Caprock: "We are initiating coverage on Pegasi Energy Resources Corporation with a
STRONG BUY rating and with a 12-month price target of $1.50. We believe PGSI’s shares offer investors a unique and favorable risk/reward profile."
Korea District Heating Corporation 071320 Algorithm Investment Report
PGSI's shares offer a unique risk/reward scenario
1. Pegasi Energy Resources Corp.
Pegasi Energy Resources Corp. engages in the exploration and production of
natural gas and oil in the east Texas oil and gas region. The company holds
interests in properties located in Marion and Cass County, Texas.
May 14, 2012 P: 646-875-4973 www.caprockrm.com
Chris Jarvis, CFA, CMT Symbol: PGSI Recommendation: Strong Buy
President & CEO Last Price: $0.85 Target Price: $1.50
chris@caprockrm.com
Risk: Speculative Sector: Energy
Peter White
Executive Vice President & CFO
peter@caprockrm.com
PGSI’s Well Positioned to Have a Breakout Year
We are initiating coverage on Pegasi Energy Resources Corporation with a
STRONG BUY rating and with a 12-month price target of $1.50.
We derived our $1.50 12-month price target by applying a 6.2x multiple to
our Next Twelve Months (NTM) EPS estimate of $0.24. Currently, PGSI’s
shares trade at 3.5x multiple to our forward earnings estimate, a 65%
discount to the company’s peer group average multiple of 10.2x.
We estimate that PGSI will become cash flow positive near the middle of the
calendar year 2012 generating revenues of $10.957 million and EPS of $0.09
for the 2012 Calendar year.
For calendar year 2013 (CY21013), we estimate that PGSI’s EPS will rise
241% from $0.09 in 2012 to $0.30 in 2013.
We are confident in our investment thesis that a strong management team
with geological experience and expertise in the Rodessa field and ability to
accumulate and consolidate acreage will drive and maximize shareholder
wealth.
2. Caprock Risk Management, LLC 5/14/2012
Investment Summary
We are initiating coverage on Pegasi Energy Resources Corporation with a
STRONG BUY rating and with a 12-month price target of $1.50. We believe PGSI’s
shares offer investors a unique and favorable risk/reward profile for the following three
reasons:
“Initiating
coverage with a
1) PGSI’s management team has a long track record of success operating in
STRONG BUY
East Texas, specifically the Rodessa field, dating back to the early 1980’s. In
rating, 12-
addition, PGSI’s management has been focused extensively on the “Corner
month price
target of $1.50” Stone” project for over a decade now and long before PGSI became a public
entity. We believe the years of experience and intimate knowledge that
management brings to the table is on the cusp of bearing fruits for PGSI
investors, which starts with the company’s first horizontal well that is
expected to be completed by June.
2) In the Rodessa field of East Texas, where PGSI operates, ownership of
mineral leases is highly fragmented. As a result, major E&P companies have
avoided the area given the difficultly of acquiring acreage. This creates high
barriers of entry for PGSI’s competitors and with PGSI the leading E&P in
the Rodessa field in terms of acreage by a decent margin, we believe the
company will continue to increase its leading acreage position, consolidating
difficult leaseholds into one package. As PGSI unlocks this value through
consolidation, we believe the company’s acreage portfolio alone will become
“PGSI’s of significant value for a major E&P in the near future. In short, PGSI is in
fundamentals the sweet spot of the Rodessa field; not too big that the highly fragmented
and current leases are non-material to the company’s business model and big enough to
valuation offers be the leading acreage acquirer.
investors a
unique and 3) PGSI’s shares are currently trading at a deep discount to its peer group
favorable average valuation as the company has flown under the radar for most
risk/reward institutional and individual investors. However, we believe the successful
scenario” completion of the company’s first horizontal well in the coming weeks with
three similar projects behind it slated to roll out over the next 12-to-18
months provides investors seeking exposure to the energy space a favorable
risk/reward scenario.
In summary, we are confident in our investment thesis that a strong management team
with geological experience and expertise in the Rodessa field and ability to accumulate
and consolidate acreage will drive and maximize shareholder wealth. We believe at
current levels, PGSI’s shares are attractive, underpinning our STRONG BUY rating.
Risks
Geopolitical Risks. In our opinion, geopolitical risks remain elevated, especially with
events out of the Middle East and North Africa. The “Arab Spring” has brought wide
scale upheaval in the region. We believe these pressures coupled with Iran’s quest to
become nuclear will intensify as we head into the second half of the year, which should
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3. Caprock Risk Management, LLC 5/14/2012
drive volatility in the energy markets. Given the fact that PGSI’s operations are
domestic, any potential impact of international instability should be mitigated.
Volatility. Although PGSI has roughly 54 million shares outstanding, the shares 3-month
average trading volume per day is 37k. The relatively low level of liquidity could
“Geographical increase share price volatility.
focus mitigates
much of the Correlation to Energy Prices. PGSI’s operating results are correlated to U.S. energy
global prices. Given the elevated geopolitical risks and global macroeconomic cross currents in
geopolitical 2012, energy prices are expected to be volatile. The company does not have a risk
risk” management program in place but following the completion of the Morse #1 well, we
believe management will institute a hedge program when appropriate.
