Description

Investment Thesis

ATPG is a cheap oil and gas company with operations in politically stable environments (US, UK & Netherlands).  The company trades around 3.5 times EV/2007 E EBITDA.  If one has a negative view on the energy sector and expects oil to trade under $40 a barrel and natural gas under $4 MBTU this is not the right investment.  ATPG has a significant ramp up in production in 2007-08 that should generate significant cash flow and gives the stock significant upside if energy prices stay the same or increase.  

ATPG web site www.atpog.com has a good investor relation section with detailed presentations on the company (9-20-2006 Analyst Conference presentation does a good job of laying out the company and its operations).

Company Background

ATPG operates in the Gulf of Mexico (on shelf and deepwater) and in the North Sea (UK & Netherlands).  ATPG is less of an E&P (exploration and production) company as it focuses primarily on D&P (development and production) of offshore oil and gas discoveries and fields it acquires. ATPG does not have the high risk profile of E&P companies focused more on exploration than development.  ATPG operates only in politically stable environments. 

ATPG business strategy has been to opportunistically acquire and develop already-discovered reserves that are not strategic or integrated to major exploration oriented oil and gas companies. ATPG acquisitions have associated probable and possible reserves (2-P and 3-P) and additional low-risk exploration targets in close proximity. ATPG edge is in its ability to turn the 2-P and 3-P reserves and prospects into proved reserves.

ATPG maintains a high working interest and wants to control operations. ATPG low risk profile is reflected in its 98% success rate in developing assets.  ATPG strategic acquisition goal is to acquire assets with high returns, proved undeveloped reserves, and properties with logged hydrocarbon and proximity to infrastructure that do not fit into the major oil and gas companies' strategic portfolios.

ATPG’s D&P model has relatively low exploration risk, as the company buys almost

exclusively discoveries and fields.  The main operational risk is capital investment and timing risks related its large scale and capital-intensive projects in the deepwater GOM (Gulf of Mexico) and the North Sea. Operational and logistical issues can cause significant delays in production which could result in a cash flow crunch, especially in a volatile commodity price environment.

There is a detailed list of ATPG projects in the appendix. 

Valuation

Capital Structure

Revolver           $50 mil.            L+350

First Lien          $898.7 mil.       L+350

Second Lien     $175 mil.          L+475

Equity               30.143 mil. Shares at $40.84 – $1.231 Bil. Equity market cap

EV                   2.354 Bil.

There is a mismatch between the company’s projected operational efficiency in 2007 and the expectation in the market.  The company has stated that it expects 2007 production to be approx 300 MMcfe/day.  The current stock does not reflect ATPG production growth profile.   

Given ATPG strategic business profile the main risk is timing risk (operational) not exploration risk.  Infrastructure issues outside ATPG’s control, such as, access to pipelines may impact the timing of production and associated cash flows.

ATPG sell side coverage is mainly smaller boutique research shops (Suntrust, Canaccord, Jefferies, Raymond James, RBC, Ferris Baker, ect.) and one bulge bracket firm – Lehman.  There are universal buy recommendations from the smaller boutique shops and an underweight recommendation from Lehman.  Lehman has been underweight this stock from under $5 so I use it as a contrary indicator. 

Assuming ATPG can produce 300 MMcfe/day during 2007 – EBITDA should over $750 mil.  The valuation catalyst for ATPG is increasing its production from 200 MMcfe/day to 300 MMcfe/day as new projects come on line.  The main valuation risk is operational risk (timing) and commodity risk.

As ATPG’s portfolio of development projects enters into production stage ATPG’s risk profile changes.  ATPG has historically been a GOM natural gas producers (70% GOM gas / 30 % GOM oil in 2005).  With production coming on line in 2007-08, ATPG becomes a more diversified business along geographic and product lines.  Year 2007 and beyond, ATPG production will be 2/3 GOM and 1/3 North Sea with 60% natural gas and 40% oil.  ATPG will become less dependent on GOM gas which is the most volatile commodity.

ATPG management in my opinion has been too active trying to sell the ATPG story.  In my conversation with ATPG management I have tried to convey to them that their main focus should be putting up operation production and cash flow numbers.  In the next year as ATPG portfolio of projects come online ATPG stock price should reflect ATPG asset value.

