A Tale of Three Reviewed IPO’s

This Year I Reviewed Three IPOs Of Note. What follows is a "That Was Then, Since Then, and So What Now?" look at the three.

Summary and Links To The Original Pieces

• Pinnacle Gas Resources Inc (PINN)

• Back in mid May, a month before this one came public, I said the valuation was too high (that's code for Avoid like the Plague) and that I would wait and watch.
• Here's the original piece carried by SeekingAlpha.

• Continental Resources Inc (CLR)

• In May I said this was good on all fronts, from production growth to falling LOE, to valuation. I took a position two days after the May IPO.
• The original write up was contained at the bottom of the May 17th post.

• Sandridge Energy (SD)

• In July I wrote up a brief summary noting their large gassy prospect inventory and drilling cost advantage. This was well before the IPO and the S1 gave no indication of pricing at the time so I couldn't make a judgment on valuation.
• Here's the original write up from early July. The stock came public in November.

For Those of You Who Don't Like To Click Through Links Here Are The Original Pieces Followed By My Current Comments

That Was Then: May 16th, 2007: Welcome to new gas player Pinnacle Gas Resources (PINN)!

• New PRB CBM [Powder River Basin Coalbed Methane] player formed out of Carrizo Oil & Gas Inc. (CRZO), Gastar Exploration Ltd. (GST) and Marathon Oil Corp. (MRO) assets and spare change from Credit Suisse.
• Large primarily undeveloped leasehold (308,000 net acres) mostly in the Powder but with about 10% in the Green River Basin. 5,000 locations identified.
• 25.9 Bcf proved reserves (which is up from about 20 Bcf as of YE06, largely due to gas prices).
• Lost 5.5% on opening day (May 15th). I wonder why?
• Massive premium to NAV [Net Asset Value].
• 28.9 million outstanding post-deal X $9/share + working capital gets you TEV [Total Enterprise Value] of around $225 million.
• I get an NAV of just over half that if I'm fairly generous with the value of their in ground reserves and undeveloped acreage.
• Steep cash flow multiple relative to peers, despite the fact that PRB here is lower R/P [Ratio of Proven Reserves] than a lot of the gassy "long reserve life" players.
• You get to wait the usual 30 days for Street coverage.
• Once this seasons a bit it'll be a good, though thinly-traded proxy for Rockies natural gas, replacing the old Evergreen Resources as the purest of the pure gas plays.
• Verdict: I'm waiting for the coverage to start, and then waiting some more. They plan to drill 200 to 400 wells per year, which should yield decent reserve growth, but hasn't in the past. They also own rights on a majority of their acreage to explore for conventional oil and gas at deeper depths than the coal formations. This one is worth watching.

Since Then:

• October 15 PINN agreed to be acquired by Quest Resources at the then equivalent price of $6.55 per share (exchange ratio of 0.6584 X $10 for QRCP stock). So I was right to wait.
• Also in the intervening span since the IPO, PINN has announced a couple of "nothing to write home about" quarters with down revenue (due to low Rockies gas prices) and increased LOE (both absolute and on a per unit basis due to high number of wells in the portfolio that are not yet productive (presumably dewatering).

So What Now?

• The trade-able vehicle following the merger is Quest Resources (QRCP).
• Quest is a Cherokee Basin (Kansas/NE Oklahoma) CBM operator who now owns a slug of Powder River Basin acreage and production.
• QRCP has 500,000 net acres in the CBM Cherokee play so this is another low cost gas manufacturing op. Nothing sexy but it is cheap and a consistent, low risk grower.
• very low F&D ($1.42 3 year average)
• long reserve life: 13+ years
• 2,300 remaining locations in the Cherokee
• grew 40% organically through first 9 months of 2007
• This is the area that NFX recently exited.
• The Street (3 analysts) have taken estimates to $2.13 since the merger with PINN was announced but the range is broad ($1.50 to $2.48). The aveage puts them at 3.3x cashflow (range of 2.9x to 4.7x). The 3.3 is very low for the cost structure and long reserve life.
• The stock has fallen since the Merger announcement as people obviously dislike the $205 million price tag implied by the stock deal for PINN's 20.3 Bcf. As in you paid what???!!! $10 / Mcfe!!!
• I will wait to act until I see the year end results and planned capital program for 2008.

