Rising Star Buy: ATP Oil & Gas

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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.

The business
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.

The risks
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.

This article is part of our Rising Star Portfolios series, where we give some of our most promising stock analysts cold, hard cash to manage on the Fool's behalf. We'd like you to track our performance and benefit from these real-money, real-time free stock picks. See all of our Rising Star analysts (and their portfolios).

Dan Dzombak can be found on his Twitter account: @DanDzombak. He owns shares of ATP Oil & Gas. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (5) | Recommend This Article (23)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 20, 2011, at 9:16 AM, TMFOpie wrote:

    Hi Dan, nice write-up. Just curious on what you think the market is missing on ATP, when your PV-10 analysis spits out shares valued at 3x the going rate. Is it the heavy cap ex required or worries about the heavy debt load (interest coverage has dropped). Just want to know what everyone else is missing.Maybe it's just the binary outcome worries that spooks less patient investors. Thanks. Andy.

  • Report this Comment On January 20, 2011, at 12:12 PM, vikingqb wrote:

    What is causing the sell off today.? Permits? Dip to $12.? Debt issue vs Permit issuance,

  • Report this Comment On January 20, 2011, at 6:12 PM, nonzerosum wrote:

    I agree about short term catalysts but I think management has not shown ability to create value. Telemark #2 is good news because its revenues should cover interest expense - I think that takes a lot of risk off the table and you should have mentioned that. HOWEVER, over the last 6 years the management team spent $3.5B and lost $75M in the process. Did they increase reserves during that time? Nope. Per share, debt adjusted BOE haven't really changed. So shareholders got nothing for $3.5B in spending. Based on that I think this is a poor management team.


  • Report this Comment On January 27, 2011, at 12:26 PM, dojodan444 wrote:

    CPE is the real winner here, up more than 5x from where it was a year ago!

  • Report this Comment On August 25, 2012, at 3:35 AM, ipsiety wrote:

    Just went bankrupt ... nice !

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