Description

W&T Offshore (WTI) appears to be the best value in the Energy sector at the moment.

W&T trades substantially below private market valuations, is being overlooked compared with a number of similarly situated peers, and presents a highly asymmetric investment opportunity.

W&T Offshore has 3 main assets that could easily be worth two times the current share price:

1) Offshore Gulf of Mexico ($1.75bn): >90% of production, balanced across a number of fields (60/40 Shelf/Deepwater) and commodities (50/50 Natural Gas/Liquids)

2) Permian Basin (“Yellow Rose”, $1bn): 25,000 net acres; Adjacent to Diamondback Energy (FANG), Pioneer (PXD), SM Energy (SM), and QEP’s recent acreage acquisition

3) East Texas: 150,000 net acres ($300mn); Adjacent to EOG, Anadarko (APC), and SM Energy (SM)

The Enterprise Value calculation to understand current valuation is: $400mn of Retirement Obligations, ~$1bn of Long-Term Debt, and at $15/share an equity value of ~$1.1bn. EV = ~$2.5bn.

Walking through this 3-Part valuation:

**1**  Producing Value is fairly easy to estimate as the company gives Proved Developed Producing (PDP) Value of $1.9bn, at $100/bbl Oil, $35/bbl NGLs, and $3.98 gas. Marking gas to $5, leads to a $2bn PDP valuation.

(Note: in addition to the above, as is common offshore, the company reports ~$500mn of Proved Developed Non-Producing Value (PDNP), which is for reserves that are up-hole in a currently producing wellbore and which for almost no cost can be developed once the bottom-hole formation is finished producing).

To verify this valuation:

1) Note that at the above commodity prices, next year’s operating cash flow is ~$700mn. Creating the company for 3.7x operating cash flow seems attractive.

2)The company’s 20-member lending syndicate has approved an $800mn secured borrowing base, which by industry standard is 2/3 of the PDP Value at ~$75 oil, net of Retirement Obligations. At $75 oil, PDP value is ~$1.6bn, so net of $400mn in retirement obligations leaves $1.2bn and further validates this PDP valuation model.

W&T has also shown a proven ability to source prospects and grow value through exploration in the Gulf of Mexico. In 2013, this was most visible with discoveries (in partnership with Noble (NBL)) at Big Bend, Troubadour, and Dantzler. Noble’s Engineered Resource estimates (P75-P25) for these discoveries are 21-45 million boe net to W&T Offshore with an associated Present Value of $300-$700mn. These discoveries will be developed and come online over the course of 2015-2016.

Besides these high-profile discoveries, W&T has shown an ability over the years to grow production and reserves through basic, lower-risk drilling at existing fields.  However, for conservatism, one could give no valuation credit to the current portfolio of exploration prospects despite a number of interesting prospects at Mahogany, Matterhorn, and East Cameron 321.

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**2**  The most surprising discrepancy (opportunity) with W&T Offshore is ironically onshore. Anyone paying attention to US Unconventional Oil will agree that the Permian Basin appears to be the next (and maybe largest) opportunity to unlock unconventional oil resources at low costs (<$60 oil price breakevens).  When you examine W&T’s contiguous acreage position, it is adjacent and intermingled with Diamondback (FANG) and Pioneer (PXD) acreage, both of which are some of the best performing energy companies over the last 12 months as a result of excitement around this acreage.

Specifically, the opportunity on this acreage is to have multiple “benches”/drilling targets within a single footprint of land.  Based on initial drilling results by WTI, FANG, and PXD on portions of this acreage, the outlook for this acreage is highly favorable. FANG and WTI have drilled short (4000 ft) lateral horizontal wells with Initial Production (IP) rates ranging from 500-600 boe per day. 30-day IP rates have been 440 boe per day (see Diamondback UL III 4-1H Wolfcamp B well) and Independent Engineers (Ryder Scott) have projected 1P (90% confidence interval) reserves per well of 638,000 boe. When compared with the longer laterals (8-10,000 ft) being drilled to the south, these IP rates are comparable with the best wells in the basin. These wells will likely generate single well F&D costs of <$15 ($8mn well cost for 600,000+ boe ultimate recovery) and returns well north of 50%.

WTI has formed a small JV with FANG to drill wells on this acreage and would likely look to monetize this acreage at the right price (>$25k/acre) as these wells come on-line. Importantly, FANG is drilling the Kent CSLA 17-1H Wolfcamp B well with an 8000ft lateral, which will likely de-risk this acreage entirely and further highlight this dramatic valuation discrepancy.

WTI's Permian Basin value is validated is a number of ways:

1) QEP resources recent acquisition of intertwined acreage of almost identical size (with respect to production and acreage) for $950mn in December, which would imply that W&T trades dramatically below private market valuation levels.  QEP appeared to pay $20-25,000 per acre, when adjusted for the value of current production. QEP noted that nearby the best well in the basin thus far, the PXD well University 7-43 10H, was drilled in the Wolfcamp D and had IP rates of >3,600 boe per day (note B vs. D are separate targets so this validates the multi-zone nature of this acreage – there are 5 total target zones).

2) Exxon did a drill-to-earn deal with Endeavor Energy Resources (private company) in the area recently for ~$40,000/acre across 34,000 acres, further validating this acreage.

