Description

Prize Energy is a leveraged equity in perhaps the only sector with reasonable economic visibility. Prize, due to its small capitalization, large controlling shareholder, technical selling pressure from a former holder, and small float has not benefited from the funds flow into energy stocks over the past year, and yet has sold off recently with the sector. In short, it trades at a substantial discount to the NPV of its cash flow, comparable companies and private market value.

Prize was formed through the divestiture of some non-core properties of Pioneer Natural Resources. It operates in the mid continent and Gulf Coast. The company has a balanced reserve profile of 50% oil and 50% gas. The LBO sponsor of the transaction was Natural Gas Partners, run by Ken Hersh with a large equity interest held by Richard Rainwater. Pioneer received a large amount of stock in the transaction that created Prize and were constant sellers in the open market at any price above $20.50 - keeping a lid on appreciation. Pioneer has sold their entire stake now.

Prize's run rate EBITDA is $120mm. The company is projecting a range of forward EBITDA from $120-140mm and thus trades between 4.0-3.4x. While capital spending is discretionary, the $60mm in the current budget should be more than enough to replace the company’s 9 million barrels of production per year (an implicit finding cost of $1.11 per MCFE). Thus free cash flow should be about $60mm or $4.8 per share. The company has hedged 50-60% of its gas production for the next two years so it is not that vulnerable to the recent decline in gas prices. This cash flow will be used for debt pay downs, share buybacks, and selective acquisitions. The company has a strong track record of integrating acquisitions. The recent Apache acquisition replaced over 125% of production at $0.83 per mcfe.

Catalyst

Prize is a company that will eventually be sold to a larger concern by Natural Gas Partners. It is the only way they can get liquidity for their 60% stake. Recent transactions have ranged between $1.04-1.50 per mcfe. Using a diluted share count of 13.43mm and assuming $14mm in cash from warrant proceeds (they are struck at $28) yields a range of takeout values of $32 at $1.0 per mcfe, $37 at $1.1 per mcfe, $46 at $1.3 per mcfe, and $57 at $1.5 per mcfe. While Prize will probably go for the low end of that range – given that it is cobbled together from unwanted assets of other companies, $32-37 per share represents substantial upside from $17.80. Its 13-year reserve life should also prove attractive to any buyer. In the meantime, the company’s $4.80 of free cash flow per share generates a 27% return on the common shares. Prize is an active buyer of it own shares and recently increased its buy back authorization. In other words, you are getting paid to wait.