Common Stock is subject to the “Penny Stock” rules and quotations are based on
the “Pink Sheets”. Currently, the Company’s common stock is subject to the “Penny
Stock” rules of the SEC, and the trading market is limited. Common stock is currently
traded based upon quotations over the counter and the bid and ask prices for the
Company’s stock could have wide fluctuations.
Valuation
We derived our $1.50 12-month price target by applying a 6.2x multiple to our
Next Twelve Months (NTM) EPS estimate of $0.24. Currently, PGSI’s shares
“We believe our
trade at 3.5x multiple to our forward earnings estimate, a 65% discount to the
multiple is company’s peer group average multiple of 10.2x (peer group below). In our
conservative opinion, the NTM EPS estimate is the appropriate metric to use considering the
and as completion of the Morse #1 well in the coming months as well as the completion
management of a second horizontal well before the end of the calendar year. Given this, using
executes PGSI’s NTM will capture the company’s true earnings power going forward.
growth strategy
over the next
PGSI’s Peer Group:
12-24 months,
multiple
expansion is S/O Market Cap
likely, or closer Symbol Symbol Last (000's) EPS PE (mil)
to the PGSI’s Spindletop O&G SPND $2.00 7,661 $0.23 8.70x $15.3
peer group Pyramid Oil C o PDO $4.45 4,684 $0.23 19.35x $20.8
multiple of C KX Lands, Inc C KX $12.01 1,942 $0.49 24.51x $23.3
Earthstone Energy ESTE $20.00 1,707 $1.73 11.56x $34.1
10.2x” PostRock Energy C orp PSTR $2.30 12,269 $2.29 1.00x $28.2
Mesa energy MSEH $0.17 80,874 $0.06 2.75x $13.3
C allon Petroleum C o C PE $5.11 39,444 $2.75 1.86x $201.4
Trans Energy TENG $2.30 12,980 $0.70 3.29x $29.9
Texas Vanguard Oil TVOC $11.75 1,417 $0.82 14.33x $16.6
Energy Partners, LTD EPL $15.25 39,233 $1.06 14.39x $598.3
Peer Group Average 10.17x
NTM
Pegasi Energy Resources Corp $0.85 54,200 $0.24 3.54x $46,070.00
Prem/(Disc) -65%
Source: Thomson First Call, CRM Estimates
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4. Caprock Risk Management, LLC 5/14/2012
We derived our 6.2 price-to-earnings multiple by applying a high growth firm multi-stage
P/E model using the following assumptions:
Assumptions:
5-year growth rate: 20%
Post 5-year growth rate: 8%
Assigned Beta 1.8 (High beta reflects drilling execution risk)
Dividend payout first 5-years: 0%
Dividend payout post 5-years: 15%
“We expect Discount rate: 11.76% (equivalent to PV-10 discount rate)
PGSI to turn
cash flow = Price-to-earnings multiple: 6.2x.
positive by the
middle of the
year with Oil
Revenue driving
Earnings Outlook
growth and We estimate that PGSI will become cash flow positive near the middle of the
earnings over calendar year 2012 generating revenues of $10.957 million and EPS of $0.09 for
the next 12-to- the 2012 Calendar year (CY2012). Our estimates for CY2012 are based on the
18 months.” company’s existing production and the completion of Morse #1 well within the
next 60-days and successful drilling and completion of Morse #2 well in the
3Q2012. For calendar year 2013 (CY21013), we estimate that PGSI’s EPS will
rise 241% from $0.09 in 2012 to $0.30 in 2013. Our CY2013 estimates are based
on the company drilling an additional 2 horizontal wells during the 2013 calendar
year. Given managements aggressive growth strategy, we believe our estimates
will likely be conservative if PGSI’s management is successful in raising
additional capital to accelerate the company’s drilling and production goals over
the next 24-months.
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6. Caprock Risk Management, LLC 5/14/2012
Company Overview
Pegasi Energy Resources Corporation (“PGSI”) is a Nevada corporation that is
headquartered in Tyler Texas with operations in Jefferson and properties in Cass and
Marion counties (see PGSI’s Acreage & Operations Map below). The Rodessa oilfield
extends from western Louisiana across the southeastern corner of Cass County and into
the northeastern corner of Marion County both Cass and Marion counties are part of the
Rodessa oil field.
“PGSI’s The company’s strategy is to maximize shareholder wealth by focusing on low-risk
management (geological) profile production by targeting crude and natural gas exploration and
team has a long production (E&P) adjacent to existing or indicated producing areas within the Rodessa oil
and successful field. Pegasi’s management team refers to this strategy as the “Cornerstone Project” and
track record in has a deep understanding of the Rodessa oil field as well as a long operating history of
East Texas, success dating back to 1980. Furthermore, and dating back to the early 1930’s, the
specifically the Rodessa oil field has been operated by small independent companies given the fact that
Rodessa field.” acreage is highly fragmented, which has created high barriers to enter for major oil
companies looking to acquire large blocks of acreage.
We believe Pegasi’s successful operating track record in the Rodessa oil field since 1980
coupled with the company’s ability to acquire and consolidate acreage through a strong
communal footprint in Cass and Marion counties provides investors seeking exposure to
domestic onshore exploration and production of crude oil and natural gas with a unique
opportunity.
