Description

Plains Resources is (1) a holding company with ownership interests in a pipeline-based master limited partnership (Plains All-American) and a California based exploration and development company (Plains Exploration: PXP); (2) deeply undervalued; (3) run by management that has made money for investors in the past, and have made substantial, personal investments in the stock; and (4) in the middle of engineering a catalyst that should lead to value recognition. Imminent time pressure compresses this submission, feel free please to follow up with questions.

(1) Asset Base: PLX owns 4 main assets. (A) 12.4mm LP units in Plains All-American, ticker is PAA. PAA owns a mix of mostly regulated pipeline assets, pays dividends at an annual rate of 2.12 off of the mostly regulated cash flows its pipelines and marketing operations earn, and trades publicly for 22.75 per share. (B) 44% of the GP interest in PAA. The GP has tiered, incentive based claims on the cash flows of PAA. As those cash flows grow, the GP gets an increasing share of them. (C) 100% of Plains Exploration, which has 239mm BOE of proven reserves, mostly onshore, mostly in California. Plains runs a low risk e&p operation (58% success rate on wells drilled over past 5 years), it hedges 75% of its production 12 months forward, takes oil out of the ground at less than $11.00 per barrel (last 5 years data, versus comparable company production costs of $2.00 higher or more), and earns its spread. The company is pursuing a couple of longer dated, home run potential development projects, but these are not material to the current investment case. Consider them upside. (D) PLX owns 25mm BOE of proven oil reserves in FL. I value these at a low price of $1.00 per barrel, or $1.00 per share.

(2) Valuation: (A) Let's value the LP units at the market price. I could write about MLP valuations at length, and this topic has gotten some solid recent press attention in the WSJ. I am not a bull on the MLPs, but these assets do trade, and can be hedged out, so to speak (although the dividend is a clear issue). If you buy the public valuation, the units PLX owns are worth $282mm. (B) The GP is going to get get 5-5.5mm in free cash flow in 02, up from 3.5mm in 01. 10x FCF suggests 50-55mm valuation. There is potential for free cash flow growth exists, as PAA has recently completed equity and debt offerings that should enable acquisitions by the MLP of comparable, regulated pipeline assets. The other 56% of the GP was sold to an investor group (which includes PLX management--this is unfortunate, but my concerns are greatly soothed by the far more significant investments management has made in PLX stock, more below) in early 01 at an implied valuation of the 44% that PLX owns of 32mm. Call a fair price for the 44% GP interest conservatively 30mm (no growth since 01 despite the cash flow growth, 10x FCF multiple). (C) PXP will produce 100mm EBITDA in 02, 110mm in 03. 5.5-6.0x is at the lower end of comparable company valuations. You need to look at oily, California focused companies like Nuevo Energy & Berry Petroleum. These companies operate at higher costs, with more exploration risk, and more commodity price sensitivity. Reference also needs to be made to the 3.25-3.50 per proven barrel that NEV & BRY trade at. 3.25-3.50 per barrel implies 775mm valuation for PXP. There are counter arguments, most of which speak to the longer reserve life of PXP's reserves, compared to NEV's & BRY's. That PXP's projects are low risk, and that its operators are good, mitigates this concern. Putting a per barrel valuation of lower than 2.75 on the reserves is just too low. 2.75 implies 650mm, or 5.9xx EBITDA. PLX has 280mm in net debt, and 25.5mm shares. It's market cap is 525mm. (A)+(B)+(C)+(D) is 987mm, less 280mm in debt, is 707mm, or $27.70 per share. This inherent value estimate is more than 25% higher than the share price, assumes the barrels in the ground at PXP are worth 18% less than their best comparables, and values the GP interest conservatively.

(C) PLX is run by Jim Flores, who founded Flores & Ruxton, and sold it to Ocean Energy for a bundle in the late 90s. Jim bought 1mm shares at $25 on joining the company in 2001. PLX's COO is John Raymond, who also has made a substantial personal investment in the stock. These guys eat their own cooking. And Jim has an established track record as a money maker.

(D) Why is PLX down 15-20% in the past 2 weeks? It tried to accomplish an IPO on PXP in mid-October at an enterprise value of 660mm, could not get it done, and pulled the deal. The issues surrounding the failed underwriting were the market, the size of the deal (280mm debt, 380mm market cap, 70mm offering), and the fact that management did not want to sell stock at an IPO discount. Rather, they are spinning PXP to PLX shareholders, 100%, in the next 3 months. The catalyst is the spin. After some time for the price to settle, I cannot believe PXP is valued as low on a reserve basis as the current price implies. The current EV is 840mm, take out 280mm for the LPs, 30mm for the GP, 25mm for the FL assets (which lie outside PXP) are you get 511mm, or $2.13 per proven barrel, for oil that they take out for 11.00 cash, and sell for 17.00-18.00, assuming the commodity declines in price substantially. After the spin, PLX will be a leveraged play on the MLP, will be unleveraged, have substantial free cash flow, and be an active buyer of its stock.

Catalyst

The spin.