Description

Tengasco is a small oil and gas company that has significant asset value in excess of its current market valuation. The company has leases on properties in Tennessee and Kansas and a pipeline adjacent to its Tennessee properties. It has recently rid itself of a poor management team and is in the process of restructuring its balance sheet. As a result of new reporting guidelines, its recently reported reserve estimates appear to be significantly understated (more below).

The company began drilling wells in 1999-2000. The production experienced to date has been significantly lower than initially predicted (when the stock was $15). The reasons for the lower production cited by the company are 1) naturally occurring fluids entering the well bore, 2) slower than anticipated production of wells due to underground reservoir characteristics that became apparent only when the wells were placed into production and 3) the inability to drill additional wells due to a shortage of available capital. The company has since taken steps to minimize fluid problems in existing wells by mechanical means and to avoid fluid problems in future wells by using different drilling and completion techniques. Capital problems have been addressed by a recent rights offering which raised $9 million and by ongoing negotiations with the company’s current lender, BankOne. The rights offering allowed shareholders to purchase 3 new shares at $0.25 per share. Prior to the offering, the stock was trading around a $1.00 per share.

In 2002 Bank One unexpectedly reduced the company’s borrowing base under its line of credit from $10 million to $3 million and demanded immediate payment of $6 million. The company filed suit claiming Bank One had acted improperly and has asked the court for $50 million in actual damages and $100 million in punitive damages. Bank One claims it has acted in accordance with the original agreements. A trial is expected to take place this summer if there is no negotiated settlement. The current balance on the Bank One debt is $5 million. Once this dispute is settled, the company should not have difficulty finding a new credit facility which would go toward growing the company’s drilling operations.

Reserves:
In the 2003 10-K, Tengasco reported the present value (PV10) of its reserves was $26 million down from $46 million the prior year. However, nothing changed geologically with the properties. The difference in estimates (made by Ryder, Scott) is a result of new guidelines whereby reserves can only be counted if the company has the financial wherewithal to pull them out of the ground. Since Tengasco was cash strapped before the rights offering and before a settlement with BankOne, the reserves are significantly understated. The $46 million figure appears to be a more useful figure if one were to try to ascertain the intrinsic value of the assets, in particular if the company were decide to sell itself. Underlying the $46 million estimate is an assumption of $26.90 price per barrel of oil (oil is now about 50% higher) and $4.22 per Mcf of gas (gas is now about 25% higher). In addition, based on geological, seismological and historical information, the company believes there is significant potential for more oil and gas reserves on properties within the company’s lease footprint that are adjacent to areas already drilled. The company has stated that they believe they have a “high probability of producing hydrocarbons” in some of these areas. This potential is not included in the PV10 calculation.

Valuation:
Assuming the after-tax PV10 of the reserves is $40 million (there is a sizable NOL), the pipeline which cost $15 million to build is worth $5 million, the lawsuit provides nothing and the adjacent land which appears promising is worth $2 million, the equity value of the company is approximately $0.83 per share.

Risks:
The company has had a bad few years while trying to get back on the right foot after being terribly mismanaged. In order for the stock to trade at or near fair value the company is going to have to show some results. This means waiting for the drilling activities (resumed April 23rd) to bear fruit. I estimate this will take 6 months to a year.

Catalyst

Re-starting the drilling program and showing some results.
Settling BankOne issues and getting a new line of credit to enhance drilling operations.
Perhaps a sale of the company to another E&P company looking to grow its reserve base.