Pegasi’s Acreage and Operations Map
Source: EIA, Company Data
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7. Caprock Risk Management, LLC 5/14/2012
East Texas History
Operating History (2000-2007): PGSI’s management team began operations in early
2000 by acquiring leases in the Rodessa field in East Texas. Management’s first
leasehold purchase was roughly 1,500 gross acres (PGSI currently holds roughly 30,000
gross acres to date, representing management’s successful track record for consolidating
acreage in a geographical location that is highly fragmented).
“PGSI’s current
growth In December 2002, management formed First Southern Crown, Ltd, a Texas limited
strategy, the liability partnership, to be a holding company for several operating entities. Management
Cornerstone rolled up their personal investment of $3.5 million for data harvesting and acreage
Project, began acquisition for the Cornerstone Program into First Southern Crown.
over 10-years
ago and is ready PGSI’s History (2007-Current): In December 2007 while operating under a company
to bear fruit for named Maple Mountain Explorations, a Nevada corporation, Maple Mountain entered
PGSI into a share agreement with Pegasi Energy Resources Corporation to acquire all of
shareholders.” PGSI’s outstanding shares. This transaction would also include the folding in of First
Southern Crown’s subsidiaries into Pegasi.
From 2000-to-date, the company has successfully drilled 12 productive wells, of which 8
remain producing. Historically, the company’s exploration and production has been
predominantly for natural gas. However, PGSI recently completed drilling the Morse
Unit #1-H horizontal well that will transform and diversify the company’s existing
production profile from natural gas to oil, a significant new direction for the
company. This well is scheduled to be completed in June
Company Management
We believe PGSI’s founders and principals have a long and successful track record
operating in East Texas, specifically the Rodessa oil field that dates back over 30 years.
PGSI’s Mike Neufeld, CEO, and Bill Sudderth, Executive Vice President, have been
partners since the early 1980’s. Mike Neufeld is a geologist with over 40 years of
experience exploring and developing natural gas and oil in East Texas. Bill Sudderth is a
well-seasoned land man with over three decades of experience in East Texas.
Collectively, both have worked together to drill over 300 wells in Texas and Louisiana,
mainly in East Texas. In our opinion, PGSI shares, underpinned by a strong
management and operating team, provides a unique investment for investors
seeking exposure to domestic onshore exploration and production of natural gas and
oil.
Below, we have highlight PGSI’s management biographies:
Michael H. Neufeld Insider Ownership (Shares)
President, CEO and Director 22,970,253
Mr. Neufeld worked for Pennzoil Company from 1972 to 1976 as Development
Geologist, Exploration Geologist and Senior Geologist working in Pennzoil's Gulf Coast
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8. Caprock Risk Management, LLC 5/14/2012
Division. He then joined American Resources Company from 1976 to 1977 as Senior
Geologist. In 1977 he joined Hunt Oil Company as Sr. Geologist working in the Texas
and Gulf Coast regions. From 1978 to 1981, Mr. Neufeld worked for Croftwood
Corporation as Senior Exploration Geologist and Vice-President of Exploration working
in the Gulf Coast of Louisiana and Texas. In 1983 Mr. Neufeld co-founded SMK Energy,
where exploration efforts were concentrated in East Texas, Gulf Coast Louisiana and the
Rocky Mountains. He graduated from Louisiana State University in 1971 with a B.S.
Degree in Geology.
Bill L. Sudderth Insider Ownership (Shares)
Executive Vice President 22,895,252
Mr. Sudderth began his career at Lone Star Producing Company in 1970 where he
worked through 1971. In late 1971 he joined Midwest Oil Corporation and worked there
until 1974, at which point he became an independent landman working the entire
continental United States. In 1981 Mr. Sudderth became a Certified Professional
Landman. In 1983 Mr. Sudderth co-founded SMK Energy Corporation, along with Mr.
Neufeld, which later merged with Windsor Energy in 1997. Mr. Sudderth received his
B.B.A. Degree from Sam Houston State University in 1970.
Billy Denman Insider Ownership (Shares)
Land Manager -
Mr. Denman has over 25 years of industry expertise and currently serves as Pegasi
“The Energy Resources Corp's Land Manager. Mr. Denman became a certified professional
Cornerstone Landman in 1992, and previously worked with Mr. Neufeld and Mr. Sudderth at SMK
Project is Energy. Mr. Denman received his B.A. Degree from Texas Tech University.
diversifying the
PGSI’s assets Cornerstone Project
into Oil as well
as becoming the
company’s
PGSI’s Cornerstone Project targets resources in and adjacent to existing/indicated
revenue and producing regions of the Rodessa field and slightly north of the Rodessa fault located in
earnings growth Cass and Marion counties. The Rodessa field was discovered on August 3, 1930 with the
driver.” first discovery oil well completed on July 7, 1935. The Rodessa field’s peak production
was in 1936 when over 19 million barrels of oil were produced. Since the original
discovery and production efforts, the Rodessa field has produced over 400 million barrels
of oil and 2.3 trillion cubic feet of natural gas.
Geographically, the Rodessa field is very large extending from the northwest corner of
Louisiana up northward into Miller County, Arkansas and southwestward into Cass and
Marion counties Texas (PGSI’s targeted exploration and production zones). PGSI has
zoned in on proved and producing reservoirs with the Bossier and Cotton Valley (CV)
Lime formations (see formation maps below) that are contained within a 225,000 acre
closure against the Rodessa fault known as the “Cornerstone Area”, thus the name of
PGSI’s strategy named the Cornerstone Project. The Bossier and Cotton Valley
reservoirs have produced over 5 million barrels of high quality light sweet crude in the
last 50 years.
