Quicksilver Gas Services: Mercury rising

These days, if you’re buying a house in or around Forth Worth, Texas, negotiations with your realtor probably won’t just revolve around marble tiling, slate roofs and granite countertops — you might also have a conversation about shale.

That’s because the region surrounding Fort Worth overlays a massive shale formation (known as Barnett Shale) that holds an enormous amount of high-BTU natural gas that mining companies are eager to get a hold of and new gas service entrant Quicksilver Gas Services (NYSE:KGS) is eager to process.

To mine Barnett Shale, mining companies have been paying huge premiums to landowners to lease mineral rights (as high as $23,000 per acre). Expensive, but worth it — as long as gas prices remain near their present all-time highs, that is. 

Mining activity in the Barnett play has grown exponentially to over 8,000 producing wells today from just one in 1981. That explosion has been primarily driven by the gargantuan amounts of gas waiting to be withdrawn. Current estimates indicate upwards of 30 trillion cubic feet of gas in the ground, making it perhaps the second-largest onshore gas field in the United States. But no one knows for sure; it seems the more they drill, the more they find.

However, what’s really turned up the competitive heat for producers was the development in the past decade of new and more efficient extraction techniques like hydraulic fracturing and horizontal drilling that made the process much more economically attractive.

Because of this, the mercury appears to be rising in the Barnett gas processing space.

Given the coincidence of this mining boom and levitating gas prices, it seems that the planets couldn’t have been more favorably aligned for the auspicious mid-2007 IPO of Quicksilver.

The $606 million market-cap company owns and operates a gas gathering pipeline system and two gas processing, treating and compressing plants aimed at serving the numerous gas producers in the area. As a “mid-stream” processor, Quicksilver stands in a lucrative middle ground, having the necessary expertise for getting the gas products ready for market but not facing direct commodity price exposure since it doesn’t ever take title to the gas it processes.

Its $97.7 million IPO proceeds were used to pay startup capital back to its 73% owner: Quicksilver Resources Inc. (NYSE:KWK) — one of the bigger gas extraction firms in the area.

Besides controlling the company, the parent also currently provides the bulk (89%) of the company’s gas processing volumes thanks to a 10-year fixed-fee service contract. Those volumes could double very soon for Quicksilver because of its plans to spend $550 million in 2008 to drill over 200 new wells.

Even so, the company is actively trying to diversify its revenue stream by attracting service contracts with other producers. Taking a cue from the very nature of gases, Quicksilver is expanding as fast as it can to fill the empty spots in the regional gas gathering space by extending its network reach.

To do this, the company is spending $80 million in 2008 to add pipelines and complete its third processing facility, which, when it goes online in early 2009, should add 62% more to volume capacity.
 
All this investment seems justified given that in the fourth quarter, the company added 67 new wells to its network and saw processing volumes rise 151% while gathering volume shot up 194% year over year.

But it’s not all just pipe dreams for Quicksilver. This growth has also translated into great financial results. Both fourth-quarter net income and revenues tripled from fourth-quarter 2006 levels. Even though third-party service revenues are still in the minority, the company’s diversification efforts seem to be paying off, as witnessed by a 17-fold increase rise in these revenues over the year.

So it’s not surprising that analyst sentiment is quite positive about the company. Goldman Sachs’ David Chiaro, for instance, has a bullish “buy” rating on the stock and raised his six-month price target to $28 on Feb. 26, based on a 33% 12-month distribution growth rate.

UBS Securities analyst Ronald Barone also “buy” rates the company but lowered his 12-month price target to $32 on Feb. 27 due to higher-costs of capital and sector risks. Among the risks he noted was the imbalanced dependence on a single producer for the majority of revenues.

But there is a silver lining to that dependency as well. It has afforded Quicksilver the ability to leverage its parent’s operational infrastructure and experienced management and the option to buy up certain of its physical assets, such as sections of completed pipeline, when it wants to.

In trading, the stock has proven rather un-mercurial since its August launch. After reaching its 52-week low of $20.10 on its first day of trading, it quickly regained composure and wound its way up to a high of $26.89 on April 9. The stock closed on Tuesday at $24.97 (an 19% increase from its $21 IPO price).

Assuming smooth growth execution and stable gas prices, the only visible long-term challenge facing the company is to keep weaning itself off its cozy parental relationship by gaining a stable and diversified client mix. It will also need to do this if it wants to outgun the other gas processors in the Barnett play, such as Crosstex Energy LP (Nasdaq:XTEX), DCP Midstream LP (NYSE:DPM) and Energy Transfer Partners LP (NYSE:ETP) down the line.

But for now, given its processed gas revenue momentum and parent’s drilling activity, long-term prospects look fantastic. Who knows, Quicksilver could become the fastest gas draw in the West.

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