Investor Opportunities in Shale Oil and Gas Drilling

By: The_Energy_Report

After nearly 30 years as an investment banker and another 20 years providing consulting to small companies, Newport Capital Consultants Founder and President Gary Bryant knows all the ins, outs, risks and rewards of small-cap investment. In this exclusive interview with The Energy Report, he shares his knowledge on what factors push small- and mid-cap growth, as well as some surprising new business models changing the dynamics of shale drilling.

The Energy Report: Gary, can you tell us about your background in small- and micro-cap stocks? You have a special interest in these.

Gary Bryant: I do. The microcaps and smallcaps have been my expertise for a number of years. I got in the business in the '60s, and in December 1963 I got a securities license. In 1965 I was fortunate enough to start my own brokerage firm, Anderson, Bryant & Company with my partner Anderson, and we did a lot of small-cap deals through the years. I was lucky enough to be one of the founders of the Regional Investment Bankers Syndicate, which was the forerunner to the National Investment Bankers Association. That began in response to deregulation in securities markets in '78, which made it difficult for small-cap brokers to operate because the large-cap brokers could no longer do business with them on those syndications. It worked really well, and we were able to syndicate a lot of offerings that way.

TER: You have said that the small- and micro-caps are key to a vital economy. Can you elaborate on that?

GB: In the United States of America, it's the real way to employ people in the absence of large-scale manufacturing. But small companies need funding, and it's been a lot harder since September 11 to get anything done. Some of the small-cap companies that I have helped fund went from zero employees to 1,200 in a matter of three years.

TER: Aside from obvious liquidity issues, what are some dangers of investing in small- and micro-cap stocks?

GB: Let's say you buy an SEC Rule 506 private placement, and you put $25,000 into it. These have to be accredited investors, meaning sophisticated, high net worth corporate or institutional investors. Thus, most of the time companies do get pretty good amounts of money. But what happens if they sell to only five or 10 investors and raise a quarter of a million dollars when the business plan calls for $1 million (M) or $2M? If you're stuck in a company that didn't get enough funding, you stand a good chance of losing your money.

Another problem is that even after they've raised capital, a lot of small companies don't have sales to justify being public. It happens all the time. However, there are many counter-examples that do get enough funding to successfully go public.

TER: Gary, what do you do for companies today?

GB: I consult for these companies and introduce them to investment bankers and capital markets. I was an investment banker all my life, and I know that business very well. I have strong relationships with broker dealers around the country.

TER: When you take a micro-cap deal to an investment bank, what's the first question they want to ask you?

GB: The first question is always, "What are their sales?" Most investment bankers qualify companies based on their sales. If your company has $1M or less in sales, then it's definitely a startup. If you're anywhere from $2M to $10M in sales, you're barely getting started. They can work with you a lot better at $50M or $75M in sales.

TER: Does the investment banker want to know how much of this stock you are going to buy, and how long you will hold it?

GB: Not really. I often put my own capital into companies. And if I do, I'm sure to tell them about it. But they would rather I own stock than not.

TER: Aside from lack of sales, what conditions would prompt you to advise a company to wait six months or a year to go public?

GB: Sometimes companies want to go public, but they frankly just don't need to be public. The management doesn't have the experience to be in a public arena. Sometimes companies go public too soon. For example, a fast-growing company may only have $2M or $3M in sales, but its product is good and it is likely to increase sales to $10M the next year or $20M the next. It would behoove the company to hold off until bigger brokerage firms are considering underwriting the company, and when it could get a bigger offering and a much higher market cap.

TER: Does the investment bank want to see that management has mortgaged their houses and gone to their family and friends first?

GB: Sure. That's usually the way it starts out. I'll just give you an example: The founders of the company sometimes put their money in before going to friends and family. The friends and family are usually accredited investors, and will invest half a million or $1M. That will be enough to push the company to the next stage, where they can do another larger private placement and later go public.

TER: What's the sweet spot in market cap size where a company is small enough to give investors huge gains but large enough so that mutual funds can own it?

GB: It's different with almost every company. Generally, companies under a $75M market cap sometimes have mutual funds and hedge funds investing, but not often.

TER: I think you were the lead consultant on Petro Resources, which was later taken out by Magnum Hunter Resources Corp. (MHR:NYSE.A).

GB: That's true. The other day I had the pleasure of talking with Brad Davis, senior vice president of capital markets at Magnum Hunter. The stock came down considerably from $8 to around $4. He said the company was three times better off than it was at $8, yet the general public is not paying the price for the stock. Sometimes stocks trade in a certain range.

Magnum Hunter bought three companies in the past two or three years that had sellers in them, and all of a sudden they get the benefits of a New York Stock Exchange company with a lot of liquidity. I think this is one factor that has caused the company to sell off. You never know.

TER: You're interested in shale-fracking technology. Will this become the new conventional technology as low-hanging fruit dries up?

