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A deep dive on Lightstream Resources

Are the much-maligned company's shares a coiled spring waiting to unload? One analyst certainly thinks so

When he was younger, Max Fawcett wanted to make a mint in the markets. Now as the managing editor of Alberta Venture he gets to write about them. Close enough, right? He can be reached at mfawcett@albertaventure.com

Jul 15, 2014

by Max Fawcett

It’s been a bad month for Lightstream Resources (TSE:LTS) and its shareholders. After rallying past the $9 threshold – a far cry from the $30-plus it traded at as PetroBakken a few years ago, but certainly better than the $5.06 low it hit last December – its shares have come back down to $7, and the shares are getting sold with particular vigor today after a disappointing quarterly update that saw the company miss expectations on production.

But if one anonymous buy-side analyst on the Internet (we know, we know) is right, it could be a fantastic buying opportunity. That’s because, as he (she?) details in an extensive post, the company could be on the verge of turning a corner. If it is, the author suggests, it’s a potential multi-bagger in the making. A few weeks back, he noted that the company is finally through the high-decline phase of its Cardium wells, and that they’re starting to cash flow positively. “Cardium wells aren’t cheap to drill,” he writes. “They cost around $4 million to drill, complete, equip and tie-in. And like all unconventional oil wells, they decline quickly. So in the early part of a developing play, the operator is running on a very fast treadmill to grow production. New wells must come online at a geometric rate. But as a play matures, decline rates attenuate. And that means less capital is required to make up for the depletion. At some point, the company crosses a threshold where revenues from production are greater than operating costs and capital expenditures, and it starts to contribute positive free cash flow to the parent. In 2013, LTS crossed that magic threshold in the Cardium. So after three years of operations, the Cardium went from cash hole to cash cow. And now that LTS is over the hump, each year the cash flow profile from the Cardium improves. Why? Because falling decline rates enable LTS to keep production flat while spending significantly less capital and because the Company learns and applies better technology and techniques to increase production.”

He thinks the company’s Cardium acreage represents a “long-term annuity” that will throw off free cash for the next 30 years. And he thinks the company’s acreage in the Swan Hills, which is even more economically attractive than its Cardium play (due to the shorter payback period and a recycle ratio that’s greater than two), offers all kinds of upside. But, of course, there’s a catch – the company’s debt load, which sits at more than three times annual cash flow. CEO John Wright said recently that “we have made no bones about the fact that we are willing to run at higher leverage levels in order to do what we need to do, and some investors don’t like that. We have other investors that aren’t concerned about our level of leverage.” Given the company’s depressed share price, the crowd of investors that is concerned is clearly much bigger than that of those who aren’t.

But our mystery analyst happens to be in Wright’s camp. “The reason I’m not concerned is due to the nature of their debt,” he writes. “LTS has financed itself using a cheap credit facility ($935 million drawn of $1.3 billion total available at May 2014; 3.5 per cent effective interest; secured; due June 2017, but will be extended from there) and $900 million of high yield, unsecured bonds (8.625 per cent interest; due Feb 2020). Once you dive into the details, you begin to appreciate that this is permanent capital. And permanent capital with no near-term maturity or call options equates to significantly less funding risk than other companies with similar debt profiles.” The company, meanwhile, has committed to selling off some assets to bring that number down to a level that more investors will be comfortable with.

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So, here’s the real question: how much is Lightstream really worth? If you apply the metrics of its recent non-core asset sales (eight times cash flow, and $116,000 per boe/d) to its total portfolio of production, you’d have a $14.50 stock, or more than double. Not bad. But what if it just decided to sell of its Bakken unit? “It could easily fetch $120,000 per flowing barrel (likely a low assumption in this market),” our analyst writes. “At $120,000 per boe /d, Lightstream would net over $2 billion, leaving the company with no debt and still producing over 27,000 boe/d. What is that worth? Conservatively, I think $20 per share.” That’s interesting. The problem with that valuation is that it doesn’t attach any value to its undeveloped land, which happens to be considerable. He thinks that could be worth an additional $10 per share.

Sure, this is a profoundly optimistic forecast, and a company that’s had the kind of operational difficulties that Lightstream has had over the past few years probably doesn’t deserve that treatment. But the markets are about value, not justice. And as Sunday’s bid by Whiting Petroleum for Kodiak Oil & Gas shows, Lightstream could one day – and maybe one day soon – justify the premium that our analyst’s forecast puts on it. Why? Well, let’s ask him. “The interesting thing about the target (KOG) is just how similar it is to LTS,” he wrote in another note yesterday. “They are both pure-plays on horizontal production, heavily weighted to oil, have similar production profiles, per-well economics, and cash flows. KOG is quite literally the neighbor across the street. Let me repeat that: KOG is a near-perfect comp to LTS. And the deal announcement between WLL and KOG creates a near-perfect precedent transaction with which to value LTS. So call me confused as I stare at the Grand Canyon-sized gap in valuation between KOG and LTS – it’s the functional equivalent of Zillow valuing your home at $50,000 when your neighbor just sold for $150,000.”

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