www.ValueInvestingCongress.

com

8th annual Spring

value investing congress

May 7, 2013 Las Vegas, NV

A Rare Breed:
Cheap Stock in a Pricey Market
Guy Gottfried, Rational Investment Group

Join us for the 9th Annual New York Value Investing Congress!

To register and benefit from a special discount go to www.ValueInvestingCongress.com/SAVE

A Rare Breed:
Cheap Stock in a Pricey Market
Guy Gottfried, Rational Investment Group
(647) 346-0464 guygottfried@rationalig.com

Agenda

One investing lesson

One investment idea

Performance: Value Investing Congress

Recommendations vs. Fund as a Whole

MRC
BRK
HLC
TWMC
CLK
CAM

Closing Price
Prior to
Closing Price
3-May-13 Dividends Presentation Total Return
$115.50
$1.05
$59.00
98%
5.40
0.02
2.45
121%
3.40
0.10
2.80
25%
4.39
0.47
2.25
116%
9.50
0.15
7.55
28%
9.62
0.00
5.05
90%
Average/weighted average:
Date presented
Holding period (months)
Total return
Annualized return - VIC picks
Annualized return - Fund (gross)

Date
Presented
3-May-11
17-Oct-11
7-May-12
7-May-12
1-Oct-12
1-Oct-12

Mar. 2012
13
80%
70%
28%

*Note: prices in local currency. Gross return used for fund in order to compare pure investment performance (since VIC picks
returns are not adjusted for any fees).

Why Have VIC Picks Fared So Much Better?

Skeptical view: stocks pop because Ive spoken about them in

public forum

However, recommendations gained approximately 10% on day

I pitched them

10% on first day not enough to drive 80% gain year or two later

Returns driven by positive fundamental developments within

underlying businesses
So whats the explanation?

Its Not You, Its Me

Difference is in my thought process in selecting what to recommend at

VIC

Know that Ill be publicizing idea to hundreds of attendees, numerous

others via internet

Also aware that some may invest in idea based on my analysis

When presenting at VIC, I know that Im putting my reputation on the line

and therefore feel greater-than-usual pressure to not screw up

Result: Greater Discipline

Particularly selective as far as choosing which investment to

present

Even stricter in terms of my criteria (business, balance

sheet, management and capital allocation, price)

Insist on even greater margin of safety

The Million Dollar Question

If it works so well, why not apply same level of strictness to

entire portfolio?

Of course, not every investment will work out like The Brick,
Trans World, Canam etc. but thats not the point

If it can help enhance ones discipline and decision-making, then

it is worthwhile asking question below
Next time you evaluate a potential investment, ask yourself:
Is this something that Id feel comfortable recommending to a
large audience and staking my name on it?

Investment Idea: WPX Energy (WPX)

Oil and Gas Producer

Snapshot
Recent Price

Diluted Shares O/S

$16.40

207 million

Market Cap

Enterprise Value

$3.4 billion

$4.9 billion

Background

Former exploration and production (E&P) division of Williams

Companies (WMB)

Spun off by WMB at start of 2012

Predominantly natural gas producer; production mix: 81% gas, 9% oil,

10% natural gas liquids (NGL)

Principal assets: Piceance Basin, Bakken and Marcellus Shales

Why is WPX Worth Your Attention?

Metrics from 2012 disposition of non-core assets imply

stock value 69% to 105% above current price

Sale not only involved two of WPXs worst properties, but also
done with gas prices 40% below todays levels

Other industry transactions of far lower-quality assets

imply upside of over 100%

Trades at 8x free cash flow (FCF) at $4 gas with material

growth prospects

Why is WPX Worth Your Attention?

Valued at 66% of tangible equity

E&Ps normally trade at several times book value; rarely at discount

unless overleveraged

One of strongest balance sheets in E&P sector

Multiple catalysts and other positive near-term developments

Why is It So Cheap?

Spinoff dynamics: WMB wanted to separate WPX in order to unlock

value of its midstream assets

Spinoff occurred at worst possible time just as gas prices plunged

to 13-year lows

Commodity weakness, managements conservative capital spending

policy obscure growth prospects

Grew rapidly as part of WMB but hasnt had chance to do so as independent

entity

Comments by Sell-Side Analysts

Two recent initiations of coverage produced interesting insights

Report #1 (Nov. 2012):

Not to be understated, the balance sheet is a key attribute from a capital preservation
perspective, the stock is unique amongst our coverage group.

On its surface, WPX is one of the most attractively valued E&Ps of the peer group. We see the
stock at a 40% discount to peers on a proved reserves basis.

Report #2 (Apr. 2013):

We believe WPX has one of the strongest balance sheets in the sector, and especially among gas
levered names.

WPX shares also trade at a meaningful discount to its peers.

