We believe that Ram Energy Resources (Ticker: RAME) is a compelling long idea with 40% near term upside potential and could double within 12 months. The core of the investment thesis is as follows:

-         Ram stock is quite cheap on core assets with the equity trading at 0.7x NAV (as measured by PV-10 discussed later).  Importantly, this NAV calculation is based on meaningfully cheaper oil/gas prices than we have today.  (Note: Were we to use today’s prices – RAME trades at a massive discount to NAV.)

-         There is little to no geological risk – the company is 31 for 31 on wells drilled this year and has a well over 90% success rate over the life of the company.  This investment is not about high-risk drilling for big targets.  Rather, it is much more about exploitation of known resources.

-         RAME has a large acreage holding in West Virginia that could represent meaningful upside potential – perhaps doubling the value of the company.  At present the company has not booked any reserves associated with this acreage and the market is clearly not assigning any value to it.  In the 3^rd quarter of this year investors will hear about Ram’s first lateral well on the property.  Another company’s wells on neighboring acreage give us a good sense of what we’ll hear from RAME.  Once the market starts giving RAME credit for reserves and production from the acreage – this will represent significant upside to the story.

-         The Ram investment thesis is about more than just undervalued and underappreciated assets.  Ram is also an emerging growth story.

-         In part, Ram’s valuation seems to be explained simply by the fact that is it not well known to investors – but this is changing. 

-         Ram has a host of other catalysts which may be beneficial to the stock in the coming quarters.

 

These are the key elements of the RAME investment thesis.  The remainder of this write-up is focused on validating our above assertions.

 

(Note: We wrote up Gulfport Energy (Ticker: GPOR) earlier this year and we see a number of similar attributes with RAME – specifically, the fact that Ram is cheap on core assets with low geological risk and big potential upside from new / unbooked properties)

 

 

Ram Energy is focused on oil and gas production primarily in Oklahoma and Texas with potential from new acreage in West Virginia.  About 60% of reserves and production are oil (and other liquids) with the remaining 40% is gas.  A little over half of the current proved reserves are being produced with relatively slow average declines of about 6% per year.  The remainder of proved reserves will be converted to producing in the coming few years.  Ram is the operator on (meaning they control development of) about 90% of their reserves.

 

RAME roughly doubled its size with the 4^th Quarter 2007 acquisition of privately held Ascent Energy. 

 

We could go into significantly more detail on all of Ram’s different properties.  But, the specifics of each and every property are not central to the broader investment thesis.  For more background and greater property level detail see the recent investor presentation on the RAME website. 

 

 

(Note:  The above RAME capitalization is adjusted for the recent conversion of a large number of warrants.  On May 12^th 17.6mm out of 18.8mm previously issued and publicly traded warrants converted to common.  The remaining 1.2mm warrants expired.  This event has had three positive impacts.  1. It removed the meaningful warrant overhang which was effectively capping the stock price from moving above the $5.00 strike price, 2. It has brought in new shareholders and improved liquidity to the stock, 3. It allowed the company to deleverage and pay down $86.6mm of high cost debt related to their Ascent acquisition.)

 

Asset Value:  In our GPOR write-up we discussed Net Asset Values as measured by PV-10.  The PV-10 calculation basically asks the following:  What do I know I have in the ground (proved reserves)?  How much can I sell it for once I extract it?  How long will it take and how much will it cost to get it out of the ground?  What is the net present value of all that worth today?  (Technically the PV-10 calculation accounts for revenues, development costs, and abandonment cost through the life of the properties – before taking into account income taxes - all discounted to present at 10% and based on constant energy prices.)

 

Companies in conjunction with their reserve auditors calculate their PV-10 value at least once a year.  On page 20 of Ram’s 10k they calculate theirs at $912mm based on $94 oil, $7.00 gas, and $55 for natural gas liquids.  Thus, we can see that RAME equity trades at 0.7x their 12/31/07 PV-10 value.  Were it to trade at 1.0x its PV-10 it the shares would be worth $8.40 per share or 40% higher – this is our base case. 

 

Is 1.0x the right multiple?  Do E&P companies typically trade around 1.0x PV-10?  Interestingly – the best comps for RAME trade near or in excess of 1.0x.  Probably the two best comparables for RAME (at least in terms of somewhat similar assets) would be ARD at 0.95x and PLLL at 1.2x their respective 12/31/07 PV-10 values.  A somewhat larger company with solid growth characteristics such as CRZO trades at 2.7x PV-10.  Were RAME to trade closer in line with these – say perhaps at 1.25x PV-10, that would imply a stock price of $11.35 or an 88% premium to the current stock price.  (Note: There are companies that do persistently trade at discounts to PV-10.  But, this is usually only companies with recent failures on the exploratory front – see EPL, or risk to timing of development – see CPE, or significant political risk – see companies with the majority of their assets in high risk geographies). 