The best indicator of ATPG management’s confidence in cash flows in 2007 and beyond is the recent changes to ATPG’s capital structure.  ATPG decided to replace its 13.5% and 12.5% PIK preferred with additional first lien and a new second bank facility.  ATPG reduced it finance cost but went from having non cash pay liabilities to cash pay liabilities.  For a firm that has historically been willing to pay a substantial premium for financial flexibility and leverage as it sought to acquire and develop projects, the signal of reducing finance costs and moving to cash pay liability reflects in my opinion, ATPG managements confidence in its 2007 and beyond cash flows from its projects coming on line.

ATPG is a growth story with its assets and working interest in projects serving as a value floor.  Please see appendix for a list of ATPG projects.  In 2007 as projects come fully online – Wenlock in the North Sea, Landybug in GOM; core fields peak - Gomez in GOM and TORS in North Sea peak, ATPG should significantly increase output by 50%.  ATPG management has stated that its existing projects have the ability to all ATPG to increase production to 400 MMcfe/day by 2008 and into 2009. 

ATPG management calculates their NAV to be $108 per share with 1.1 Tcfe of proved, probable and logged inventory.    If ATPG achieves its operational target of 300 Mmcfe/day it should generate $750 mil. in EBITDA in the current commodity price environment and trade at 3.5 times EV/EBITDA.  Comp E&P firms trade at 5.6 times EV/EBITDA. 

Risk Factors

ATPG Management – The main risk in my opinion in ATPG is reinvestment risk.  ATPG management has created as successful company by being bullish on energy.  The risk is that the cash flows generated by ATPG is not returned to shareholders but reinvested in new projects.  The capital structure of $1 bil. in debt may act as a cushion and absorb some of the cash flows if management repays debt instead of investing in new projects.  I doubt ATPG management will repurchase stock with its cash flow preferring to reinvest it in new projects.  In my conversations with ATPG management they have stated that these see significantly higher returns on capital on new projects/developments than in repurchasing their stock even though they think their stock is very cheap. 

Hedge Fund Ownership – ATPG is a crowed hedge fund trade.  Checking holders on Bloomberg shows the majority of large holders are hedge funds.  Being a relatively crowded hedge fund trade brings along associated hedge fund risk.   ATPG’s management pitch has been primarily bought by a select group of hedge fund who specialize in oil and gas, commodities and the energy sector.   

Volatility – ATPG is a volatile high beta stock.  Owning an E&P company and the current state of the energy commodity complex entails volatility. 

Insider Selling – There has been some recent insider selling of the stock.  Insiders still own over 30% of ATPG and the insider selling has been small relative to inside ownership. 

Hurricanes – In 2006, 76% of ATPG’s production was GOM-based.  Going forward ATPG’s more diversified production base will mitigate GOM hurricane risk but one still has to be cognizant of hurricane risk.  2006 was a very quite season for hurricanes but going forward one cannot ignore hurricane risk. 

Operation Risk - This timing issue was more acute in the past when ATPG’s production portfolio was small and concentrated. Year 2007 and beyond with a large number of productive fields coming on line and growing cash flow, portfolio diversification should mitigate timing issues related to any single project and should have a lesser impact on ATPG.  Given the large-scale and technically complex offshore projects, operational issues are part and parcel of the risk on investing in ATPG. 

Catalysts

Cash Flow Generation – As ATPG’s assets generate significant cash flows in the current commodity environment the street should take notice.  ATPG is a growth story with its assets and working interest in projects serving as a value floor.  As ATPG brings its projects on line its cash flows will accurately reflect the asset value in its portfolio.  Cash flows and operational success – increasing production of 300 MMcfe/day will act as a catalyst to get the stock closer to its underlying asset value. 

Long Oil & US/UK Natural Gas – ATPG is a long play on energy and oil gas commodity.  If one has a negative view relative to current futures prices, ATPG is not the right investment. 

Long Only Institutional Ownership – ATPG ownership base should change with more visibility on operations and cash flows.  ATPG is currently owned primarily by value hedge funds with a commodity bent who have bought into the ATPG story.  Eventually the long only institutional investor base will be interested in a company trading at 3.5 times EBITDA and at a significant discount to peers with a lower risk profile production model.