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9. Caprock Risk Management, LLC 5/14/2012
Bossier/Cotton Valley Formations
“PGSI is the
leading acreage
holder in the Source: Company Data
Rodessa field…
The Rodessa field has historically been predominately explored and produced by small
…high barriers independent operators and is not a legacy field for any major oil company since
to enter will inception. As a result, mineral rights are highly fragmented creating high barriers to
likely keep PGSI entry for major exploration and production (“E&P’s) companies seeking to acquire
at the top of the acreage in the Rodessa field. Several major E&P’s have attempted to acquire large
acreage list.” acreage positions, however, the highly fragment leases that require an intensive time
investment as well as expertise necessary to consolidate the acreage necessary for major
E&P’s have led these companies to focus elsewhere geographically. For PGSI, this
creates a competitive advantage in the Rodessa field as management has a long track
record of operating and acquiring acreage through cultivating existing communal
relationships in Cass and Marion counties. In our opinion, PGSI’s ability to
consolidate acreage in the Rodessa field as well as being the largest acreage holder
in the 225,000 acres of the Bossier/Cotton Valley formation unlocks significant value
for shares of PGSI.
PGSI’s Competitive Advantages: Process Driven
PGSI’s 3 step process for identifying, acquiring, and producing acreage in the Rodessa
field is highly unique and specific to PGSI. The process is fortified with years of
expertise/ experience targeting high valued acreage in addition to the company’s ability
to consolidate key acreage by leveraging PGSI’s landmens’ deep rooted community
relationships with mineral owners. Overlaying PGSI’s experience/expertise and
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10. Caprock Risk Management, LLC 5/14/2012
communal ties is PGSI’s cutting edge technology platform that enables the company to
move more swiftly and efficiently relative to other E&Ps operating in the Rodessa field.
Below, we have provided a schematic overview of the company’s process:
PGSI’s 3 Step E&P Process:
#1) Mike
Neufeld
If #3 is not feasible,
Geology Identifies
restart the process.
Attractive
Acreage.
#2) Bill
#2) If acreage
Sudderth and
acquisition is
PGSI’s Technology Platform Billy Denman
feasible, go to (Right of Way Land Services, LLC) call up PGSI’s
step 3, if not
“PGSI’s has repeat 1.
mapping
three system.
competitive
advantages in
the Rodessa #3) If acreage identified
field that will can be acquired, PGSI’s PGSI’s 25 Staffed Landmen Team
drive and landmen make contact (Right of Way Land Services, LLC)
maximize with leaseholders
shareholder
wealth.”
Source: Company Data, CRM estimates
April 2012 Site Visit
During our site visit in early April to the company’s headquarters in Tyler Texas and land
operations in Jefferson, our expectations were exceeded by PGSI’s E&P process,
information systems, and landmens’ long standing relationships with the community.
Clearly looking at Mike Neufeld’s and Bill Sudderth’s successful track record in East
Texas, PGSI’s geological efforts are certainly a major strength for the company. With
that said, our site visit also provided us with a unique insight that is difficult to attain
from an annual report or other financial information available to the investment
community. In our opinion, the insight and information (we go into more detail on
the following page) that we gathered during our site visit accentuates PGSI’s
multiple competitive advantages that enhances and optimizes PGSI’s business
model, which we believe will drive shareholder wealth for the foreseeable future and
is currently being undervalued by the market today.
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11. Caprock Risk Management, LLC 5/14/2012
Right Of Way Land Services, LLC
Jim Gallant is the founder and CEO of Right Of Way Land Services and has a long and
solid relationship with PGSI’s management team of Mike Neufeld, Bill Sudderth, and
Bill Denman. Mr. Gallant, with the help of Mr. Denman, conceptualized and formed
Right of Way Land Services in the early 2000’s. Since then, Jim Gallant and his team
have built a mapping technology around PGSI management’s needs, customizing the
program and fine tuning the platform to its current day form. In addition, Right Of Way
Land Services provides PGSI with a staff of 25 professional landmen that are deeply
rooted in the Cass and Marion county communities, enabling PGSI to consolidate acreage
that in the past, has been difficult to acquire by outside E&Ps. In short, Right Of Way
provides PGSI with a cutting edge technology platform as well as boots on the ground in
the Rodessa field that is well respected in the community.
Technology:
“ROWLS
PGSI uses a cutting edge front-end system that was designed specifically for the
provides cutting
company by Right Of Way Land Services, LLC (company based in Fort Worth Texas) to
edge technology
and boots on target new acreage as well as to manage existing acreage in real-time. The front-end
the ground for interface is a web based program (screen shot on the following page) that provides PGSI
PGSI, a vital with 1) real-time mapping information for prospective and current acreage, 2) easy access
part to our for management, and 3) very user-friendly interface that promotes efficient and timely
investment use of information. In our opinion, PGSI is effectively using this high-end technology
thesis and platform that many of the major E&P’s would likely be envious of.
