ATP Oil and Gas: Unbelievably Inexpensive, If You Believe the Company's Story
by: George Fisher June 27, 2011
Two weeks ago,
I penned a commentary outling why ATP Oil and Gas (
ATPG) was a “screaming buy”. Since then, share prices have fallen 9.8%, a pretty dramatic drop. At its current $14.67 per share price, I went to the thesaurus to find a better adjective. One step up from “screaming” could be “ear-piercing”, or “shrill”, or “thunderous”. My choice is “Unbelievably inexpensive - if you believe the company's story”.
Not much has changed from the production information outlined in the previous article. However, their financial picture has changed a bit, and based on your bias, is either to the betterment of shareholders or to their detriment. Management has stated on previous occasions this year that liquidity was such that no further equity raises were foreseen. 2011 operating cash flow (ocf) and cash in the bank totaling $300 million, augmented by $200 million of NPI rollovers, was sufficient to meet 2011 capital expenditure budgets.
Then, last week, management announced a $172.5 million offering of an 8% convertible preferred stock with a $100 par, convertible at $22.00 (ATPGP.PK $91). At the same time, the company announced a covered call strategy whereby they positioned call options at $27.50 for both this issue and the previous convertible preferred issue of Sept 09. These calls cover approximately 14.1 million shares. The new preferred was sold at $91 per share, and after fees and the call spread strategy costs netted the company $123.5 million. The company also recently announced the closing of new NPI contracts.
Again, based on your bias, this equity raise is either a good thing or just another example of management not giving complete / proper guidance and piling on the debt.
It seems to me that raising $123 million on the sale of 6.9 million shares equals net proceeds of $17.83/share inclusive of the call spread cost of a $1.88/share to implement, and would represent a 13% dilution. However, by instituting the call spread, both of the preferred issues won’t be dilutive to existing shareholders until the common rises to $27.50 – quite a ways off from here. Dividends on the new preferred shares will cost the company $13.6 million a year.
It also seems to me that the company raised equity at about the market price just before the announcement, net to the company, without any dilution until the common rises by 84%. I would think this could be considered a pretty fair deal for current shareholders in a cash-strapped company.
The reasons for the need and timing of the equity raise may be just as complicated as the company's financial structure. Management has been plagued by the over-promise and under-deliver syndrome for the past few years. Some of the under-performance has been caused by internal issues, but much can be placed at the footsteps of the 09 credit crisis and the government shutdown of their lifeline – the Gulf of Mexico. Be that as it may, investors-- both large and small, novice and professionals-- don’t enjoy being told one forecast only to have future reality be different.
I believe the reason and timing is due to the opportunity presented itself to do the deal as outlined above. As discussed in previous articles, production needs to be in the 40 mboe/d range to fund cap ex and NPI payments from internally generated cash flow. Current production is at 26 to 29 mboe/d, and will average around 26 mboe/d for the soon to be closing 2nd quarter. The stated cap ex budget includes funding from cash and internal cash flow of $300 million. At 26 mboe/d, cash flow for the 2nd quarter should be about the same as the 1st quarter, or about $83m, less about $50m in average quarterly NPI payments. Cash at the end of the 1st quarter was $182M. Combining cash in the bank, anticipated net operating cash flow for the 2nd quarter, and the recent equity raise, ATP has covered their end of cap ex funding for the balance of the year.
As the hurricane season is approaching, drilling and production in the Gulf becomes a bit riskier. The ability to have the company’s portion of cap ex in the bank is a large cushion, especially with the critical importance of continued short-term growth in production. This added production is significant to the prosperity of the company and the ability to maintain their drilling program at this juncture with a bit of insurance that operating cash flow is not needed to complete the 2011 cap ex program seems like a prudent move. If ocf exceeds projections then the need for roll-overs of NPIs becomes less, or the excess cash can be used for 2012 cap ex.
The recently announced NPI contracts should come as no surprise to investors, as management has been clear and transparent concerning this cap ex funding source. If the average 2011 NPI contract is for $25m to $50m, investors should expect four to six such announcements over the course of the year.
With the current drilling and completion work at Telemark well #4 still progressing with an anticipated on-line date of mid-Aug or sooner, short-term production increases will obviously be stair stepped. Production will be in the 26 to 29 mboe/d range until the next well comes on-line. Additional drilling at the Titan platform will hopefully follow close behind and, if the permits are issued before mid-Aug, the next well at Telemark #3 should come on-line mid to late 4th quarter.
These two wells should bring production up to the high 30s and low 40s mboe/d – right at the company’s threshold of long-term survivability. This is similar to the goal laid out in previous articles. The only change has been that we are now closer to the timeframe for well completion and new permits.
Due to the lack of investor confidence in management’s ability to achieve this goal, it seems only increases in reported cash flow will move the share price. This lack of confidence is evident by the 18 million share short position, or 32% of total float, and low share price. Increases in cash flow will only come with higher production levels, and increases in share price will only come with higher ocf.
The next jump in cash flow will come with the Telemark #4 well completion mid-Aug. The average Street ocf estimates call for each 1 mboe/d to generate
.32 per share in operating cash flow, or about $16.6 million. If well #4 produces 7 mboe/d, it will add $2.21/share a year to ocf or about $117 million. If it produces the same as a similar well at the same drilling site, or 11 mboe/d, additional cash flow could be $3.50/shr or about $180 million. Duplicate these numbers for Telemark #3 when the permit arrives, and overall production increases again in December. Combined, these next two wells could be substantial.
Production levels in the 40 mboe/d range should generate about $12.80 in cash flow. At a discounted 2 to 2.5 times ocf, share prices could be in the $26 to $32 range.
But the Street doesn’t seem to credit the stock price until this cash hits the bank. So investors will need patience and the belief that these production goals are obtainable. This is the heart of the current risk and the reward of ATP. It seems over the past several years, nirvana has always been just around the corner. For some, investor patience is understandingly wearing thin. For others, their sights are set on what the company could look like in only 6 months.
The current share weakness is due to the recent preferred issue, the company’s high leverage, currently flat production levels, a lack of credibility for management’s forecasts, and sporadic performance updates. The only action plan that will resolve these issues is one that reaches positive operational free cash flow – and the cash is in the bank and on the balance sheet.
There is plenty of downside risk to offset the potential upside of investing in the company. It is intriguing that small-cap energy companies are historically either way undervalued or substantially overvalued with little ground in between. This is especially true of even riskier deepwater players.
ATP is currently way undervalued from where it will be if the next 180 days pan out according to management's action plan. However, until there is positive production developments, share price weakness should be expected. It may drop some more – undervalued stocks can always get more undervalued, just as the opposite is true as well. But as a value buyer with a longer than six-month horizon, and as a willing buyer of their leveraged financial risk, along with their leveraged exposure to the strong oil market and large potential production gains, I would rate ATP as “Unbelievably inexpensive - if you believe their story.”
Previous articles on ATP can be found
here and
here.
As always, investors should conduct their own due diligence, should develop their own understanding of these potential opportunities, and should determine how it may fit their current financial situation.
Disclosure: I am long ATPG.
Additional disclosure: Author has been a shareholder since 2007.