Acquisition – Given ATPG management’s 30% ownership and the underlying value of ATPG projects.  ATPG could be a target for acquisition – a cheap way to acquire portfolio of assets in politically stable environments.  ATPG management might also be tempted to take the company private given the current debt market environment and the strong demand for ATPG paper in the credit markets.  

Appendix

ATPG US Offshore Gulf of Mexico (GOM)

Year-end 2005, ATPG owned 276,308 net acres and 232 bcfe of proved reserves in the Gulf of Mexico, of which 70% is natural gas

• The Lady Bug Field (Garden Banks 409, 1,300 feet water depth/WD), one of ATPG’s first “deepwater” fields, began production in 2001. The lower zone is still productive but with increasing amounts of water. A new well at an up dip location has been drilled this fall and is currently waiting for sub-sea connections. The lower zone at the old well will be shut off, and production will start at two shallow zones. These two wells are expected to produce at 20 mmcfe/d (net) at year-end of 2006 or early 2007. The field has 7 Bcfe of proved reserves and a total expected recovery of 24 bcfe and exploration upside of 10-20 bcfe.

• The Gomez Field (Mississippi Canyon 711, 3,000 feet WD) was acquired in March 2003.  Currently, 105 mmcfe/d net is being produced from two southern wells. Proved reserves are 88 bcfe, expected total recovery is 154 bcfe and there is nearby exploration upside of 40-100 bcfe. The field has been prolific, producing more gas then expected. The Gomez Phase 2 Project is designed to expand capacity up to 200 mmcfe/d by mid-2007.  The Green Canyon 37 (1,800 feet WD) was acquired through the Central Gulf of Mexico Offshore Lease Sale held in March 2006. Green Canyon 37 was originally drilled in 1996 and logged both oil and gas pay sands, but was not developed due to low commodity prices. Development work will begin in 2007 with first production expected in 2008, adding 30 mmcfe/d net to ATPG.

• The Telemark Hub (4,000 feet WD) was consolidated by ATP during 2006. The company became the 100% owner and operator of four blocks: Atwater Valley Block 63 (Telemark), Mississippi Canyon Block 941 (Mirage), Block 943 (Oasis prospect), and Mississippi Canyon 942 (Morgus). Telemark, Mirage and Morgus all have logged hydrocarbons. The company is planning to drill 5-6 wells in 2007 and begin production at 180 mmcfe/d of production in 2008 using an innovative “MinDoc” floating production facility.

• The King’s Peak (Desoto Canyon 133, Mississippi Canyon 173 and 217, 6,500 feet WD) was acquired in 2005 and produced until May 2006 at 20 mmcfe/d until the well “sanded up.” The well was temporarily plugged and abandoned. ATP plans to go back in 2008 to drill one re-entry and two sidetrack wells, targeting to start production again in 2008-2009.

ATPG UK North Sea

Year-end 2005, the ATPG owned 95,972 net acres and 295.4 bcfe of proved reserves in the North Sea, of which 64% is natural gas.

• In June 2001, ATP acquired the Tors area from BP with two separate gas discoveries, Garrow and Kilmar, which are located about 22 km apart. These fields are located in about 190 feet of water. The company has installed platforms at both fields, and the pipelines are installed as well.

• The Kilmar 1 well began production in Q2/06, followed by Kilmar 2 in Q4/06. During Q4/06, production was 45-50 mmcfe/d net.

• The Garrow G1 well is currently being drilled. Proved reserves are 71 bcfe with total expected recovery of 113 bcfe. There are an additional 35 bcfe of exploration upside nearby.

• In 2001, ATP also bought BP's 50% interest in the Venture Field, later renamed as Wenlock (Block 49/12a North). ATP subsequently bought out ConocoPhillips’s 50% interest in 2006. The field is expected to begin production in Q2/07 at 60 mmcfe/d.  Proved reserves are 30 bcfe, with total expected recovery at 57 bcfe.

• ATP acquired the Emerald Oil Field (later renamed as Cheviot) during the 21st licensing round in 2003. Reserves are estimated at 287 bcfe. Development will begin in 2007, with first production expected in 2009. The company will present field development plans to the Department of Trade and Industry (DTI) in Q1/07.

Catalyst