PGSI’s
attractiveness.” PGSI’s Land Management Front-End System: Cutting Edge Technology for PGSI
Source: Right of Way Land Services, LLC
In summary, PGSI has three very distinctive competitive advantages: 1) Management’s
geological experience and expertise for East Texas, specifically the Rodessa field, 2)
experienced landmen that are utilizing a cutting edge proprietary mapping platform, and
3) using local landmen to consolidate leases in a highly fragment market. We believe
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12. Caprock Risk Management, LLC 5/14/2012
these competitive advantages individually, and collectively, enable PGSI to acquire and
produce acreage in a swift, cost effective manner that is very difficult to replicate by
another competitor, which gives PGSI a leading position in the Rodessa field.
Acreage
As of December 31, 2011, PGSI had 26,868 gross acres, 18,017 net acres with 11,998 net
acres with working interest. We estimate that the company has acquired a significant
amount of more acreage since the beginning of the year, or north of 30,000 gross acres
and 14,000 new acres with working interest. Overall, of the 225,000 gross acres of
Bossier and Cotton Valley formations, we estimate that PGSI now holds roughly 13% of
this total gross acreage while PGSI’s total competitors’ positions (please see “PGSI
Cornerstone Project, Rodessa Field” illustration for competitors) are roughly 8,000 gross
acres collectively, or just under 4%, making PGSI the biggest operator in the region.
“PGSI currently
holds about PGSI Acreage
13% of the total
acreage in the
Rodessa field…
…next biggest
competitor’s
position is 8,000
gross acres or
4% of
Rodessa’s total
acreage.”
Source: Company Data, CRM Estimates
As of December 31, 2011, PGSI has 5,116 developed gross acres and 4,648 developed
net acres while for undeveloped acreage the company had 21,752 gross acres and 7,350
net acres.
PGSI Developed/Undeveloped Acreage
Source: Company Data, CRM Estimates
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13. Caprock Risk Management, LLC 5/14/2012
PGSI Cornerstone Project, Rodessa Field With Competitors
“Acreage and
position in the
Rodessa field a
Source: Company Data, CRM Estimates
puts PGSI pole
position in
Marion and Cass
counties.” Leases Per Acreage
The company has roughly 1,200 leases for Cass and Marion Counties, which averages
out to be about 22 gross acres per lease, 15 net acres per lease, or 10 net acres with
working interest per lease (see chart below). Clearly acreage mineral ownership is highly
fragmented and difficult to consolidate making the Rodessa field unattractive to larger
E&P’s. However, as PGSI continues to consolidate these leases into one package, we
believe a major E&P will begin to take notice as PGSI reaches critical mass required by
the majors.
Number of Acres Per Lease On Average
Source: Company Data, CRM Estimates
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14. Caprock Risk Management, LLC 5/14/2012
Acreage Comparisons
Based on PGSI’s enterprise value (see chart below), we estimate that the company is
being value at roughly $2,400 per acre. Compared to recent transactions in Eagle Ford
and Bakken over the past few years in which we have calculated the average cost per acre
to be $14,000 (Eagle Ford) and $8,300 (Bakken) respectively, PGSI shares are trading a
significant discount on a per acreage basis. We believe the discount largely reflects the
fact that the major E&P’s are not in the Rodessa field given the fact that mineral leases
are so fragmented and difficult to consolidate. As PGSI accumulates the Rodessa
acreage, we believe these efforts will bear fruit for PGSI shares as management unlocks
the value of this acreage through consolidation.
Cost Per Acre Comparisons
“On a per acre
basis, PGSI’s
shares are
trading at a
discount to
recent
transactions in
the Eagle Ford
and Bakken.”
Source: Company Data, CRM Estimates
*PGSI Enterprise Value is Market Cap + LT Debt Equals $54.3 Million
PGSI Growth & Diversification Strategy
“Morse #1 Well Over the next 12-24 months, PGSI is targeting 8 horizontal wells in each of the five
a major target zones for total wells of 40. The wells will be predominantly oil and represents a
milestone for significant new direction for the company. Not only will this strategy switch the
PGSI… company’s portfolio from predominantly natural gas to predominantly oil, we estimate
the new production will have a significant impact on PGSI economics (see our estimates
… Will on the following page). PGSI just completed the first of these 8 horizontal wells called
transform and the Morse #1. In addition, the company expects to drill a second horizontal well in the
diversify the summer called Morse #2 with roughly the same economics as Morse #1. PGSI expects to
company’s complete this well within in the next 60 days. PGSI raised capital in July 2011 with total
assets as well costs for drilling and completion of $6 million, representing a significant capital
as drive investment for the company.
growth”
Going forward, the company will likely use the cash flow from Morse #1 as well as
raising capital or debt financing, or combination of all three, to drill Morse #2. We
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15. Caprock Risk Management, LLC 5/14/2012
believe the success of Morse #1 will enable the company to be in a strong position to
finance the company’s growth strategy and ability to raise addition capital.
Production 2009 2010 2011 2012E
Net oil production (Bbls) 5,719 4,346 4,063 101,639
Net gas production (Mcf) 64,003 61,678 117,461 200,387
Average sales price per Bbl of oil $56.62 $76.11 $93.63 $100.00
Average sales price per Mcf of gas $3.25 $3.91 $3.85 $2.18
Year-Over-Year Growth 2009 2010 2011 2012E
Net oil production (Bbls) -24.0% -6.5% 2401.6%
Net gas production (Mcf) -3.6% 90.4% 70.6%
“Morse #1 Well Average sales price per Bbl of oil 34.4% 23.0% 6.8%
scheduled to be Average sales price per Mcf of gas 20.3% -1.5% -43.3%
completed by
June and a Crude Production: Morse #1 & 2 Will Have a Material Impact on PGSI
second
horizontal well
slated to be
drilled and
completed by
the 3Q should
push PGSI’s oil
production over
100k barrels in
2012.”