Reports recognize WPXs attractiveness yet neither rates it as Buy

Telling remark (from report #2): Bottom line, we view WPX shares as inexpensive, and we like
the financial flexibility that its clean balance sheet provides, but we dont expect the stock to
outperform without a continued increase in natural gas prices.

Accounting Creates Confusion

Two accounting methods for exploration and production

activities: full cost and successful efforts

WPX follows successful efforts, expenses all G&A

Former allows overhead costs associated with exploration and

development to be capitalized; latter does not

Most peers follow full cost; some capitalize up to half their G&A

Company often criticized for having bloated G&A costs

relative to peers who employ full cost

Penalized for using more conservative accounting

Asset Quality: Piceance

Companys largest, most important asset

Most efficient producer in Piceance by far

In best part of basin: Piceance Valley; accounts for vast majority of

reserves, production

Structurally lower cost (drill from much lower elevation to reach same formation)
Only player with meaningful presence in Valley

Recent major discovery in Niobrara shale

Enormous reserve potential; more on this later

Cost Advantage in Piceance

*Source:WPX

Asset Quality: Bakken and Marcellus

Recognized among best, if not the best oil and dry gas shale
plays, respectively

North Dakota Bakken: most prolific oil field in US

Prudhoe Bay, largest US oil field to date, produced 1.5 million b/d of
oil for 9 years before going into decline; ND Bakken projected to
sustain that rate for 25 years*
WPX in core of play

Marcellus: too early to tell whether company in core as

operations have been hampered by infrastructure issues

Despite bottlenecks, WPX has seen substantial reserve growth, cut

production costs in half last year alone

*Source: Oil and Gas Journal

Proved Reserve Growth

Bakken Proved Reserves (Bcfe)
350

600
480

500

322

300
250

400

200

286

300
200

Marcellus Proved Reserves (Bcfe)

142

150
137

100

100

50

0
2010

2011

2012

28
2010

2011

2012

Asset Quality: Additional Properties

Oil exploration: company drilling and leasing acreage in undisclosed

oil play

Others: San Juan Basin, Powder River Basin (PRB), Apco Oil and Gas
(oil-weighted producer in Argentina and Columbia; WPX owns 69%)

Announcement likely coming this summer

Lower-quality properties, directing almost no capital, pursuing disposition of

PRB and Apco

Above assets very small relative to size of company

Piceance, Bakken and Marcellus account for ~90% of reserves and

production, even greater proportion of intrinsic value

Finding and Development Costs

One of lowest F&D costs in industry

*Source:WPX, JP Morgan

Management

CEO Ralph Hill joined WMB in 1981

straight out of college

Has been running WPX (E&P division of WMB prior to spinoff) for 20 years

WMB nearly went bankrupt in 2002; Hill forced to sell assets in order to raise
cash for parent company

Largely built business into what it is today

Experience has helped shape attitude toward maintaining balance sheet strength

$21 million in WPX shares 12x 2012 cash compensation (much higher based
on intrinsic value)

A Few Words on Natural Gas

Prices have rebounded from 13-year lows in 2012 but remain weak (now at $4)
Average NYMEX Price, 2000 to 2012
10
9
8

$7.23

$6.86

$6.14

$5.39
$4.89

5
4

$9.03

$8.62

$3.89

$4.27

$3.99

$4.39

$4.04

$3.22

$2.79

3
2
1
0

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Median
Ex-2012

Supply: Producers Cutting Back

Major declines in gas drilling, spending across industry

Most E&Ps have portfolio of oil, liquids-rich and dry gas plays; returns on
first two (esp. oil) dramatically superior to gas

Shale boom has saddled industry with debt as firms feverishly leased
acreage, drilled to hold by production

Production still stable due primarily to associated gas from shale oil
and liquids-rich drilling but this highly unlikely to offset reduced gas
drilling indefinitely
Will take sustained higher prices to stimulate growth by industry as a
whole given preference for oil and NGL development

Natural Gas Rig Count vs. Price

Gas rigs near 18-year lows, down 62% since 2011;
continuing to fall despite recent price increase

*Sources: Baker Hughes, Reuters

Rig Count: Gas vs. Oil

Oil rigs now account for 80% of US onshore rig count
compared to approx. half two years ago, one-quarter in 2009

*Sources: Baker Hughes, Natural Gas Intelligence

Demand: Long-Term Trends Favorable

Power: utilities have announced 40 GW of coal plant closures in next

few years 13% of total US coal power capacity*

Natural gas emits half the carbon dioxide per kilowatt hour, much more efficient
(therefore cheaper to operate), drastically cheaper to build
Nuclear not viable alternative public concerns, very expensive; no nuclear plant
built in over 30 years

Industrial: companies spending billions to build or expand US capacity in

order to exploit cheap gas

Longer term considerations: export (LNG terminals), fuel (trucking/logistics

companies)

