opportunity knocks, page-13

interesting article from seekingalpha.com (June 18 - 2008)about Encore a gas and oil play in the US. Selling because they consider themselves undervalued and currently trading on a PE of 52. Some Aust gas and oil stocks would dream of being that undervalued.
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There are so many exploration and production companies in the oil and natural gas space (most have some mix of both oil and natural gas, but are heavily weighted towards one or the other), that it is nearly impossible to keep track of them all unless it was your full time job. That said, one name that keeps popping on my screen is $4 Billion market cap Encore Acquisition (EAC), aka the artist formerly known as $2 Billion market cap Encore Acquisition.... 3 months ago. As they say, a picture is worth a thousand words; this is a 100% gain in under 90 days.

Now for the 1000 words ...

Why do I highlight this name at this point since the horse is FAR out of the barn? Well even after this 100% gain, the company believes its assets are undervalued and potentially could be putting itself up for sale. (this news is from late May)

* Onshore oil and natural gas exploration company Encore Acquisition Co (EAC) said on Wednesday it was exploring strategic alternatives, including a possible sale.
* The Fort Worth company, which has acreage in the Bakken, Haynesville and Tuscaloosa Marine shale plays, said Lehman Brothers Inc has been hired as adviser.
* "It is our belief that Encore's current share price is not reflective of our record operating results and our ability to efficiently fund these projects through our upstream master limited partnership, Encore Energy Partners," Encore Chief Executive Jon Brumley said in a statement.

Judging from the acquisition activity in this space, and their still relative small size (very similar in size to an acquisition XTO Energy (XTO) made in the natural gas space), they could be a nice bolt on addition for a host of companies.

* Encore Acquisition Co (EAC), an oil and gas exploration company which put itself up for sale this week, is likely to draw interest from both big and small suitors whose coffers are full of cash, thanks to record crude prices, analysts said.
* Encore, which owns oil and gas properties in the Permian Basin in west Texas, the Haynesville shale in northern Louisiana and the U.S. Rockies, said on Wednesday it was exploring strategic options because the market is undervaluing its shares.
* "A number of exploration and production companies could pull off this acquisition," Pavel Molchanov, analyst with Raymond James said, noting that Encore's market capitalization is a modest $3 billion. (note, this article was written in late May, the company has increased another $800 million in valuation since!)
* "Even if oil prices were well below where we are today the acquisition of Encore would be significantly accretive to any purchasers, given that incredible strength in oil and gas prices," he said.
* Companies with complementary oil and gas assets that may be interested in acquiring Encore include Occidental Petroleum Corp (OXY), Noble Energy Inc (NBL) and Anadarko Petroleum Corp (APC), Raymond James' Molchanov, said. For example, Occidental has operations in the Permian basin and the U.S. Rocky Mountains, while Noble and Anadarko both have properties in the Rockies.
* Another energy company that may be interested in some of Encore's assets rather than the entire company is Chesapeake Energy Corp (CHK), Phil Weiss, analyst at Argus Research. "If they were to split up the assets and the price were reasonable, I could see Chesapeake being interested in the Haynesville part," Weiss said.
* The announcement surprised some investors because the company's stock is up more than 90 percent so far this year, not a typical performance for an unvalued stock. Still, some analysts said they see room for upside.
* "With Encore's discounted valuation versus its peers and upside to net asset value, we believe this announcement will yield continued outperformance," investment bank Simmons & Co told clients on Thursday.
* And if buyers for Encore do emerge, then the odds of oil-driven deal frenzy go up, David Heikkinen, head of exploration and production research at Tudor, Pickering Holt & Co Securities, said.
* Potential takeover targets include Arena Resources (ARD), Brigham Exploration Co (BEXP), Berry Petroleum Co (BRY), Concho Resources Inc (CXO) and Rex Energy Corp (REXX), Tudor Pickering, said. (a lot of these names have been showing up on my weekly "top performer" lists, especially CXO)

So all things being equal, we might develop a thesis here, that it might be sensible to build in exposure in smaller E&P companies with the carrot of potential takeouts. The typical market cap of the names above is $1 to $3 Billion.

That said, worst case scenario, if you don't get a buyout, one would be stuck with a company whose estimates are exploding upward as analysts have completely understated earnings potential - something I expect to see across the board in this sector. After Encore's last earnings report, in which they produced a $1.08 vs analysts $0.87, the full year estimate for 2008 jumped from $4.33 to $5.14. 30 days earlier it was $3.24. Similar situation in 2009, but again earnings results for these type of companies are very tied to the pricing of crude and natural gas; I do expect to see some weakness at least in the former sometime in the 2nd half of 2008. Oh yes, one more bonus, Encore
bought back 1.2M shares (for about $39M) at an average cost of $33. Not a bad investment, and it reduced shares outstanding by 2% to boot.
So this is one to think about on a pullback...