Source: Company Data, CRM Estimates
For 2012, we estimate the company will generate revenues of $10.956 million with oil
revenue accounting for nearly 93%, or $10.163 million (please see our revenue per
category on the following page). We estimate PGSI will generate $0.438 million for
natural gas revenues. Although we forecast a significant increase for the company’s
natural gas production, we have modeled in an average price per MMBtu of $2.18, which
makes our natural gas estimates conservative. A strong rebound in natural gas prices
would prompt us to raise our estimates, a scenario that we believe is likely given our
2012 forecast (see our macroeconomic section on page 21 for our price forecast). All of
our estimates have been based on the successful completion of Morse #1 in the coming
months and Morse #2 this summer.
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16. Caprock Risk Management, LLC 5/14/2012
CRM’s 2012 Revenue Estimates Per Category
“PGIS’s
Horizontal well
will push PGSI
revenue mix
heavily towards
oil…
…however,
PGSI’s natural
gas assets are
robust and any Source: Company Data, CRM Estimates
rebound in NG
prices will CRM’s 2012 Quarterly Revenue & Gross Margin Estimates
create a second
source of
significant
revenue”
Source: Company Data, CRM Estimates
By the end of 2012, we believe that PGSI’s annual run rate for revenues should be around
$20 million with oil revenue from the Morse #1 and Morse #2 accounting for the bulk of
the revenue. If the company is successful in raising addition capital to drill 2 to 3 more
horizontal wells heading into 2013, we believe PGSI would be on solid footing to drive
and maintain a rapid growth rate over the next 12-24 months.
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17. Caprock Risk Management, LLC 5/14/2012
3rd Party Engineering Report
PGSI’s latest engineering report, dated 1/31/2012, generated by James E. Smith &
Associates estimates Total Proved (P1) to be $23.8 million with Probable of $11.1
million and Possible of $111.3 million. Total Proved and Probable (P2) is $34.874
million. We believe with the successful completion of Morse #1 and Morse #2 in the
summer, the company’s PV-10 will likely be significantly high this time next year.
James E. Smith &B Associates, Inc. 1/31/2012 Engineering Report
PGSI PV-‐10 P1 P2 P3
rd
“3 Party $23,763.569 $34,874.753 $146,192.042
Proved
Engineering Proved Proved Non-‐ Behind Proved Total
shows Income Entities Unit Producing Producing Pipe Undeveloped Proved Probable Possible
significant Gross Oil Production (MBBLS) 18.990 71.070 468.989 205.428 764.477 205.428 15,667.015
Proven Behind Gross Natural Gas Production (MMCF) 1,070.717 678.711 13,968.628 11,477.167 27,195.223 11,474.746 72,487.320
Net Oil Production (MBBLS) 9.473 42.612 280.896 115.173 448.154 108.280 6,663.315
Pipe and PV-10 Net Gas Production (MMCF) 352.819 411.191 8,357.710 5,744.294 14,866.014 5,461.298 35,620.441
should Net Oil Price ($/BBL) $92.100 $92.100 $92.100 $92.100 $92.100 $92.100 $92.100
significantly Net Gas price ($/MCF) $3.620 $3.620 $3.620 $3.620 $3.620 $3.620 $3.620
increase Net Oil Sales (MS) $872.463 $3,924.565 $25,870.522 $10,607.433 $41,274.983 $9,972.588 $613,691.312
Net Gas Sales (MS) $1,277.205 $1,488.511 $30,254.910 $20,794.344 $53,814.971 $19,769.899 $128,945.996
following PUD Total Net Sales (MS) $2,149.668 $5,413.077 $56,125.432 $31,401.778 $95,089.954 $29,742.487 $742,637.308
to PDP with the Ad V alorem Tax (MS) $81.461 $207.466 $2,106.536 $1,174.122 $3,569.585 $1,111.997 $28,186.760
Morse 1 and 2 Production Tax (MS) $113.173 $226.383 $3,462.006 $2,048.683 $5,850.245 $1,942.579 $37,968.254
wells coming in Direct Operating Expense (MS) $955.183 $1,057.251 $11,113.015 $2,235.012 $15,360.461 $2,112.854 $132,277.812
Equity Investment (MS) $0.000 $640.000 $4,400.000 $8,195.000 $13,235.000 $7,832.000 $311,244.469
line in 2012.” Future Net Cash Flow (MS) $999.851 $3,281.977 $35,043.875 $17,748.961 $57,074.663 $16,743.057 $232,960.013
Cum. Disc. (10%) Cash Flow (MS) $863.789 $1,914.899 $8,595.262 $12,389.619 $23,763.569 $11,111.184 $111,317.289
Life (YRS) 8.7 26.8 42.6 10.3 42.6 10.8 44.7
Source: James E. Smith & Associates and Company Data
PGSI Total Proved (P1) Per Segment (000’s): PV-10
Source: James E. Smith & Associates and Company Data
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18. Caprock Risk Management, LLC 5/14/2012
PGSI Total Proved, Probable, and Possible (000’s): PV-10
Source: James E. Smith & Associates and Company Data
PGSI Total P1, P2, and P3 (000’s): PV-10
Source: James E. Smith & Associates and Company Data
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19. Caprock Risk Management, LLC 5/14/2012
Financial Review
In 2011, Pegasi finished the year off on a strong note both operational and financially.
