Description

Despite the recent sell-off in the energy complex as a result of crude oil weakness, most E&Ps are still up 30-100+% YTD. Most of the mid-to-large cap names in the group trade at 100+% of their net asset values, using a conservative oil price forecast of <$30 from 2006 and beyond and a natural gas price forecast of <$6 (and <$5 from 2007 to 2009). It is rare to find a company trading much below its NAV that does not have some reputation or management issue (see names such as KMG and UCO), and even rarer still to find one with a catalyst that has the potential to help it close the gap… CRK is one such example.

Trading at $20.17 versus a year-end 2005 NAV conservatively determined to $27.56, the stock has a gross return potential of 37%. When you add the value created by the upcoming IPO of its joint venture, Bois d’Arc Energy (BDE), the total return potential expands to 44% (more on that below). This transaction will hopefully serve as the catalyst to highlight the margin of safety in the name.

CRK is focused on the Gulf of Mexico and onshore Texas and Louisiana, and has a consistent history of growing reserves and production. It has added to its asset base with opportunistic acquisitions with an average cost of $0.87/Mcfe (including its recent acquisition of Ovation Energy LLP)…compared to acquisitions by peers typically at >$1/Mcfe and a peer group 3-year average finding & development cost of >$1.50/Mcfe, these deals look quite attractive. Management is focused on low-risk, repeatable drilling and has a significant backlog of prospects: the company quantifies its reserve potential offshore as 1,055 Bcfe, to be contributed to BDE; onshore, assets such as the (potentially) 100-150 Bcfe Ross prospect and (potentially) 350 Bcfe Robin prospect will add substantial reserves if proven (currently, proved reserves are 617 Bcfe). The company’s drilling success rates speak for themselves: 92% in East TX/North LA since 1995; 70% in South TX in 2003-1H 2004; 97% in the Gulf of Mexico in 2003-1H 2004. This has resulted in a 5-year average finding cost of $1.21/Mcfe.

The company’s success in the Gulf of Mexico can be largely attributed to CRK’s lengthy relationship with Bois d’Arc. In 1997, the company acquired $200mm worth of properties from two of the principals of BDE (Gary Blackie and Wayne Laufer), including blocks at Ship Shoal and South Pelto. In addition, CRK signed an agreement with the pair to get an exclusive look at prospects found by the pair, in return for warrants in the company. Given their knowledge of the region, these two provided CRK with numerous profitable wells, and for their work were rewarded with warrants worth $7.5mm in 2003 alone.

CRK created Bois d’Arc earlier this year by contributing 180 Bcfe of offshore reserves – and $103mm in debt – to the JV, while Blackie and Laufer contributed their 120 Bcfe and $49mm in debt. By creating this entity and bringing it public, CRK will realize a number of benefits:

1) Provide it with a significant stake in future GOM exploration prospects.
2) Halt the issuance of warrants for prospects.
3) Allow for more focus and attention on the GOM.
4) Remove the required capital expenses – offshore is far more intense than onshore exploration and development – from CRK…BDE will be self-funding. Thus, CRK will be able to focus more of its capital on its efficient and profitable onshore operations.
5) The IPO should allow BDE to come public nearly debt-free and will substantially reduce CRK’s leverage (by $103mm).

Once all is said and done, CRK will own 51% of the post-IPO entity (from 59.9% today). A quick calculation shows that this transaction creates approximately $1.50 in value for CRK. Added to a conservatively-estimated YE 2005 NAV of $27.56, CRK should trade to $29.

(For those who can, there are numerous candidates to short to hedge out commodity price risk, if that is your leaning…I have no suggestions in this posting as to which are the best candidates but there are many E&Ps trading well above 100% of NAV.)

How did I get to $1.50, one may ask? If you assume that CRK contributes 180 Bcfe to the JV but will be a net owner of 153 Bcfe post-IPO (51% of a 300 Bcfe BDE), it appears they “sold” 27 Bcfe. At an NAV-deduced price per Mcfe of roughly $1.75, the value of the sold reserves is $46.7mm. Since they are able to reduce their debt by $103mm (and BDE should be debt-free by applying the IPO proceeds to its debt balance), the “value” created will be $56.3mm, or ~$1.50/share.

CRK Asset Valuation Summary @ YE2005

Value Total
Quantity $ Per (000s) (000s)
Projected Reserves YE 05
Liquids (Mbbls) 18,952 11.64 220,667
Gas (MMcf) 613,337 1.79 1,096,438
Other Assets at Book Value 12,042

Total 1,329,146

Consolidated Balance Sheet Data:

Working Capital 4,977
Long-Term Debt (327,653)
Exercise Of Options: 31,340
Total Asset Valuation 1,037,811

Fully-Diluted Shares 37,660

Asset Value--$/Share $27.56

Plus Value Created by Bois d'Arc IPO $1.50
Total CRK per share Value $29.06

Shares Outstanding 34,111
Outstanding Warrants/Options 3,549


(Assumptions: using only proved reserves; modest 3% reserve growth from 2004E to 2005E, none thereafter; price of oil at $29 for 2006 and ranging from $26-$29.28 for the period in question; price of natural gas at $5.25 for 2006 and ranging from $4.70-$5.67 for the period in question; 3% production cost inflation)

Catalyst

BDE IPO - Q1 2005
Exploration success, reserves booking for 2004