*Source: Energy Information Administration

Takeaways on Natural Gas

Gas price low, supply set to drop and demand set to rise

Importantly, WPX thesis not predicated on continued price

increase

WPX compellingly undervalued in present commodity

environment

2012 Disposition

Last year, WPX sold its Barnett Shale and Arkoma Basin assets

Bad assets: had taken large write-downs, receiving no capex, dry gas
(whereas WPX has significant oil, NGL reserves)

Dramatically worse than Piceance, Bakken, Marcellus

Reached deal for disposition in April 2012 trough for gas prices (in
low $2s then vs. $4 today)

In short, company sold lousy properties in terrible commodity

environment

Stock Price Implied by Barnett/Arkoma Disposition

WPX significantly undervalued even using metrics from sale of among its
lowest quality assets in harsh price environment
Proceeds

$306

Proved reserves (Bcfe)

225

P/Bcfe proved reserves

1.36

WPX proved reserves (Bcfe)*

5,339

Implied EV

$7,261

Debt

(1,511)

Equity value

$5,750

Per share

$27.79

Premium to stock price

69%

Further, above calculation lumps together gas and oil reserves unlike gas, oil prices
are strong and Bakken is arguably best oil play in US
*Note: amounts in millions unless stated otherwise. Proved reserves as disclosed by company based on 2011 year-end commodity prices
(gas: $3.68 per Mcf, oil and NGL: $86.75 and $51.83 per barrel).

Stock Price Implied by Barnett/Arkoma

Disposition Adjusted for Bakken

Value: proved reserves excl. Bakken

Bakken value*

$6,604
1,863

EV

$8,467

Debt

(1,511)

Equity value

$6,957

Per share

$33.62

Premium to stock price

105%

Over 100% upside using separate (still conservative) value for Bakken
*Note: amounts in millions. Bakken value estimated based on original purchase price, industry transaction.

Recent Piceance Transactions

Two recent deals involving Piceance assets (both announced Nov. 2012)

Bill Barrett: sale of assets in Piceance, Wind River and Powder River basins; Piceance
accounted for ~60% of proved reserves

Antero Resources: sale of all assets in Piceance

Sold at $1.38/Bcfe of proved reserves

Values WPX at $34.01 per share (107% above current price)

Sold at $7,051 per Mcfe of production*

Values WPX at $35.91 per share (119% above current price)

Based on above transactions, value of WPXs Piceance asset alone justifies its
enterprise value, providing rest of business for free

Same applies to aforementioned Barnett/Arkoma disposition

*Note: proved reserves not disclosed for this transaction

FCF Multiple at Current Gas Price

2012 EBITDA
Interest
Taxes
Maintenance capex

$1,000
(102)
(65)
(900)

Incremental FCF: cost improvements

124

Incremental FCF: higher gas price

367

Adjusted FCF

$425

Per share

$2.05

P/FCF

8.0

Attractive multiple for company capable of double-digit annual growth

for years to come in stable price environment
*Note: amounts in millions

Price to Tangible Book

E&P companies typically trade at several times book value;
conversely, WPX trades at meaningful discount

Book value (mil)

$5,151

Per share

$24.90

P/BV

0.66

Peer group median

2.86

Peer group mean

3.53

WPX has lowest P/BV in group; every other peer trading below book is overleveraged (e.g. Chesapeake) while WPX has one of strongest balance sheets in
sector
*Peer group includes 14 E&P firms cited by sell-side analysts covering WPX and additional companies selected due to
comparability (US-based, heavily gas-weighted)

Catalyst: Cost Structure Improvements

Company burdened by several uneconomic contracts expiring or

being replaced this year and next

Also negotiating to buy out unutilized transport commitments

Estimated cumulative pre-tax benefit of $150 to $210 million per

annum starting in 2015

Approx. 40% boost to FCF at $4 gas*

*Note: FCF benefit already incorporated in preceding FCF multiple calculation

Catalyst: Sale of Company

Cheap valuation means buyer can pay sizeable premium and

still execute accretive deal

Larger acquirer can create enormous value on PV basis by spending

more capital to bring reserves into production

Attractive asset base

Low-risk: 100% drilling success rate last year, 99% in 2011 and
2010

Additional Developments

Progress with Niobrara shale

WPXs first well most productive ever drilled in Niobrara formation;

additional wells planned this year
Potential to double 3P reserves
Infrastructure in place formation lies in Piceance just below where
companys already drilled 4,000 wells

Sale of non-core assets

Marketing stake in Apco, PRB; already received offers on latter

Will improve cost metrics (PRB in particular has very high costs),
provide capital to invest in higher-return opportunities

Conclusion
Any way you slice it (transactions, FCF, book value), WPX a
serious bargain
Existing asset base offers considerable growth opportunities
for foreseeable future
Several catalysts and near-term
value-enhancing initiatives
Special thanks: David Ahl
Energy expert who sacrificed many hours helping me better understand the oil and gas business