3) FANG as an entire company is ~3x the size of W&Ts asset (in production and acreage terms) and raised money recently at well over a $3.5bn valuation to purchase more acreage for $22,000/acre this past week.

Therefore, W&Ts acreage should be conservatively valued at $500-600mn and could easily be a $1bn asset (including production) in the private market, given the multi-zone prospectivity of the Wolfcamp A, Wolfcamp B, Wolfcamp D, and Spraberry formations.

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**3**  WTI's third asset is a large (150,000 acre) position targeting the James Lime oil formation in East Texas along with other notably smart onshore explorers EOG, SM, and Anadarko (APC). With a chunky 150,000 acreage position and 5 wells to date, a conservative estimate of value is likely ~$2000/acre, or $300mn for the project. De-risking this acreage would be a further catalyst in the coming year. EOG has reportedly ramped drilling activity in the area recently.

Adding up this fairly conservative (and private market-based) asset valuation of W&T Offshore, you can easily get to $2.75bn of value for the offshore segment ($1.75bn PDP, .5bn PDNP, .5bn non-producing) and $1bn ($250mn PDP, $750mn acreage) for the onshore segment, leading to an Enterprise Value of $3.75bn or $30/share of equity value. An upside/optimistic case probably extends upwards of $40/share of value. Even in a lower commodity price environment, it is very hard to envision a scenario for long-term capital impairment when creating this company for $15/share at the current price.

Finally, shareholders should be comforted that W&T founder, Tracy Krohn, owns ~50% of the equity, and is therefore highly aligned with outside minority shareholders to crystallize value.

Catalysts that should close this valuation gap include:

- Feb 26th: Apache will host an investor day with focus on the Permian where they are expected to announce they will expand activity in the Northern Region

- March 7th: Financial results reporting: should highlight Permian acreage and announce results from the currently drilling FANG wells on WTI's acreage

- Howard Weil Conference: W&T presents at fairly few conferences, however Howard Weil as the premier E&P conference (in March) should help illuminate this opportunity, particularly because the Permian Basin appears to be capturing a large amount of investors mindshare at the moment (evidenced by FANG and RSPP stock movements/valuations) and there will likely be numerous data points coming out around this conference from multiple operators

- Finally, brokers are broadly neutral on this stock - only 4/15 are buy-rated, compared with FANG at 19/20, RSPP at 9/9, and PXD at 27/41 - this sentiment change could magnify any sentiment re-rating

This appears to be a fairly straight-forward and semi-obvious situation to diligence, understand, and value. The following should help corroborate the thesis as laid out above:

http://ir.wtoffshore.com/phoenix.zhtml?c=179783&p=irol-newsArticle&ID=1900153&highlight=

(WTI Operations Update: Good summary of operations and recent discoveries, particularly for Proved Developed Reserve Valuation, and recent Noble Energy Offshore discoveries/valuation)

http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9MjA0OTIwfENoaWxkSUQ9LTF8VHlwZT0z&t=1

(WTI Slides: Specifically slide 28, which shows the contiguous nature of W&Ts Permian acreage and the proximity with PXD, FANG and the FANG UL III 4-1H well)

http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9MjE0Nzk1fENoaWxkSUQ9LTF8VHlwZT0z&t=1

(Most Recent WTI Slides: Specifically slide 21, showing recent well results nearby)

http://files.shareholder.com/downloads/AMDA-1AK3IX/2979707533x0x724639/07A4D90E-EA55-4EC6-80DE-133B18B78344/Diamondback_Feb_14.pdf

(FANG Slides: Specifically slide 9, which shows well results for a number of FANG and PXD wells which are contiguous with WTI acreage)

http://ir.diamondbackenergy.com/releasedetail.cfm?ReleaseID=824053

(FANG Operations Update: particularly Ryder Scott's engineered well recovery of 630,000 boe in the North area)

http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9MjIxMzU1fENoaWxkSUQ9LTF8VHlwZT0z&t=1

(SM Energy Slides: Specifically slide 37, shows economic production from acreage North of WTI's position, and illustrates WTI's successful Wolfcamp A test, confirming at least 3 zones of commercial potential (A,B,D))

http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NTIzMDM4fENoaWxkSUQ9MjA4MzM5fFR5cGU9MQ==&t=1

(SM Energy 3Q Slides: Specifically slide 16, showing adjacent PXD tests of 4 additional zones, leading to 5 zones of potential commerciality)

Catalyst

- Feb 26th: Apache will host an investor day with focus on the Permian where they are expected to announce they will expand activity in the Northern Region

- March 7th: Financial results reporting: should highlight Permian acreage and announce results from the currently drilling FANG wells on WTI's acreage

- Howard Weil Conference: W&T presents at fairly few conferences, however Howard Weil as the premier E&P conference (in March) should help illuminate this opportunity, particularly because the Permian Basin appears to be capturing a large amount of investors mindshare at the moment (evidenced by FANG and RSPP stock movements/valuations) and there will likely be numerous data points coming out around this conference from multiple operators

- Finally, brokers are broadly neutral on this stock - only 4/15 are buy-rated, compared with FANG at 19/20, RSPP at 9/9, and PXD at 27/41 - this sentiment change could magnify any sentiment re-rating