I recently built a short position in Synergy Resources (SYRG). Synergy stock has more than tripled in the past year from a low of $2.80 to a recent price of $9.90 per share. This rapid move, combined with the potential fundamental risks and challenges from a recent natural disaster, caught my attention. The situation reminded me in some respects of a short position I put on in August, Green Hunter (GRH), that subsequently traded down more than 45% after I published my analysis, despite a rising stock market and rising oil prices. After more work, I built a short position in SYRG and expect the stock may fall for some of the following reasons:

1) Ultra-high valuation multiples - SYRG is trading at ~21x 2013 EV/EBITDA according to consensus estimates, much higher than small-mid cap average of ~8.4x or even than rapidly growing peers at ~10x. It is also trading at 4.6x its most recently reported proved reserve value, versus a peer group average of 1.7x. These are the two most prevalent and meaningful valuation metrics for E&P companies, and they imply a value for SYRG of less than half of the current share price if SYRG were to trade in line with its peers.

2) 1,900 wells in the Wattenberg field have been shut in (temporarily turned off) because of flooding. While Synergy provided a "status update" saying that there has been limited impact to their fields, flood maps show at least some of their fields were directly affected. And there will likely be numerous logistical challenges to bringing wells back onto production and to drill and complete new wells (this was acknowledged in the status update). This will likely delay at least some production growth that might have been achieved otherwise, challenging the ultra-high multiple. This affect is already being factored in by investment bank research analysts covering large companies with exposure to the Wattenberg field.

3) Environmental risk from recent flooding - SYRG is small player in the big Wattenberg field, but it is also a small company with a small balance sheet compared to other operators in the field, such as Noble (NBL), Anadarko (APC) and Encana (ECA). Synergy could be disproportionately challenged if there is a large environmental liability, and there are already reports of oil spills into the flood waters and mentions in the news of potential substantial environmental liability.

4) Recent acquisitions in the Wattenberg field imply a much lower private market value per acre than Synergy's stock price implies (enterprise value of ~$700 million, implied transaction value of core field of ~$212 million). The most recent public transaction was actually an acqustion by Synergy itself, which netting out production value at $60,000 per boepd, indicates a $3,100 per acre value for core Wattenberg land (this math was used in several investment bank research report updates on the transaction). Synergy held 20,000 core acres in the Wattenberg, according to their September presentation, implying core Wattenberg land value of $62 million. Generously using Synergy's own estimate for Q4 2013 average production of 2,500 boepd and the production value of $60,000 per boepd, this indicates a $150 million value for Synergy's production. The combined value of land and production of $212 million is in line with Synergy's last reported proved reserve value of $149 million, and less than 1/3 of its current ~$700 million enterprise value.

Investors in Synergy may be considering the potential for substantial value in the "Wattenberg Extension", but it is worth considering that that acreage was acquired via a JV only a few months ago for $175 per acre. With ~20,000 net acres there, that implies a low ~$3.5 million private market value for that land. While prices in the area may have trended up in the few months since March, it seems unlikely they have moved enough to materially affect the sizeable gap between Synergy's current ~$700 million enterprise value and the implied liquidation value of its core field of ~$212 million, as discussed above.

5) Part of the value Synergy gets in the market is from NAV credit for potential value of the "Wattenberg extension." Synergy's particular land is in an area that reputable operators view as less prospective, as can be seen in the below maps of resistivity and Thermal Maturity. In particular, maps in presentations by Bill Barrett (BBG) and Carrizo (CRZO) seem to imply limited prospectivity. This could help explain the low recent acquisition price for the land.

Here is a map of Synergy's "Wattenberg Extension", which if zoomed in gives township and range information to locate it:

And here is Carrizo's map showing their view of prospectivity in the area (Synergy's land is circled in green, clearly in an area CRZO views as less prospective:

(click to enlarge)

Next is a map from Bill Barrett of resistivity, with Synergy's acreage circled in black, also indicating a less prospective area from Bill Barrett's perspective:

And next is a map from Bill Barrett of thermal maturity, which also indicates limited prospectivity for Synergy's "Wattenberg Extension" acreage. Synergy's land is in the yellow oval, and is outside of the purple thermally mature area.

6) Since I do invest in oil and gas E&Ps on the long side, I search for low valuaiton, high growth potential investments. Fortunately, I do not have to buy stock in a company trading at more than 2x the typical EV/Ebitda multiple for high growth small cap oil companies, more than 3x recent core transaction values and well over 3x the most recently reported proved reserves. Fortunately, I have identified excellent alternatives for myself. One such alternative is Gastar Exploration (GST). Gastar trades at less than 7x 2013 EV/Ebitda, at just over the value of its proved reserves, and is tripling Ebitda from 2012 to 2013, according to analyst estimates (with more growth yet to come in 2014). For a variety of reasons, investments like Gastar have stayed off the radar of investors bidding up stocks like SYRG to much higher valuations. As a value investor, I prefer to buy lower valuation stocks rather than higher valuation stocks, particularly when I can get similar substantial growth and similarly high rates of return on invested capital. As investors discover alternatives like Gastar, particularly as they search for alternatives to Wattenberg "pure plays" in the aftermath of the recent severe flooding, this could benefit stocks like GST and negatively impact stocks like SYRG.

Having shared 6 reasons why I am short Synergy, it is relevant to share some background information about Synergy for a more full overview of what it does and how it got to where it is. Synergy is a small E&P company, currently producing ~2,200 boepd (according to its September 2013 presentation). It has grown that production rapidly, and is focused on acquisitions and development in the Wattenberg field, particularly in the Niobrara and Codell zones. It has just under 70 million shares outstanding, and prior to the affect of recently announced acquisitions (which may not have closed yet), had approximately $25 million in net debt and an enterprise value of approximately $700 million, according to a recent analyst report.

Synergy has management with oil and gas operational experience but without prior experience managing multi-hundred million dollar public oil companies. It appears they recognize this gap, highlighting a non-executive board member who does have such expertise. And the CFO was previously the CFO of Gold Resource Corp (GORO), a highlycontroversial mining company.

(click to enlarge)

And Synergy does have some blue sky upside from potential success in the "Wattenberg Extension", despite the low private market value and the negative view on the area from respected industry leaders like Carrizo and Bill Barrett (and others who did not even include that area in their maps). And it has some potential from an emerging resource play in Nebraska, where there is insufficient data to support anything beyond a token valuation for now, and which appears to be a Pennsylvanian extension of the trend from the Kansas extension of the Mississippi Lime play (yes, 2 extensions, perhaps not so promising after the limited success in the Kansas Mississippian extension).

Full disclosure: this is not a buy or sell recommendation, just an exposition of my analysis. I reserve the right to buy or sell any security mentioned without further notification. I am long GST and short SYRG via put options and common stock.