Pegasi’s production rose in 2011 while production costs fell simultaneously, which we
highlighted below:
Operating Highlights:
Description 2010 2011 Y-O-Y %^
Net Oil Production (Bbls) 4,346 4,063 -6.5%
Net Gas Production (Mcf) 61,678 117,461 90.4%
“Cratering Total Production (MBoe) 14,626 23,640 61.6%
natural gas Average sales price per Bbls of oil $76.11 $93.63 23.0%
prices more
than offset an Average sales price per Mcf of gas $3.91 $3.85 -1.5%
increase in gas Average production cost per Boe $14.07 $10.87 -22.7%
production of
over 90% in Source: Company Data, CRM Estimates
2011 over the
previous year…
Income Statement Review:
… a rebound in For the Year Ending December, 31
gas prices
would provide
Results of Operations ( 000's) 2010 2011
PGSI investors Revenues
with another Gas Revenues 248 458
significant Oil Revenues 331 380
increase in
Other Revenues 309 350
revenue
streams” Total Revenues 888 1,188
Operating Expenses 645 681
General and Administrative 2,083 2,175
Depletion and Depreciation 187 277
Total Operating Expenses 2,915 3,133
Operating Loss (2,027) (1,945)
Other Expenses (4,267) (3,409)
Miscellaneous Income ( Loss) (197) 785
Net Loss (6,491) (4,569)
Source: Company Data, CRM Estimates
Total Revenues jumped 34% in 2011 year-over-year versus 2010. Gas revenues
increased 85% for the same time period, primarily from the Norbord well that came
online in December 2010 while Oil revenues increased 15%, mainly due to higher oil
prices.
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20. Caprock Risk Management, LLC 5/14/2012
Total Operating Expenses were 7% higher, driven by an increase in depletion and
depreciation. Pegasi continues to closely manage General and Administration expenses
as well as SG&A expenses as both fell as a percentage of total revenues in 2011.
We believe that Pegasi is on track to generate net income and cash flow from operations
in 2012, given the company’s drilling program that should continue to bolster PGSI’s
balance sheet.
Balance Sheet Review:
Financial Condition ( 000's) At December 31
2010 2011
Assets
Cash $250 $6,749
Other Current Assets 775 674
Total Current Assets 1,025 7,423
Net Property and Equipment 20,689 22,188
Other Assets 1,266 210
Total Assets $22,980 $29,821
Liabilities
Current Liabilities $11,204 $7,827
LT Debt and Other Liabilities 5,147 8,657
Total Liabilities 16,351 16,484
Total Equity 6,629 13,337
Total Liabilities and Equity $22,980 $29,821
Source: Company Data, CRM Estimates
In 2011, Pegasi significantly improved its financial condition when it raised $5,200,000
of equity. As a result, cash increased to $6,749,000 while negative working capital
decreased to $404,000 and debt to equity ratio improved to 1.2 to 1.
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21. Caprock Risk Management, LLC 5/14/2012
Macro Economic: 2012 Energy Markets Outlook
For 2012, we believe there is a significant amount of uncertainty for the energy
“Geopolitical
markets that could drive major price swings in either direction from current levels
Risks will
making this the most difficult year in recent memory for our year-ahead preview.
dominate
The two major issues overhanging the global markets are no strangers to the energy
headlines in
2012 with
complex: 1) European debt issue and 2) Geopolitical risks. However, we believe as
Europe concerns Europe kicks the can down the road over the systemic debt issues overhanging sovereign
taking a back nations, the risk of the Euro breaking up in some format will be elevated in 2012 while
seat” geopolitical risks, which are a constant, are not appropriately discounted the heightened
level of turmoil in the Middle East and beyond. In fact, we believe geopolitical risks in
2012 will dominate the headlines, especially as we head into the second half of the year.
In short, 2012 could be one for the books as we expect volatility to be elevated relative to
historic levels.
2012
Price
Targets
At the beginning of the year, we raised our WTI price target from $100 to $125 a
barrel for 2012. We believe the average price for the year will be $110. Incorporating
geopolitical risk such as a successful oil embargo on Iran, we believe prices can rise
between $125 and $150 a barrel in relatively short order. A direct military conflict with
Iran would push prices $150+ depending on the length and severity of the campaign.
“Crude oil prices Our 2012 price target for natural gas is $2.50 MMBtu, which we adjusted down
are likely to from our original 2012 price target of $3.75 MMBtu. We have revised down our price
remain elevated target given the fact that we had one of the warmest winters on record, which lead to the
given weakest withdrawal season in over 20-years. Although prices have recently broken the
geopolitical $2.00 MMBtu level, we do believe price spikes lower will likely be short lived. At
risks and an current levels, or $2.34 MMBtu, we wouldn’t be surprised to see a retest of the recent
improving global lows set in April, especially as we head into the peak injection season which occurs in
economy… late May. However, we do believe fundamentals have to improve based on structural
issues alone. Maximum storage capacity for the U.S. is 4.1 TCF. Once the injection
…natural gas season comes to an end in late October, we will likely reach capacity at 4.1 TCF, which is
prices will put in only about 250 BCF over the all-time high set last year (3.852 TCF), or 6.4% higher than
a secular bottom
the previous high and much lower than our current surplus of 58% over the 5-year
in 2012”
average. Furthermore, the extreme price moves lower have caused forced shut-ins as
well as natural gas rigs counts hitting a 20+ year low. If the 2012/2013 winter is colder
than the national averages, we believe the withdrawal season could be one of the
strongest considering declining production levels. In short, we expect a silver lining for
the natural gas producers once this year’s injection season comes to an end in the fall.
