0.2

Dividend per share (annual)

 

$1.08

Payout ratio

 

73%

Sustainability ratio

 

95%

Sustainability ratio calculated as dividends plus capex divided by cash flow.

 

 

 

 



We estimate that EBITDA will grow to $180M in 2013 with CapEx of $35.  The annual dividend per share will likely exceed $1.50 per share.  The 20 highest yielding Canadian companies average debt/EBITDA is 3.3x with an average yield of 12%.  Due to the low leverage ratio and high growth characteristics of Poseiden, we feel the stocks should yield closer to 7 to 8%.  Valuation would be $13.50 mid-2012 and growing to mid $18s in 2013 on a comparative yield basis.  The average yield in the Oilfield services sector is 2.3% and most would be hard pressed to show growth even close to what Poseiden is. 

NewCo

NewCo's plan is to operate and grow high-quality Deep Basin assets - Ansell/Sundance and Rough.  Initially the company will have $15 million in net debt and $75 million in bank lines.  2011 guidance calls for 6,200 boe/d exit rate and $25-$30 million funds from operations.  The company believes they can exit 2012 at 10,000 boe/d and estimate $60 million in funds from operations.

FD&A costs were only $8.67 per proved plus probable boe added in 2010. These competitive FD&A costs, along with strong operating netbacks, generated recycle ratios of 2.6 times and 1.3, respectively. Every year since commencing operations, Open Range has replaced its annual production by several times over, and the reserve-life-index of 15.3 years reflects long-life, low-decline production.  At $4 average price per mcf, NewCo generates a 70% IRR on their horizontal wells. 

The Company's proved plus probable reserves growth was solid at 21 percent year-over-year to 20.4 million boe at December 31, 2010, according to the independent reserve evaluation by GLJ Petroleum Consultants Ltd. (GLJ).  Year-end net asset value of $226.3 million or $3.62 per fully diluted share (proved plus probable, 10 percent discount, before tax).

Valuation

The highest yielding Canadian stocks trade at 7.2x EBITDA on average with Debt/EBITDA ratios of 4x.  Based on 2011 numbers for the same high yielding stocks, the average EV/EBITDA is 7.9x. Based on 2012 numbers it is 6.3x.  Applying the 6.3 multiple to 2012 numbers gives a valuation of $819M or $11.60 per share.  On a

Valuing NewCo at PV-10 of $226M or $3.62 per share is reasonable.  This would be less than 4 times 2012 cash flow.  The average Canadian gas producer trades at 4.1x cash flow.

Total value $15.20 + 12% dividend yield

As a side, insiders are large holders and have been adding on nearly a daily basis over the last couple of months.  Their Executive VP/Geologist made these trades just last month.

Sep 20/11 Sep 16/11 Costigan, Gerald - Acquisition 18,500 $9.450 
Sep 20/11 Sep 16/11 Costigan, Gerald  - Acquisition 13,300 $9.440 
Sep 20/11 Sep 16/11 Costigan, Gerald - Acquisition 7,500 $9.430 
Sep 20/11 Sep 16/11 Costigan, Gerald - Acquisition 200 $9.420 
Sep 20/11 Sep 16/11 Costigan, Gerald - Acquisition 2600 $9.410 
Sep 20/11 Sep 16/11 Costigan, Gerald - Acquisition 2,200 $9.400 
Sep 20/11 Sep 16/11 Costigan, Gerald - Acquisition 4,800 $9.390 
Sep 19/11 Sep 15/11 Costigan, Gerald - Acquisition 600 $9.290 
Sep 19/11 Sep 15/11 Costigan, Gerald - Acquisition 8,800 $9.280 
Sep 19/11 Sep 15/11 Costigan, Gerald - Acquisition 19,200 $9.270 

Risks

-          Regulation in the fracturing industry.  The Poseidon system lines and encloses their fracturing fluids making it safer for humans and wildlife above ground.  As a result there is no permit required to store the fluids unlike traditional fracturing.  We recognize that new regulations could be coming to the industry which could severely curtail North American fracturing operations as governments try to get a handle on risks to water aquifers.  While we see tougher regulations likely coming to the industry, we do not believe that state governments will be willing to jeopardize this important source of revenue especially as fracturing operations tend to run 10,000+ feet below the water aquifers. 


Catalyst

- October 31st split of Open Range into Poseidon and NewCo.  
- Implementation of the $.09 per month dividend at Poseiden.
- Market recognition that you are getting a high growth oil services company paying a 12.5% dividend yield and trading at 3.9x 2012 cash flow.  
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