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Continental Resources (CLR):

That Was Then: May 17th, 2007: Large and In Charge. This is a totally different animal than yesterday’s look at (PINN).

• Enid, Oklahoma based E&P focused on the Rockies and Mid-Continent with a small amount of Gulf Coast reserves, founded in 1967.
• Both management and science are seasoned and deep.
• Technically proficient in horizontal drilling, enhanced recovery
• They operate 95% of their reserves.
• Reserves: 118 MMBoe, 86% Rockies and 83% Oil. Nearly all reserve adds in the last five years have been through the drillbit. This is a low exploration risk, resource play. While the preponderance of reserves are in the Rockies the company has substantial positions in several unconventional plays including the Woodford Shale (45,000 net acres).
• Just over half of their current production comes from the prolific and vast CedarHills Anticline. Horizontal development with high pressure air and some water injection with very good results. Well density is low so there is potential to downspace the acreage.
• They’re attempting to produce the Lewis Shale in both conventional sand and siltstone intervals but also unconventional in the shale itself. Results to date have been encouraging.
• Production: 26.5 Mboepd 4Q06, 28 1Q07. Production visibility is good for strong growth through at least 2009.
• R/P of 13 years which is likely to fall a bit
• They’ve managed to shrink per unit LOE in linear fashion from 2004 to 2006. Unreal.
• Fairly massive Rockies and Mid-Continent undeveloped leasehold.
• Balance sheet is clean, and following this offering they’re probably a little under leveraged.
• At $14.35 and with 168 million shares outstanding after the deal CLR is firmly planted in E&P midcap territory. Valued at a little over 5x trailing cash flow this seems very reasonable unless I’m missing something.
• The CEO retains 71% of the company.

Since Then:

• The shares priced at $15 on May 15, 2007.

• Opening trade of $14.50.

• I purchased the stock at $14.25 on May 17th.

• They've reported two strong quarters since the IPO, added some favorably priced oil hedges, now have over 1,500 unbooked locations in their two large emerging plays (the North Dakota Bakken oil shale and the Woodford Shale), and they anticipate adding 6,000 BOEpd (roughly 20% growth) over the next 4 quarters.

• 2008 Capex is set to jump 28% to $616 million and unlike many of their peers, they will likely stay within EBITDAX. Emphasis on their largest producing property (The Red Hills units in North Dakota) increases as a percent of budget in this coming year but they also plan to step up spending in the ND Bakken and Woodford. Debt remains low and is likely to fall unless they acquire something.

• Unit costs continue to improve as rising production more than outstrips service inflation. Taking a look at cash operating expenses you can easily see discipline in the numbers with cash margin gains outstripping top line advances (a lot of their peers have been relying on continually rising prices to boost income, not them):

 

• Imagine if they get some help on natural gas prices with higher expected production coming from the Woodford over time. Also, those Woodford wells should help in reducing per unit LOE as they will no doubt be quicker to jump to pad drilling and multi-frac routines pioneered by NFX and others in the play.

• Oh yes, and the stock has nearly doubled since the IPO.

So What Now? I entered the shares because I thought the stock was coming to the market cheaper than they should given their platform of assets, management, etc. and now at 7.6x 2008 consensus CFPS of $3.56 they are more fairly valued if not a bit ahead of many of their peers. However, there's that growth rate, and extreme long reserve life that's rare among the oilier names so maybe its just getting some respect and not the pendulum swinging too far...at least not yet so I'm holding on. Normally for oily exposure I'd rather hold a slightly less expensive (DNR) or (APA) but the unique circumstance of strong growth from both core and emerging arenas keeps me interested here. I plan on holding at least a piece of this in the IRA for a long time as it will do well in either a long term inflated oil price environment (anything over $60) and that's what I expect us to be in for quite some time. They should also do well in a more moderately priced oil and gas price environment given their low cost structure and variety of plays to accelerate and decelerate depending on prices.

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