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22. Caprock Risk Management, LLC 5/14/2012
Disclosures and Certification: Independent Fee-Based Research
• CRM only accepts cash compensation for our work and do not accept any
compensation contingent on the content or conclusions of the research or
the resulting impact on share price.
• Report Discloser:
- CRM received a 12-month contract for $4,116 a month starting March
15, 2012 to launch and maintain independent fee-based research on
Pegasi Energy Resource Corporation shares.
- CRM and/or our staff have no personal, professional, or financial
relationship with Pegasi or its subsidiaries, agents, or trading entities.
- CRM analyst credentials, including professional designations and
experience: Chris Jarvis is Chairman, Chief Executive Officer, and
President of Caprock. He has served as Senior Commodities Strategist
for vFinance Investments, a unit of National Holdings Corporation of
New York, New York. Prior to working at National, Mr. Jarvis was a
senior energy and commodities strategist with Merrill Lynch and
Advest.
He holds a BA from University of Massachusetts and a MBA from
University of Connecticut. Christopher has earned the right to use the
Chartered Financial Analyst (CFA) designation. He is a member of the
CFA Institute. Lastly, Christopher has also earned the right to use the
Chartered Market Technician (CMT) designation and is a member of
Market Technicians Association (MTA).
CRM will provide continuing coverage on Pegasi. Interested parties can
either visit www.caprockrm.com or email Chris Jarvis at
Chris@caprockrm.com or Peter@caprockrm.com for future updates.
CRM is not aware of any matters that could reasonably be expected to
impair our objectivity in drafting the report.
There is no history of recommendations for the subject-company and
number and distribution of recommendations for all companies we cover.
I, Christopher C. Jarvis, hereby certify that the analysis or
recommendations contained in the report, if any, represent the true
opinions of the author or authors.
CRM refrains from engaging in, or receiving compensation from, any
investment banking or corporate finance-related activities with the issuer.
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23. Caprock Risk Management, LLC 5/14/2012
CRM’s analyst(s) do not share information about the subject company or
the timing of the release of a research report with any person who could
have the ability to trade in advance of (“front run”) the release of a report.
CRM and affiliates refrain from trading in the shares of the subject
company in advance of the release of a report or update.
CRM refrains from trading in a manner that is contrary to, or inconsistent
with, the employees’ or the firm’s most recent published recommendations
or ratings, except in circumstances of unanticipated extreme financial
hardship.
CRM abides by all laws, rules, and regulations that apply to registered or
regulated analysts.
About Caprock
Chris Jarvis, CFA, CMT founded Caprock Risk Management, LLC (“CRM” or
“Caprock”) in 2006. Caprock’s mission is to add value for our clients by
providing superior market intelligence and advisory services for energy risk
management.
Management
and
Employees
Chris Jarvis is Chairman, Chief Executive Officer, and President of Caprock. He
has served as Senior Commodities Strategist for vFinance Investments, a unit of
National Holdings Corporation of New York, New York. Prior to working at
National, Mr. Jarvis was a senior energy and commodities strategist with Merrill
Lynch and Advest. He holds a BA from University of Massachusetts and a MBA
from University of Connecticut. Christopher has earned the right to use the
Chartered Financial Analyst (CFA) designation. He is a member of the CFA
Institute. Lastly, Christopher has also earned the right to use the Chartered
Market Technician (CMT) designation and is a member of Market Technicians
Association (MTA).
Peter White is Executive Vice President and Chief Financial Officer. Mr. White
is an innovative and proficient executive with over 30 years of experience with
private and publicly traded companies in the financial and investment sectors. A
CPA, Mr. White has a MBA from New York University and an MAB from
Bowdoin College.
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24. Caprock Risk Management, LLC 5/14/2012
Disclaimer
This publication is intended for informational purposes only and the opinions
set forth herein should not be viewed as an offer or solicitation to buy, sell or
otherwise trade Equities, futures and/or options. All opinions and information
contained in this document constitute Caprock Risk Management (CRM)
judgment as of the date of this document and are subject to change without
notice. CRM, persons connected with it, members of the CRM, subsidiaries
and affiliates ("Affiliated Companies") and their respective directors and
employees may, directly or indirectly, effect or have effected a transaction for
their own account in the investments referred to in the material contained
herein before or after the material is published to any customer of an
Affiliated Company or may give advice to customers which may differ from
or be inconsistent with the information and opinions contained herein. While
the information contained herein was obtained from sources believed to be
reliable, no Affiliated Company accepts any liability whatsoever for any
direct, indirect or consequential loss arising from any inaccuracy herein or
from any use of this document or its contents.
This document may not be reproduced, distributed, or published in electronic,
paper, or other form for any purpose without the prior written consent of
CRM. This report has been prepared without regard to the specific investment
objectives, financial situation and needs of any particular recipient.
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