Turnkey E&P TKY CN
December 14, 2006 - 1:28pm EST by
2006 2007
Price: 5.05 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 105 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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Turnkey E&P (TKY CN -  CAD$5.05)                                                           12/14/2006
With cash and easily saleable assets of $97m, you are paying a stub value of only $8m for a growing collection of low risk oil & gas farm-ins that are being drilled using Casing Drilling in exchange for a working interest in situations where conventional drilling was not successful or economic, but the hydrocarbons are known to be in place. This collection of assets will grow in time and I think will be worth several hundred million dollars within three years.
24.145m shares at CAD$5.05, fx rate .864  (all that follows in USD unless specified)
Also has a USD tracker symbol TKYEF
$105m Market Cap, no debt
$52m Cash on hand at Sept 30, 2006
$45m in rig value (4 easily saleable rigs).
$8m EV
A unique history and business model:
Turnkey E&P was split out of Tesco (TEO CN) in December 2005 in order to be an E&P company focused on farm-ins in exchange for Casing Drilling services.  Tesco is a service company and did not want to be in competition with its E&P customers, so it made Turnkey into a free standing business.  Simultaneous with a December 2005 IPO, the company used $35m of the proceeds to purchase four drilling rigs from Tesco (which were appraised at $41m in Sept ’05 and prices have since soared… thus the $45m value is conservative), leaving the company with approximately $60m in cash post IPO. 
The company seeks exploitation situations with known hydrocarbons that for a variety of reasons were either undeveloped or abandoned after conventional drilling attempts failed. They are drilling these “turnkey”, hence the company name, meaning that they take over the drilling and provide the partner a well outfitted such that they only need to turn a valve and the oil or gas will flow into a tank.  They get paid by negotiating in advance a working interest percentage in whatever comes out of the well. 
Casing Drilling:
This drilling technology eliminates much of the geological risk from well collapses because it cases the well as it drills.  In conventional drilling, you bore into the ground and after reaching total depth you pull out your drill “string” of connected pipes and leave the hole exposed and self supporting until you can put casing, or cylindrical steel tube, into the well.  Conventional wells can collapse or have severe problems when exposed if there are sections with differing pressure, or very porous rock that could turn to gravel, or salt or chalk that dissolved as the water used to lubricate the drill went through that section.  Literally hundreds of thousands of wells have been abandoned over the past 50 years in the US alone due to well collapses.  In a great many of these situations, hydrocarbons are known to be there, but they were not accessible with conventional drilling.  Many operators sunk funds into drilling, suffered a collapse (or two, or three), and gave up not wanting to pour more funds “down the hole”.   Casing Drilling solves this problem of well collapses by putting the steel casing in place as the well gets drilled.  And, it is a proven and tested technology (which Tesco, who owns the technology, is going to make a fortune on by selling the required tools as it gets adopted by mainstream drillers.  Apache, Conoco, Encana, and others have been early adopters for their difficult to drill locations). 
In fact, the origination of Turnkey as a company came from a field that Apache had tried to drill twice with no success so they put it out for sale at $50m but received no bid… so they dropped the price to $30m and still had no bid.  Then Bob Tessari (Tesco’s Vice Chairman and Technology Chief) offered to try his Casing Drilling for a 25% farm-in… In the few years since, that field has proved up over $200m of reserves for Apache!  As a result of this experience, Tessari saw a business in the E&P side of Casing Drilling (rather than Tesco’s supply role) and launched Turnkey E&P, of which he is Chairman.
Many operators with collapsed wells have written them down to zero, so the opportunity to negotiate a large farm-in percentage is real… especially if you are willing to take the drilling risk.  Their current $52m in cash will allow them 30 plus situations to drill (assume $1.5m cost per well) which diversifies their drilling risk.  I’m certain they will turn cash flow positive and self funding by having several “strikes” where they can participate in the spoils long before getting through all that cash.  For the meantime, they operate lean and have some drilling assignments for the rigs that allow them to be cf breakeven while they seek out a portfolio of farm-ins.
In the past year, the company has negotiated its way into several interesting farm-ins detailed below.  During this time its cash balance diminished by only $5.8m.
Existing projects:
Exploitation Project, Louisiana, 100% working interest