 

Finally, since the beginning of the year energy prices are up ~50% for oil and ~85% for natural gas.  What if an investor concluded that current energy prices are a decent proxy for oil and gas prices for the next 15 years – what would the PV-10 be then?  For simplicity, we can assume an even production profile for Ram’s assets over the next 15 years (even though in reality it would be more front-end loaded).  That means that over 15 years 19,544 MBbls of oil would be produced at $46 more per barrel than the year-end PV-10 calc assumes.  For natural gas reserves there is a $6 differential on 93,358 MMcf and for Nat Gas Liquids lets assume about $25 difference per barrel for 4,271 Mbls.  The NVP of these differences at a 10% discount rate is $794mm.  If you add this amount to the 12/31/07 PV-10 you can estimate PV-10 at the current price deck is about $1.7bn.  1.0x that amount would imply a share price of $18.50 – more than 3.0x today’s level.  We run this quick analysis just to point out that if investors believe the current energy prices will persist on average for the next 15 years then RAME is an absolute steal (as would be a number of other E&P companies though).  Also, we reiterate this point to remind potential investors that this investment thesis is not predicated on current (perhaps inflated) energy prices.

 

That sums up our valuation of RAME based on assets value.  At a base case of 1.0x NAV the stock is worth $8.40 – a 40% premium to current.  If the stock trades at a premium to NAV as some of the comps do or, if one uses a long term price deck closer to current energy prices – then there is a potential return of 2x or more in the stock.

 

This above piece of the valuation is base solely on proved reserves. 

 

As investors we prefer not to take much geological risk and therefore take comfort that RAME is 31 for 31 on their wells this year and has about a 93% success rate for the lifetime of the company.  That means investors do not need to worry about dry-hole risk but rather can focus on well economics etc.

 

 

 

As part of the Ascent acquisition Ram picked up acreage in Appalachia with resource potential in the Devonian shale.  This is a non-producing asset with only six vertical ‘science wells’ which are used to further understand the resource.  Based on information from these wells and knowledge of the success of other companies in the area, RAME is drilling their first lateral well which is intended to be a producing well.  A key catalyst for this stock will be what investors learn about the success of this well in the 3^rd quarter – perhaps as soon as the 2Q conference call. 

 

What is the likelihood of success?  Can we learn something from neighboring properties?  Adjacent to and somewhat intermingled with Ram’s acreage is land owned by Cabot Oil and Gas Corp. (Ticker: COG) in what they call their ‘Hurricane’ project (see Page 17 of their April 7^th, 2008 investor presentation).  They have drilled 11 horizontal wells in the play with initial production rates of 1 to 2 Mmcfe per day and they estimate ultimate recoverable reserves per well at 0.8 to 1.5 Bcfe.  They have plans for 19 wells for 2008.  On their 134,000 acres they believe there are 850-1,100 drilling locations.  Translation:  COG is about one year ahead of Ram and is experiencing very solid success in the Devonian on adjacent acreage.

 

If Cabot has been successful does that mean Ram will be as well?  Our belief is that it is very likely that Ram can replicate the success of Cabot.  If you look how close/intermingled their land holdings are, proximity alone would suggest they should be similar.  One might ask – are we sure the shale under Ram’s land will have the same thermal maturity as COG’s? (‘thermal maturity’ is a fancy term for whether the earth baked the hydrocarbons for as long).  According to geologists we’ve spoken with there is a good degree of uniformity to the shale in the area.  It is overwhelmingly likely that Ram’s shale will be as thermally mature as Cabot’s.  As well, RAME has their science wells which have also instructed them as to what they are likely to encounter with the new laterals.  Ram is devoting $19mm which is almost 25% of their 2008 Capex budget to drilling 14 wells in the play in 2008.

 

We think the above factors suggest that Ram will experience the same success as Cabot.  When they do and the market starts assigning value to this acreage it could translate into meaningful upside.  On their 47,000 acres Ram estimates there are 500 drilling locations.  If recoverable reserves per well are consistent with what Cabot is finding then this would imply 400Bcfe to 750Bcfe of recoverable gas.  The low end of this range is equivalent to 67Mboe and would thus more than double reserves for the entire company.  Now of course it will take time to prove-up all these reserves and then produce them.  But, clearly if they can prove they are as successful as Cabot, there is tremendous potential upside to reserves and ultimately production. 

 

In the last year companies participating in the Bakken shale and the Haynesville shale have seen dramatic moves in their share prices as investors have become aware of the economics and potential magnitude of these plays.  The Devonian shale has not yet received as much attention as some of the more publicized shale plays but we think it may be on the cusp of broader attention.

 

Most importantly, the RAME investment thesis does not require success in the Devonian.  But, based on the success of Cabot, our conversations with experts, and comments from the company - we put a high likelihood on Ram proving up and producing a highly commercial resource.  Investors should hear the first well results in the 3^rd quarter and see a production impact in the 4^th quarter.  If this comes to bear it will represent meaningful upside reserves, production, and we imagine the stock price.  

 

 

 

Ram has an $80mm Capex budget for 2008, the overwhelming majority of which is devoted to growing production (very little true exploration Capex).  The company faces about 6%-7% annual declines from its existing properties and has guided to 2%-3% quarterly production growth.  That means that if existing wells decline about 1.5% per quarter then the company needs to grow production from new wells about 3.5% to 4.5% to hit their target.

