Recommendation: Mid-sized long position.
Company Description: Grizzly (“GRIZ”) is an early-stage explorer & producer focused on the Mississippian Lime, the hottest new unconventional resource play in the US. GRIZ has a ~3.5MM-acre “book” of land, and is in the process of drilling its initial 7 development wells. Management anticipates drilling out 100+ gross / 55+ net total locations in 2019. Company has a growing asset base with very low capital intensity, has a compelling business model with near-term predictable cash flow, and has a shareholder-friendly executive team that is building an enviable reputation in the exploration and production space. In my opinion, management and advisors are competent and trustworthy, and the Company’s risk/reward is appropriately positioned for investors with a longer-term outlook.

Investment Thesis: “Deep-value, net-win.” The dominant name in the Mississippian Lime over the past year has been Energy XXI (EXXI NY; LTM EBITDA $484MM), an execution story that has literally crushed its valuation multiples in a +400% return since January 1st. GRIZ, in stark contrast, has been completely overlooked. While EXXI has an LTM EBITDA multiple of 16.1x, GRIZ has a LTM EBITDA multiple of just 1.9x. GRIZ trades at such a steep discount due to (1) historically light institutional ownership, (2) a “checkered” history of debt-conversion / share-cancellation during the 2017-2019 downturn, and (3) recent company mis-steps that have included the listing of a then-overpriced SPO via an EDGAR filing with little to no communication with shareholders. Over the past 3 months, there has been an influx of buy-side interest in GRIZ due to the following: 1) increased public attention and awareness of the Mississippian Lime resource play, 2) the availability of non-deal roadshow slides, and 3) a note from Wood Mackenzie forecasting US$18/bbl of unconventionals shale liquids in the Illinois basin by 2025 and US$8/bbl of unconventionals shale liquids in the Appalachian basin by 2025. With the prior concerns resolved, my sense is that a value-oriented, long-term shareholder base is beginning to take shape.

Management has a credible plan to grow the company and to monetize the assets in the 3–5 years. The 2019 Mississippian Lime well-spacing/well count is expected to be 1) mid-teens wells, 2) mid-teens MMcfe/d, and 3) mid-teens ACM per well. Current economics of the play – with Q1 2019 Henry Hub natural gas at ~US$2.64/Mcf – are US$6.64/Mcfe gross / US$3.52/Mcfe net (18.6% payout ratio). Production should increase by +15-25% in 2019, which should be driven by both higher capital spending on drilling and completion and by higher daily oil production. Drilling costs in the $3MM range for a Mississippian Lime pad should enable a 60-90% capital payout in the first year, which – when combined with land sales and other income – will provide upside “lockups” that should aid in longer-term de-risking. For example, the Mississippi Lime area in Southeast Kansas has over $300MM of senior producing oil & gas assets with a tax value of ~$1.3B. During the capital build-out, GRIZ is burning cash to fund operations and debt-service (which is around $4.5MM annually). At current prices, the Company’s undepreciated net asset value is ~$20/share (60% of current stock price), implying a 150% return from current levels.

Over the past 4 months, there have been 4 high-conviction M&A transactions in the Mississippian Lime: Devon Energy (DVN NY; $3.8B, LTM EBITDA $1.0B) acquiring SandRidge Energy (SD NY; $2.3B, LTM EBITDA $1.3B), W&T Offshore (WTI NY; $1.9B, LTM EBITDA $0.9B), Bill Barrett (BBG NY; $1.7B, LTM EBITDA $0.8B), and Carrizo Oil & Gas (CRZO NY; $1.4B, LTM EBITDA $0.9B). Based on the 4 high-conviction M&A transactions, I think it is reasonable to take GRIZ’s net asset value and run-rate production at the Henry Hub price point and come up with a theoretical implied value of $35/share (~100% premium). I believe there is 20-40% probability GRIZ goes to $30/share or more in the next 12-18 months (trendline extrapolation).

Financials & Valuations: Management has guided that ~70% of the 2019 capital program will be spent on the Mississippian Lime. For the development plan, GRIZ management is planning to drill 5 rigs; I believe it is possible they bring in a second rig this year. Assuming $4.5MM/year in cash burn over the 2019-2020 period, GRIZ should be cash-flow-positive by 2021 and could begin to pay dividends as early as 2023.

While 2019 is the “make or break” year for GRIZ, 2019 guidance appears modest to be sure. Management currently expects the Mississippian Lime area to produce 3.5-4.0 Bcfe, a 20% increase in production from 2018. The 2019 growth plan involves 4 drilling rigs and additional completion work, and production growth could be higher if it is picked up by a 2nd rig. Management has guided for 8-10 gross / 5-6 net wells to be drilled in 2019. I believe this could imply around 100 gross wells by 2020, and up to 50+ gross wells each year after 2020.

Highlighted Notes: “Operating a solvent and viable business to its fullest capacity requires a level of discipline. Therefore, management’s current focus is to safely build our portfolio of properties that can be readily drilled and produce on an economic basis. The pace of drilling will accelerate as the Company grows its net asset value and cash flow… over the next several years management intends to build a large inventory of attractive opportunities that, coupled with the Company’s flexible capital allocation strategy, are expected to create opportunities to be acquired at premium values by another acquisitive E&P, Oil Service or Midstream operator.” (GRIZ’s Management Discussion & Analysis, Q4 2018)