6,000 acres (80% already contracted) for the Clear Creek formation.  80 acre spacing with 8 wells per section, and nine sections… thus over 70 wells potential.  Each well should produce 80-100 bls/day with a single frac from a zone with 1.7 to 2.0 meters in thickness and have 250,000 bls in place recoverable (at 17% recovery rate which is comparable with the history of the area).  But, there is multi-frac potential from several zone depths which could 2x or 3x the flow rates.  In addition there is the adjacent Huricane Creek formation which adds 30 to 40 drilling locations.   Success here makes this stock a home run.  Management views this as low risk drilling.  The first well will be drilled by year end 2006 and Turnkey is seeking additional adjacent acreage.
Fetter Project, Wyoming, 40% WI on first two wells, 15% WI thereafter
A rather difficult 12,498 ft well was successfully drilled and encountered “encouraging” flow rates during drilling.  Turnkey pays 60% of costs to the casing point and 40% thereafter for 40% of the first two wells, and has an option for $750k to farm-into the rest of the field (potentially 38 additional wells) at a 15% working interest.  Well completion and testing results are expected before year end, and the risk is what the permeability will be at 12k feet.  The partner, American Oil & Gas (AEZ), has seen its stock double since March on Fetter (and other fields), yet Turnkey with its interest in this same field remains largely unknown. 
Tumlinson Project, Texas, 10% WI
280 acres potential.  One well drilled to 13,202 ft in August 2006.  Electrical logs confirm 150 feet of pay over 12 zones.  Fracs need to work and show decent flow rates for a hit here.  Also planning to test a deeper zone.
Big Wells Project, Texas, 13.22% WI
2,530 acres with potential for 6 wells at 250 bls/day per well in a chalk zone drilling horizontal extensions.  Management says the first well was drilled with “good” results, similar to existing commercial wells in the field.  We await a more detailed announcement. 
Lack of projections:
It is too early yet to have a read on cash flow or proved reserves.  This is a big part of the reason why Turnkey is currently unloved and undiscovered.  However, with so many projects already in work and $52m to spend to drill their way into additional farm-in situations, there is going to be a robust portfolio that is not priced in the stock currently.  Even if you figure that eventually the cash will be spent and add $52m back into the EV, that $60m pales in comparison to what any reasonable portfolio of 30+ situations would represent.
Hardly anybody is competing for farm-in opportunities of this type except private company Drillmar Energy, out of Houston, TX.  The landscape of scavenger plays to go after is vastly larger than both Turnkey & Drillmar can handle.  If either of them shows success, other players will likely enter the space.  However, only Turnkey has its roots inside of Tesco and shares the same Chairman (who put founding stock of Turnkey into a trust for his three children via an entity called Tesvesco).  Turnkey’s employees are former Tesco employees (pre IPO), and Tesco owns 1m warrants that strike at $6 per share exercisable until Dec 16, 2007.  Drillmar is also a Tesco customer, but is fully arms-length away.   Preferential treatment on equipment shortages, referrals from Tesco, etc… all will go toward Turnkey.
Drilling risk exists beyond the geological problems they seek to solve with casing drilling.  There could be equipment problems, or severe weather, or the drilling could go smoothly but then hydrocarbons could be situated in rock that lacks enough permeability to allow economical flow rates.  Some misses could happen, but with $52m left to run a diversified program of farm-ins they should be able to score a few hits… which is all they need… In conversation, management privately guessed that they think the hit rate will be north of 85% since they are only focusing on known hydrocarbon producing locations where they see the types of geological formations (such as salt domes and underbalanced pressure) for which Casing Drilling is ideally suited.
Could operators go around them and contract Tesco to drill their deposit directly?  Ultimately yes, but for now Turnkey and Tesco have a Preferred Supplier Agreement which says that Turnkey will purchase Tesco’s services & equipment at market price, and Tesco won’t compete in North America for 18 months after the IPO.  Beyond then, Tesco could compete, but likely will not because if they wanted to be in E&P they would not have separated Turnkey.  Tesco will have the Casing Drilling contracting business from the majors because well funded players would not accept a farm-in partner when they can afford to pay their own way on drilling.  However, thousands of small to medium sized companies are amenable to farm-ins/JVs because they are either cash strapped or shell-shocked from prior conventional drilling failures and looking to diversify their risk. If your well is collapsed and the drilling funds are gone, why not let Turnkey take a shot at reviving your reservoir at their own cost for a 50% farm-in… half of what is currently nothing could be something!  See www.turnkeyep.com.


- First well in LA project drilled by year end

- Flow rate results on first Fetter project well by year end

- Thinly traded, but possibly an opportunity to catch some capitulating tax-loss seller by year end.
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