Tuesday, 24 April 2012

ATP Oil and Gas - Value or Value Trap?

Put simply, ATP Oil and Gas is wildly, grossly, shockingly undervalued...if it doesn't go bankrupt.  How high is the value?  How big is the "if"?
The Value
Most oil and gas producers trade at or near their net asset value (NAV) over time (NAV is typically defined as the dollar value of 2P reserves, plus cash and investments, minus long-term debt).  In ATP's case, however, there's a Grand Canyon-sized gulf between NAV and market value.  At year end 2011, ATP's 2P reserves were valued at $7.3 billion, NAV was about $4.4 billion, while market value is presently a mere $325 million or so.  NAV is around $85 per share, but the shares currently change hands for under $7.  What accounts for such a striking discrepancy?  In a word: debt.
Debt - The Big "If"
The company's debt load is crushing, and it's accompanied by large interest payments.  At year end 2011, overall debt was $2.935 billion, with net debt at $2.882 billion.  Interest expense for 2011 was $299 million.  The large amount of debt includes the confusing presence of royalties and overrides, which many investors detest.  Fortunately, the vast majority of the company's debt doesn't come due until 2015, and the obligations have no significant maintenance covenants.  The royalties and overrides pay out over time as the company produces.  Though expensive, they have the advantage of transferring some risk to third parties, and they don't mature in a large chunk as bonds do.  As long as ATP remains current on its interest payments, management has several years to resurrect the company and its stock.
From Here to 2015
At current production levels, the company stands no chance of retiring its debts, which would leave it with a range of bad options, including a massively dilutive equity financing or even bankruptcy.  But current levels of production are poised to jump sharply, and soon.  Indeed, there are several near-term catalysts, and the company's long-term future will become much clearer over the next year.
The Catalysts
1) Increased production from existing wells
At the recent IPAA conference, the CFO said that the company expects 4-7 mboe/day of incremental production in Q2 2012 from two workovers at existing wells.
2) Monetization of Octabuoy Platform
Management believes they will sign a deal in the next couple of quarters to monetize the Octabuoy platform, which is currently being constructed and is expected to be deployed in the North Sea in 2014.  The company has suggested that a deal could be worth several hundred million dollars.
3) New production at Clipper
Of the soon-to-come catalysts, new production at Clipper will have the biggest impact.  Better still, the odds of success on schedule are high: after all, the two wells are both drilled, completed and have been tested at 16.2 mboe/day (62% oil).  The company expects the wells, which will be tied into a third party production platform, to come online early in Q4 2012.
4) New production at Gomez
Drilling is predicted to begin on two wells at Gomez starting in late 2012, though they're largely first-half 2013 events.  Each well is estimated to produce 5 mboe/day.
If all of these efforts are successful, in about a year ATP will be a transformed company.  It would presumably be producing about 50-55 mboe/day.  Assuming the lower end of that range, and a $50 netback, the company could be earning $900 million in cash flow (pre-tax).  This figure is well above ATP's ongoing capex program, which will allow the company to begin paying down its heavy debt burden, and would "unlock" some of the interest payments and convert them to cash flow.  At minimum, the enhanced financial strength will likely allow ATP to refinance its debt, likely at a more palatable interest rate.
On surer footing, the company will be able to develop its properties at Entrada in 2013-14.  In 2014, the company will begin production at Cheviot in the North Sea.  Peak production at the Octobouy platform is expected to be 25 mboe/day of oil, plus 50 mmcf/day of gas.  If current exploration in Israel yields results, there will be tremendous potential in the future.  Though exploration brings high risks, especially for a company that usually only develops proven reserves, success could add significant reserves and production.  Indeed, the company believes it could double current reserves.  CFO Al Reese has said the company expects production to reach 80 000 boe/d by 2015.  Assuming a $50 netback, ATP would be generating $1.46 billion in CF per year (pre-tax) at that rate.   
If all goes according to plan, where could the company be by the end of 2015?  Assuming a modest 6x multiple on CF of $1.5 billion, ATP would command an enterprise value of $9 billion.  Assume further that the company still owes $1 billion in net debt, leaving it with a market value of $8 billion.  Assuming 64 million shares outstanding (up from 51 million today), the company's share price would trade at $125.  This is high, to be sure, but not outlandish.  After all, the other customary measure of value, NAV, currently values the company at $85-90/share, on the present 51 million share count.
The Smaller "If"s
For this "road map" to lead to a financially sound business and a high-priced stock, many things must go right; more accurately, many things that can go wrong must not.  Some of the "if"s that might go wrong include: hurricanes in the Gulf of Mexico, which can disrupt both drilling and existing production; the chance that another prominent spill occurs in the Gulf and cannot be swiftly contained; regulatory, legal and compliance challenges; the inevitable technical difficulties of drilling in the deepwater; swings in commodity prices; macroeconomic and financial turmoil etc. 
These potential pitfalls are not hypothetical, either: all of them have already affected the company, and in a big way.  In fact, these past few years the company has been living "Murphy's Law," where everything that can go wrong, does.  Still, the almost-in-the-bag catalysts, if realized, will buy time and flexibility to withstand the inevitable future challenges.  Offering further safety, the company could partially monetize its other two platforms (both have already been partially monetized), sell reserves, bring in partners etc.
To Invest or Not to Invest?
In my judgment, the odds that ATP files for bankruptcy by 2015 are less than 25%.  Being very conservative, however, let's assume that they're 1 in 2.  If the company executes, and enjoys a little good luck, as outlined above, the stock could realistically reach $125 over several years.  For safety's sake, assume a more modest $75, though.  Using those assumptions, and adjusting for risk, what's the stock worth?  A 50% chance of gaining $68.50 ($75 minus the current $6.50 share price) is worth $34.25, minus a 50% chance of losing the entire $6.50/share ($6.50 x .5=$3.25) = $31.  A nearly five-for-one return over several years would be welcome in anyone's portfolio.  But beware: ATP is an all-or-nothing stock, and there is a real chance that it could plummet all the way to zero.
Disclosure: At the time this article was published, the author was long ATPG stock and options

Sources: ATP 2011 10K, Corporate Presentations, available at www.atpog.com

There's ongoing commentary on ATP Oil and Gas: a first quarter 2012 update; the arrival of a new CEO; the abrupt resignation of the new CEO; exploration success in Israel; workover success at Telemark; renewed fears of bankruptcy; imminent bankruptcy

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