GB: Absolutely. Hydraulic fracking on shale plays is a tremendous invention. Ten years ago this technology was not developed. As a young man going to high school, I worked on some drilling rigs just to make enough money to buy a car. But when we hit shale, it was a really bad situation. Today they've learned how to go down to depth and then go two miles horizontally. I saw them fracking one of the Barnett Shale wells the other day. It is definitely the new-and-improved process with horizontal drilling.

TER: Do you have any favorite shale-fracking companies?

GB: Certainly. I like the major players, such as Continental Resources Inc. (CLR:NYSE), Devon Energy Corp. (DVN:NYSE) and Williams Companies (WMB:NYSE). They have been doing a lot with these particular formations. Now Magnum Hunter has interesting plays in the three big shale formations: the Eagle Ford, the Marcellus and the Bakken. Of course, there are a lot of other shale players too, like GMX Resources Inc. (GMXR:NYSE) on the border of Texas and Louisiana. It's a gas play, and it's doing pretty well.

TER: Are there any small- or micro-caps you have good feelings about right now?

GB: There's one called Eagleford Oil & Gas Corp. (ECCE:OTCBB) and another called U.S. Energy Corp. (USEG:NYSE), which is run by the Lawson Family. U.S. Energy appears to be doing very well in the Bakken formation in addition to having success in its Wyoming production. I like Lucas Energy Inc. (LEI:NYSE.A). I like CAVU Resources Inc. (CAVR:OTCPK). Billy (William C.) Robinson is the CEO. He's kind of changing his tune on how he's doing business, as are others who are discovering opportunities in the sector beyond oil itself. For example, Xtreme Oil & Gas Inc. (XTOG:OTCBB) and CAVU are both drilling water disposal wells and making quite a bit of money by charging producers for water disposal services. Shale drilling involves getting rid of a tremendous amount of water, which has become a big problem over the last 10 years. For every barrel of oil recovered, some water is also extracted, and it's not like drinking or ocean water. It's more of a brine—twice as heavy and loaded with salt and chemicals.

TER: Do water disposal services de-risk these plays?

GB: They do, because the process alleviates an environmental problem by putting water back in the right sand. Companies build what are called saltwater disposal wells, and drill 4,000–5,000 feet, similar to an oil well. They reach a deeper, different type of sand in which they deposit the water, so it won't touch drinking water sources.

TER: Gary, Xtreme Oil & Gas has been hurt pretty badly over the past 12 months. It's down about 76% over that period, and it has a market cap of under $14M. Why have investors forgotten it?

GB: Knowing this company as well as I do, I know that it was a Gray Sheet company for years, and there was hardly any market in the stock. So when they registered on the Bulletin Board, it was trading around $1, but lightly. Market breaks have suddenly come in and driven the stock down. I've talked to CEO Will McAndrew about this, and the company has earned money two quarters in a row. Its disposal well business should help provide more sales and earnings. It's one of those situations where the company has been improving but the stock has been going the wrong way.

TER: What do you think would get investors' attention here?

GB: Making money three quarters in a row would probably do the trick. It needs to attract more institutional buyers and get the word out. I'm a believer in the value of attending conferences. The company has to do more PR and get some publicity from companies like The Energy Report.

TER: That micro-cap size is just a tough nut to overcome.

GB: It's a very tough nut to overcome. No one has the solution to that. But Will McAndrew can get them out of the ditch. I see it every day. Before the Magnum deal, Petro Resources was a Pink Sheet-type of company, but it went out and raised a lot of money, so it was able to go from Pink Sheets to the American Stock Exchange. A large brokerage firm jumped on them and loaned them $75M to acquire properties up in North Dakota in the Williston Basin. Once companies get the ball rolling, doors open, but that first push is tough sometimes.

TER: Gary, it's been a pleasure meeting you.

GB: My pleasure. Thank you.

Gary Bryant is the current president and founder of Newport Capital Consultants, Inc., an Orange County, California-based firm that has been providing consulting services to private and public companies since 1991. Since gaining his securities license in 1963, he has gained over 40 years of experience in the investment banking services industry, and was recently involved as a co-founder of the Southern California Investment Association (SCIA), which offers select small-cap companies a venue to present to investment professionals. In December of 2006, Gary received the prestigious "Founders Award" from the National Investment Banking Association, and in October of this year he was honored with a lifetime achievement award from the West Coast Wall Street Conference.

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DISCLOSURE:
1) George Mack of The Energy Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned are sponsors of The Energy Report: U.S. Energy Corp.
3) Gary Bryant: I personally and/or my family own shares of the following companies mentioned in this interview: Magnum Hunter Resources Corp., Continental Resources Inc., Chesapeake Energy Corp., Devon Energy Corp., GMX Resources Inc ., Eagle Ford Oil & Gas Corp., Lucas Energy Inc., CAVU Resources Inc. and Xtreme Oil & Gas Inc. I personally and/or my family am paid by the following companies mentioned in this interview: None.

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