Model Portfolio rmcduff:RMG2

Spindletop Oil & Gas Co. (OTC BB: SPND) ($5.50) is a debt free microcap oil and gas firm operating primarily in the Fort Worth area of Texas.

I estimate that the trailing EV of Spindletop was $37 million at the end of 2007. The company may have generated $4.7 million of EBITDA.

SPND develops & operates 91% of its gas/oil prospects. Production is largely natural gas. Management has historically used existing cash flow & partners to develop assets.

The company generally spends less on development than is generated from operations. A solid cash balance has built up. Management controls 77% of the shares.

2006 was a transformational year

SPND held 6656 acres of highly prospective Barnett shale acreage, but lacked the necessary capital to develop the assets. 4275 acres of these lands are in Parker County, directly adjacent to production.

A potentially lucrative development agreement was finalized late in 2006. This joint venture (JV), with Williams Production Company, requires Williams to pay 100% of the drilling cost on horizontal wells. SPND maintains a 50% carried interest in each well, at no direct cost.

After 90 days of production, SPND also becomes the operator of each well. I assume that successful wells may be tied into the Spindletop owned gathering system, creating additional pipeline revenues.

The initial results from the Williams' joint venture are encouraging

In late 2006, 2 wells were drilled. They were tied in mid February/March 2007. Initial production rates (net to SPND interest) were 1100 mcf/d (550 mcf/d per well).

Through the 3rd quarter of 2007, Williams had drilled 5 more wells, of which four were considered successful. These wells were far more successful, averaging 1043 MCF per well, net to Spindletop.

Several more wells were planned in the 4th quarter of 2007, but details are not available as of today's date.

Spindletop continues to develop its primary gas field

In the past 3 years, SPND drilled 7 vertical Barnett shale wells on operated acreage in Denton Country. The Denton wells initially produced a daily average of 861 mcf per well and roughly 22 bpd of ngl/oil per well.

Production growth may have exceeded 100% in 2007

It is conceivable to envision 2007 year end natural gas production of 5500 mcf/d. Exit rate oil/ngl production could be 110 bpd.

Further carried interest drilling success may greatly enhance 2008 revenues and 2008 EBITDA

Needless to say, no cost development drilling and well operatorship carries very high profit margins. The firm does not hedge natural gas sales and is fully exposed to rising prices.

If natural gas prices remain above $8 per mcf, 2008 revenues may touch $20 million. EBITDA could exceed $10 million.

This would result in a 2008 year end EV/EBITDA ratio of 3.7X.

Spindletop could be a triple in 3 years time

Tight gas producers tend to sell for higher EBITDA multiples than do conventional gas producers.

Based upon a continuation of the Williams joint venture, an 80% development success ratio and natural gas prices of $8 per mcf; SPND could generate more than $40 million of revenue and $20 million of EBITDA by 2011.

My three year return forecast is based upon a 5X EV/EBITDA ratio, which is in line with conventional producers. This suggests a potential share price of $16.5.

Conclusion

Barnett Shale wells are generally slower to deplete than conventional natural gas wells. The benefits of the Williams JV should become evident, as more wells are brought on stream.

Due to the largely cost free nature of the Williams JV; Spindletop will be able to use internal cash flow to speed up development of its Denton County Texas field.

There are smallish, conventional production E&P firms selling for lower forecast EV/EBITDA. However, few peers are debt free, have cash in the bank and own their own pipeline. I have yet to see a development agreement as generous (for the vendor) as is the Williams JV.