 

We think this current guidance is potentially conservative.  It is difficult to determine how new wells are coming on line but here is what we can determine from recent presentations:

-         South Texas:  Three new wells came on line (late Q1 and Q2) with combined initial net production to RAME of about 1500 Boepd (more wells were being drilled in Q2)

 

First quarter production averaged about 6725 Barrels of Oil per Day.  The above wells alone would add almost 1000 barrels per day to Ram production even if they very quickly declined 50% from their initial rate.  This would suggest more like a 15% increase in production from new wells compared to 3.5% to 4.5% to meet guidance. 

 

The limits to publicly available information surely cause our math to miss a number of factors that contribute to production - we do not actually expect a jump of 15%.  But more generally, it does seem like their $80mm of Capex with the 100% success rate on wells so far in 2008 may result in higher growth than management’s current guidance.  In fact, our discussions with management suggest that they are rather eager for investors to better understand Ram’s growth potential.  We think there is some chance 2Q numbers will begin to show evidence that Ram has started a multi-year growth trajectory.

 

 

 

We would argue that RAM is the typical under followed name that has yet to receive broad shareholder attention.  The company went public via a SPAC in May of 2004 and has thus received somewhat limited equity coverage.  There is additional evidence of how unknown / under followed RAME is:

-         Equity analyst comp sets covering a broad array of domestic E&P names seldom include RAME 

-         The company tends to be ignored in industry journals.  Look at: Shales and Coalbed Methane; Oil and Gas Investor – January 2008 (free on their website).  It has a list of 50 U.S. public companies that play in the shales but RAME is not among them. 

 

For whatever reason, at present this company has a rather low profile and is not known by a lot of investors.  We think this may start to rectify itself though.  Just six months ago the Ascent deal doubled the size of the company.  As well, a number of new shareholders have come into the stock (per mgt comments) as 17.6mm warrants were purchased in the open market and then converted into common shares in mid-May.  Liquidity has also improved as average volumes have moved from ~100k shares per day in the first quarter to ~350k recently.   The combination of these elements means that investors now have a larger and more liquid company to invest in.  We think these facts combined with a solid investment thesis will make it harder for Ram to go unnoticed. 

 

 

 

Devon Well Proposals:  Part of Ram’s Barnett shale acreage is partnered with Devon (Ticker: DVN; $51bn market cap).  In this acreage Ram has a 36% interest and Devon sets the drilling schedule.  Per the agreement between the companies, Devon only has to propose a new well 120 days after the completion of the previous well.  What this means practically is that Devon only needs to propose 2-3 wells per year.  But, Ram mgt has suggested that Devon is moving more aggressively and may propose 6-7 wells this year.  We think this will require Ram to up their Capex budget for the Barnett and more importantly investors will understand that this is a real potential growth area.  We should hear more on the 2Q call about how many wells will be drilled in this acreage in 2008.  (Note: current production guidance only assumes 2-3 wells)  

 

Price Deck:  Ram’s agreements with their lenders require them to hedge a portion of their production.  This means that half of production is hedged at old prices near $80 oil and $10 gas.  As these hedges roll off and the company replaces them with newer hedges at much higher prices the realized prices the company receives will continue to go up.  This means that even if, for instance, oil dropped to $110 – the effect of this would be negative on what the company realizes for their spot sales but the old $80 hedges would still roll of to much higher levels.  This means that higher realized prices should be a tailwind for a number of quarters.

 

New Reserve Report:  Ram will do a mid-year reserve report with their auditors.  This means that investors will get a better understanding of the extent to which Ram has been able to prove up new reserves.  Also, current oil and gas prices will be applied to the reserve report and we should have an updated PV-10 value.  This will allow an accurate reflection of NAV at current prices – something closer an audited version of the rough analysis we did earlier in this write-up. 

 

Refinance:  Resulting from the acquisition of Ascent, some of Ram’s debt is rather high cost – in excess of 10%.  There is some speculation that with the mid-year reserve report and higher production levels, Ram could refinance and lower their borrowing costs.  

 

 

-         As with any E&P investment, a dramatic fall in the price of oil and gas would likely cause this stock to fall as well. 

-         For years the current CEO operated the company (and its predecessors) with a business partner who is now deceased.  His shares were inherited by his daughter who is now a larger holder (11mm shares out of ~80mm shares).  She has recently been selling shares and perhaps this could create an overhang on the stock. 

 

 

Ram is cheap based on its core assets (30% discount to PV-10)

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Ram’s assets have low geological risk

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Ram has significant upside that the market has ignored (Devonian could more than double reserves)

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Evidence of RAME growth story should start to emerge

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Size, liquidity, and new investors are beginning to raise Ram’s profile

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There are a number of other potential helpful catalysts

 

 

We think all of the above should equal a higher stock price.  $8.40 is our base case at 1.0x 12/31/07 PV-10 value which was based on much lower energy prices.  Current energy prices, potential premium multiple to PV-10, upside from the Devonian, growth in production and reserves, etc, etc, could combine for a double or more in the stock.

 

 

-         We could be wrong

-         Do your own due diligence

-         We may buy or sell RAME stock in the future