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ATP Oil & Gas (ATPG) will report its yearend 2010 results on March 11th. As of September 30, 2010, the company’s oil and gas mix stood at 54% oil and 46% gas. Oil and condensate revenues from production rose a whopping 53%, to $78.1 million in the third quarter of 2010. Since its incorporation as a publicly traded company in 1991, ATP has had an exceptionally strong development success rate of 98%. This means that of all the proven, yet undeveloped, projects it has taken on, 98% of them produced oil and/or gas. Obviously, management at this company has a knack for productive drilling. (The CEO, Paul Bulmahn, has run ATP since its founding.) The cost of developing these fields, however, has been high. ATP has taken on a considerable amount of debt (almost $1.8 billion, compared to $461 million in shareholders’ equity) to pay for this production. Luckily, interest rates on the debt have been low.

ATP’s portfolio is heavily weighted toward the Gulf of Mexico (GOM), having substantial reserves in the Gomez and Telemark fields. It also is planning to add another 10 wells to its inventory over the next two years. Its remaining holdings are situated in the North Sea.  The company was poised to cash in on its GOM assets last year, before disaster struck in the form of BP’s (BP) Deepwater Horizon oil spill. ATP limped through the remainder of the year (from an operating cash flow viewpoint), by monetizing its Titan holdings for $150 million, and securing more assets in its core Telemark fields. The company also picked up holdings sold cheaply by BP (to pay for its remuneration and liability costs). Debt covenants were renegotiated, and payments were pushed further into the future. At this juncture, ATP is playing a waiting game. That is, it is waiting until it can obtain permits to capitalize on its huge proven reserves. We think this will only be a matter of time. The Obama Administration is keen on ensuring that as many safety measures as possible are put in place before allowing new wells to be opened for business. At the same time, though, there is mounting pressure to allow drilling to resume. The GOM is an important resource for domestic oil production. Due to natural well decline rates, the lack of new permits is reducing production. A greater reliance on foreign oil is something that has become increasingly unpopular among domestic consumers since it speeds the outflow of U.S. wealth to overseas providers, and contributes to the increase in the cost of home heating oil and gas, as well as raising prices at the pump. As a result, pressure to distribute permits to domestic GOM drillers is steadily increasing.

The Case for a Merger
Many large-to-mid-cap oil and gas entities have been eyeing ATP as a potential acquisition. At present, ATP stock looks undervalued given its potential. Once it receives permits to drill in the GOM, however, its stock will likely increase in value, and potential suitors would have to pay much more to buy the company. It appears that it would behoove such buyers to make an offer for ATP before this scenario unfolds. So far, though, as far as we know, no-one has stepped up to the plate. The closer ATP gets to acquiring drilling permits, the more likely, we believe, a company will make an offer for it. ATP’s CEO and President Paul Bulmahn recently agreed to a new contract that grants him three times his present salary plus a large bonus if the company is acquired. This should incentivize him to go along with a sale should an offer arise. In addition, short covering has been intensifying. This is a company that generally has about 40% of its float sold short. This figure has come down considerably in past weeks as traders have increasingly covered their positions, anxious that the stock will soon rise in price. All told, we think this issue holds appeal as a takeover candidate. But even on its own, given imminent potential access to proven reserves in the GOM, new wells being drilled, the high price of oil, unrest in the Middle East, and the likelihood that gas prices will start to rise soon, we think this company can be operating cash flow positive (at a production level of 42 million barrels of oil a day) very soon.

At the time of this article’s writing, the author did not have any positions in any of the companies mentioned.