Spartan Energy (TSX-V: SPE) is a Canadian traded E&P company with assets primarily in South East and West Central Saskatchewan. It is a re-cap of the old Alexander Energy (which was a recap of Petro-Reef Energy), with management brought in from the prior entity Spartan Oil, which was sold for $480 million to Bonterra in 2012 for a massive gain to Spartan equity holders.

 

At the original Spartan Oil, management rapidly secured financing, acquired under developed assets, exploited those assets, grew production, secured more financing, and so on. Management is pursuing the same business plan, albeit more aggressively, in the new Spartan Energy. So far, they have re-capped the old Petro-Reef, which had tremendous undeveloped value but couldn't get together the right financing and management. And they have acquired an asset from Renegade Petroleum, and subsequently acquired all of Renegade, in an attractively valued transation (just over ~$100,000 per bopd, for assets with a ~20% decline rate and massive undeveloped inventory).

 

Subsequently, the stock has rallied, approaching a reasonable valuation for the current asset base if the assets were to perform how they had under prior management. However, new management has already proven an aptitude for dramatically improving the asset performance, (thus the "why now" versus previously when the stock may have been "cheaper" but less proven). And the stock is certainly not attributing any value for management's proven ability to acquire and exploit assets to the substantial benefit of equity holders.

 

The evidence of this is in the recent announcement by management (http://finance.yahoo.com/news/spartan-energy-corp-provides-drilling-120000341.html), in which wells which had been forecast to produce at 60 bopd came online at an average of 189 bopd. It is highly unusual for wells to come online at 3x the type curve (engineering production forecast), and there have now been 10 wells that have produced on average more than 3x their forecast production. One or two wells might be an anomaly, but 10 wells tells us that either 1) the resource is much better than had been previously forecast 2) management is much better at drilling these wells than prior operators or 3) both.

 

In the absence of such operational outperformance, there could still be an argument to buy Spartan, driven by valuation discrepancies between larger public E&P companies in Canada and smaller asset level valuations. Assets are trading for 2-5x cf and at historically low price to nav while larger / "in favor" Canadian E&Ps in many cases are trading for 10x cf, with financing readily available in the debt and equity markets. This dislocation is driven by the "broken" market for Canadian Junior E&Ps, which had historically purchased these assets. Canadian Junior stocks have started to rebound with the rebound in natural gas prices, but there is a large backlog of assets available for purchase, and in conversations with management at a number of E&P companies, they believe that this backlog will last for a while in the current funding environment.

 

This means there may be a long runway for Spartan management. And considering the operational outperformance Spartan management is already achieving, their cost of capital may further decline, further increasing the arbitrage available to them and increasing the probability and level of accretion of future transactions.

 

Obviously VIC members should be skeptical of roll-up stories, as many underperform over time. However, the E&P space is highly fragmented, and certain roll ups such as Linn Energy (and other acquisitive MLPs and non MLPs) Have achieved considerable success for investors (despite Hedge Eye / the recent issue with hedging disclosures and the SEC, LINE has been a huge home run for early investors on a total return basis). In this case, there are proven synergies and operational improvements, and management has already done this before at a smaller scale. And fortunately, the investment is available at a discount to NAV, as Spartan is still relatively unknown in the US and has not yet gotten full "support" of the investment banks / equity research in Canada.

 

In terms of underlying valuation, of the few banks that do cover Spartan, one note I saw yesterday upped their NAV estimate to $5 on the back of the recent operating results. It was interesting because that report had a substantially incorrect 2014 production estimate of ~5,000 boepd (versus management's guidance of over 6,000 boepd and actually being on track to exceed 7,000 boepd). Returns from the 60 bopd wells that are actually coming on at 190 bopd are, as expected, excellent, with payouts in under 5 months. And in other areas, returns from new wells are in the ~40% IRR range, with wells paying out in 2 years.

 

It does not make a lot of sense for this investment thesis to go into detail into the current assets, as management is in the process of re-working the asset base, disposing non core assets, drilling wells that far exceed type curves, buying new assets, etc. If interested, the company's presentation can be found here (http://www.alexanderenergy.ca/documents/presentations/SPE-Presentation-2014-03.pdf). It is sufficient to review their excellent progress to date, their strong and growing cash flows, and the near 0 debt they have on their balance sheet. At a forecast 10x 2014 and likely a lot lower in 2015 with the growth the company is already achieving, this is highly investable and a reasonable valuation to pay for an unreasonably talented management with a well timed business.

 

There are numerous catalysts in place. These include: further equity research coverage, non core asset sales, further operating results, uplisting from the tsx-v to the tsx, possible listing on the NYSE, additional accretive acquisitions, etc.

There are numerous catalysts in place. These include: further equity research coverage, non core asset sales, further operating results, uplisting from the tsx-v to the tsx, possible listing on the NYSE, additional accretive acquisitions, etc.