CRGY - HighPeak Energy: New Issue Issues Mitigated

Summary

• It is hard to understate the relative safety of a new issue that goes public when "no one else goes public".
• Management has built and sold companies before.
• The emphasis the Midland Basin appears to have backing from more established operators.
• The finance strategy appears aggressive. But the outlook for robust commodity prices appears to be reasonable.
• A combination of organic growth and acquisitions is likely to continue.

HighPeak Energy ( HPK ) began life as a public company at a very unusual time. That generally mitigates a lot of new issue risks. Research long ago established that roughly 95% of new issues will disappear without a trace within about 5 years of going public. That usually applies to the time in the market cycle when hoards of companies go public in an industry during a favorable environment. Writers such as David Dreman have covered this in their books many times over, and it is a standard subject in business school finance classes.

But a new issue that goes public when hardly anyone goes public is a whole other ballgame.

Clearly, this new issue went public at a time when "no one in their right mind" would have even thought about such an idea. People who "know" would wait for more favorable conditions. Anything had to be more favorable than fiscal year 2020.

But a knowledgeable owner who sees a chance to make money when few others do is likely to go public at any time simply because they can. It is actually a sign of a quality issue that the company could sell shares during a time like 2020.

The Chairman and CEO, Jack Hightower, is a person who has built companies before. His reputation for making money for investors is probably one reason that this company could even think about going public at a time when many others did not have the option.

For shareholders and potential investors, most would know that insiders go public when they think they can get a good price for the stock. Indeed, the stock price did drop somewhat after the initial trading began. However, there is a world of difference between paying "top dollar" at the bottom of the market and "top dollar" at a market peak. The difference is shown above as the stock price has appreciated decently from the market bottom.

That means there is a measure of safety to the risky business of investing in new issues that go public when "no one else is".

Midland Basin

Further confirmation of the management strategy is the operators also heading in the same direction.

HighPeak Energy has operations in the Midland area. Well-established operator Diamondback Energy ( FANG ) not only had acreage there as shown above but also has recently announced a second acquisition in the Central Basin as it heads in this general direction. Another operator, Laredo Petroleum, considers this the most profitable acreage in its portfolio to the point that it is solely developing this acreage at the current time.

This is the kind of confirmation of strategy that a new issue needs when an investor is doing the necessary due diligence. The Midland and Central Basin appear to be the new "hot spots" in Texas because the cost of this acreage is cheaper than known hot spots like Reeves County. So, the strategy is to achieve better corporate profitability through lower acreage costs.

Most companies do not show the acreage cost in the well breakeven presentation because the acreage cost is not a proper cost to consider in whether or not to drill a well. However, that acreage cost per well will help determine corporate profitability as it has to be accounted for as do all the costs before there are shareholder profits. So, there is a time when "all the costs", particularly acreage costs are relevant. Having acreage costs in a breakeven calculation for wells demonstrates to shareholders at least one material reason why corporate profitability is often lower than well profitability.

Finances

Long-term debt is approximately $562 million at the end of the third quarter. There is an additional working capital deficit as well. The current environment of robust commodity prices allows for a comfortable debt ratio in the current environment.

As management demonstrates above, just about any projected EBITDA will cover the current debt and working capital deficit comfortably. This management appears to have a robust view of the future. That would make sense from an absence of speculative money that would have allowed a lot more companies to go public at the same time with rich pricing.

The current environment appears to allow for some decent commodity prices for the foreseeable future. This would allow what would normally be a risky debt strategy to succeed long before the cyclical top occurs. The management experience of building companies before this one mitigates the risk of rapid growth. So even though both of these are risks, this management is doing a lot of this at the right time with less competition than might otherwise be the case at a different time in the business cycle. This also explains why management was willing to go public at a time when not many others would.

Investors should probably expect a continuation of organic growth and acquisition in the future. There are a lot of companies out there that were formed to take advantage of this buyers' market. Crescent Energy ( CRGY ) and Earthstone Energy ( ESTE ) would be two obvious companies with the same strategy. All of these companies, including this one, have a very favorable environment to continue the strategy because the competition is not yet what it will become at a cyclical business top.

Risks

In addition to the ones described, the CEO and Chairman is key to the company's success. His demise or absence would have a material effect on the company in the future.

An unexpected drop in commodity prices to (for example) WTI $40 would definitely slow down the expected progress here. This company appears to be set up for prices as low as WTI $70. That to me appears to be very reasonable.

The Future

This new issue has far better than expected odds of success (for the typical new issue). The aggressive growth strategy that management has embarked upon appears warranted, in my opinion. When considering new issues in any industry, investors need to consider the new issues that go public when "no one else does" like this one. This is the kind of new issue that has a far better than normal chance to succeed. The quality of a new issue like this one is seldom matched, if ever, by the rush of new issues at a cyclical market top.

This is a company that is going to be built to be sold. Therefore, if an investor decides that this company is for them, then the time to sell is when the backer sells the company or when the strategy appears to be becoming too risky for the business environment. A management as experienced as this management should treat investors well as long as the investor knows how to handle the risks.

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