Arabella Warrants Attention

 | Mar 14, 2014 | 3:00 PM EDT  | Comments
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The warrants to purchase Arabella Exploration (ticker: AXPLF, warrant symbol: AXLWF) are the most obscure of my "Mad Money" portfolio holdings. I'll go through the technical details of the warrant below, but it's important to understand what underlies what we're buying.

Arabella currently has seven producing wells (one has a double lateral, so actually eight producing units), two in completion and eight more to be drilled in 2014. The company is in the Southern Delaware Basin in West Texas, primarily targeting the Wolfcamp shale formation. It's a baby company, and the key to the story is twofold.

  1. Increasing production growth, with management providing a credible, well-by-well roadmap. Its projections indicate production (roughly 85% oil) will increase from 106 barrels of oil equivalent per day (BOE/D) at the date of the last reserve report in August 2013 to more than 2,000 BOE/D by the end of 2014. Current production is about 500 BOE/D (all figures represent Arabella's net interest in the wells.)
  2. The juice in the Arabella story is its use of dual-lateral technology, which allows the company to go back into a well and literally add another productive channel. So, Arabella can drill a typical well and then decide after all production log data has been processed whether to add another lateral.

At its most recent presentation, Arabella CEO Jason Hoisager pointed out that this technology has been used successfully offshore -- the North Sea was the example he cited -- for a decade. So, the fundamental story is tight, but there are a few key points to remember about Arabella warrants.

  • They carry a strike price of $5
  • They expire Dec. 24, 2016, the three-year anniversary of the Lone Oak/Arabella combination
  • They are callable at any time should Arabella common trade above $10.50 for 20 of 30 trading days. The call price is $0.01 per warrant.
  • They are only exercisable if the underlying shares are registered in the U.S., which they currently are not (hence the "F" in both ticker symbols.)

So, it might appear that AXLWF is massively "in the money" based on the prices quoted for AXPLF, but the warrants won't be exercisable until Arabella is registered. When I spoke with Hoisager and Arabella board member William Heyn last month at the Independent Petroleum Association of America's OGIs conference in Florida, they estimated it would take a year.

The bigger question is the value of the underlying common stock, which of course, is the ultimate value driver for AXLWF. I went back and looked at "Mad Money" component Miller Energy Resources (MILL) at a similar stage of growth to get a valuation bite on Arabella. Looking at Miller's fiscal results for the period ending April 31, 2013, as a guide is intriguing. At that point, Miller had reached a daily production run rate of 1,700 BOE/D, lower than Arabella's 2014 goal, but "oilier" and thus more valuable, so it's a good comparison.

Miller had an equity market cap of about $175 million when the 2013 results were reported on June 10, 2013, with another $51 million in debt, so, an enterprise value of $226 million. If we assume Arabella is valued that way a year from now (when its 2014 results would have been priced into the stock) that $226 million EV is a benchmark.

Subtract Arabella's $3 million of debt and what I believe will be another $32 million -- assuming an average net interest to Arabella of 50% -- of capital raised this year (to fund their drilling program: $8 million per well x 8 wells x 0.5) gives a net subtraction of $35 million.

Assuming full exercise of Arabella's warrants and knowing that about half are eligible for cashless exercise would add about $26 million to the company's value. So, we arrive at an implied equity value of $217 million for Arabella.

Obviously, all those warrants create a huge change in Arabella's share count (10.7 million assumed exercised + 4.8 million shares outstanding) and the denominator would then be 15.5 million shares.

So, $217 million/15.5 million shares gives a March 2015 fair value for Arabella of $14 per share.

AXLWF is constrained in value by the call provision, which would only kick in after an approximately 50% move in the common, AXPLF, to $10.50, so that's the ceiling on AXLWF's value even if the shares rise to the mid-teens.

That's the roadmap from current market value of $1.16 to a current intrinsic value of $2.28 to a Portfolio Guru fair value of $5.50. I own it for my "Mad Money" portfolios and select risk-tolerant clients.

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