This article is part of our Rising Stars Portfolios Series.
Today, I'm excited to recommend and open a 2-Year LEAP position in ATP Oil & Gas (Nasdaq: ATPG ) , which at its current value will represent 8% of the year-end portfolio.
Like Cobalt International Energy (NYSE: CIE ) and Callon Petroleum (NYSE: CPE ) , ATP is an exploration and production (E&P) company, unlike them, ATP takes the "E" out of the equation. It does this by buying proven, yet undeveloped, offshore fields and bringing them into production.
2010 was supposed to be such a banner year for ATP that our own Toby Shute picked the company as the best stock for 2010. Life has a way of throwing wrenches in our expectations, though, and that wrench was BP's (NYSE: BP ) Deepwater Horizon disaster. A moratorium was imposed, and a series of confusing new regulations were drafted. The moratorium was lifted in October but deepwater permits were still very difficult to come by.
ATP kept chugging along and finished the year intact. It monetized its ATP Titan adding $150 million of immediate liquidity. The firm then completed its second Telemark well, increasing production and allowed an additional $100 million to be drawn from its asset-backed credit facility. So why do I like it?
Why buy: It's cheap ...
ATP is sitting on large proven reserves and everything is finally falling into place. Using the industry standard PV-10 for valuing proved and probable reserves, and assuming a value of $1 billion for ATP's in place infrastructure, you get a total value of $6.6 billion. Subtracting $2 billion for taxes on the PV-10 and ATP's debt of nearly $1.8 billion, you get an equity value of $2.8 billion. That's over three times the current equity value of $855 million, a huge margin of safety.
... has a strong and aligned management ...
CEO T. Paul Bulmahn has run ATP since he founded it in 1991. As you would expect, he owns a sizeable 12% stake in the company. Bulmahn is no slouch of an owner -- he deftly pulled the company through the debt crisis of 2008, when ATP had a significant need for cash and he has a proven track record of increasing reserves.
... with catalysts!
There are three catalysts which excite me even more:
1. This year, ATP should be able to drill four more wells in the Gulf (two at Telemark and two at Gomez). The increased production should lead the market to revalue the company over time.
2. There has been increased M&A activity in the oil and gas space as the majors have been selling off lesser fields to Energy XXI (Nasdaq: EXXI ) and Occidental Petroleum (NYSE: OXY ) , among others. This gives ATP the opportunity to potentially pick up new reserves on the cheap. Also, there is an increased likelihood of the company being acquired. ATP recently agreed to a new contract for Bulmahn, with a provision that grants him three times his salary and bonus if the company is acquired; he also gets three years of continued medical, dental, life and disability benefits for himself and eligible dependents. This should incentivize him to go along with a sale should an offer come along.
3. Next year ATP should complete the Octabuoy, which will allow it to begin drilling in and producing oil from its Cheviot field in the North Sea.
ATP has survived thus far but still has roughly $1.8 billion of debt, essentially double the firm's entire market cap. The key challenge in 2011 is navigation of the permit process, and the key risk is that the Telemark wells could experience production problems, requiring more the burning of more cash.
I see this stock as a binary outcome: It's either going to soar or crash. As it's already a binary outcome, I'm increasing the reward-risk ratio by buying two January 2013 $12.5 calls of ATP tomorrow. If the stock takes off, I'll do better than what an investor now would make -- if it goes to 0, both I and a stockholder will suffer. It's really the asymmetric payoff which makes this interesting.