Ron Baron likes to buy small companies with growth potential. He holds these companies for long term and watches the business grow. His investment philosophy is more like Peter Lynch, focusing the long term growth of business, but still don't overpay. He has achieved a lot of success with this strategy. His firm now manages more than $19 billion. These are the comments on Gartner, Inc. (IT, Financial), Petroplus Holdings AG (PEPFF.PK, Financial), AECOM Technology (ACM, Financial), Carrizo Oil & Gas (CRZO). All these companies have market cap of a few billion dollars.
Gartner, Inc. (IT)
Gartner is the leading independent provider of research and analysis on the information technology industry. The company’s core research business employs a team of 650 analysts who track, evaluate and quantify technological developments in the IT (information technology) space and convey their findings to customers through published reports and phone/in-person meetings. Typical users of Gartner research include technology end-users, technology vendors, professional service firms, and investors. The company also offers strategic consulting services and hosts events and expositions for the IT community. We believe that the Gartner brand is highly valued in the IT community, as evidenced by its over 80% customer retention rate and its frequent citations in the mass media as the leading expert on IT trends. Gartner currently has about 50,000 subscribers to its research product out of an estimated 1 million U.S.-based IT managers who control a discretionary budget, implying to us that Gartner’s research user base continues to be significantly underpenetrated.
Gartner’s new management team is in the midst of restructuring its core research offering, which we expect will result in improved revenue growth. This platform, now branded as Gartner for IT Leaders, segments research users by their role in an organization and is designed to become the user’s first stop for all technical information and analysis related to his or her specific job. The research is accessed via a role-specific website, which also includes “must read” articles, a list of most viewed articles, blogs, podcasts, market news, and several analytical templates. A subscription to Gartner for IT Leaders costs more than twice as much as the legacy research offering, and since almost no new content will be created, we believe that margins could be higher than the legacy product. Over the longer term, we expect Gartner to further subdivide the roles in its Leaders program, and to launch roll-based offerings for its vendor, consultant, and investor client bases.
In addition to robust revenue growth from its restructured product line, we believe that Gartner’s EBITDA margins are poised to increase due to both a renewed focus on long term value creation and significant operating leverage. During the tech downturn, Gartner’s strategy was to focus on customer retention at the expense of long term value creation. However, a 2004 management change has resulted in several strategic adjustments designed to better capture the value inherent in the Gartner product. These changes include the elimination of significant discounts (up to 60%) off of core research list prices, annual price increases of 3% to 5% following six years of stagnant pricing, the elimination of “enterprise” contracts that granted unlimited research access for a fixed price, increased monitoring of customer usage to reduce subscription sharing, and aggressive sales force expansion to appropriately cover new and underserved accounts. We believe that Gartner’s business model also has operating leverage which should help earnings growth exceed revenue growth. We believe that Gartner’s main sources of operating leverage include its analyst staff, which we think does not need to expand significantly to support the expected growth in sales, and the electronic delivery of its research product.
Petroplus Holdings AG (PEPFF.PK)
Petroplus Holdings is one of the largest independent oil refiners in Europe. We first began acquiring shares in the company’s initial public offering in November 2006, and we have added to our position since then. Refining is an inherently cyclical business, and while we have a positive outlook on refining margins in general, what made Petroplus stand out to us is its management team. The company is led by the same team that built and ultimately sold both Tosco Corporation and, later, Premcor, providing excellent shareholder returns in both cases. In fact, Baron Growth Fund and Baron Small Cap Fund initially invested in Premcor in April 2002 at the IPO price of $24 per share, and the company was acquired a little more than three years later for over $89 per share.
Having created great wealth for both himself and his shareholders, Petroplus CEO Thomas O’Malley could have retired after the sale of Premcor, but as a noted workaholic and dealmaker, he was soon back at work. He found his next challenge in the form of a sleepy little European energy trading and refining company, Petroplus, which was controlled by private equity in search of dynamic leadership for its investment. When O’Malley came to Petroplus, he brought the same strategy that had worked well at Tosco and Premcor— only this time he was going to apply it in Europe instead of in the United States. Rather than be daunted by the change of scenery, O’Malley signaled his confidence in the company by investing over $30 million of his own money when he joined and buying more stock in the IPO.
The game plan at Petroplus is fairly simple: sell-off non-core assets to become a pure-play refiner, operate refineries as efficiently as possible and pursue growth through high-return, quick-payback internal investments while looking for acquisition opportunities that will be significantly accretive. Since O’Malley and team joined in May 2006, it has, in our view, successfully followed through on this strategy. Most remaining non-core storage and trading assets were sold in August last year, and Petroplus today is a pure-play crude oil refiner and wholesaler of the products it produces. In addition, the new operating team has been hard at work to maximize operating synergies and to more efficiently secure crude oil supplies. Finally and most important, the company has completed two transforming refinery acquisitions over the last six months.
In April, Petroplus closed on the acquisition of ExxonMobil’s refinery in Ingolstadt, Germany for $628 million. The transaction was negotiated shortly after O’Malley’s arrival at Petroplus, and his long-standing relationship with the top management at ExxonMobil was a key, in our view, to winning the deal. Ingolstadt was Petroplus’ fourth refinery, and its 110,000 barrels per day of capacity increased the company’s total refining capacity by 37% to about 405,000 barrels per day. In early June, Petroplus closed on the $1.6 billion acquisition of BP’s Coryton refinery near London, which we expect to be over 60% accretive to EPS.
This is a large (172,000 barrels per day throughput capacity), highly complex refinery, and we think it offers excellent synergies with two of the company’s nearby refineries. Once again, this deal was made possible in part by the CEO’s strong relationship with the top management at BP. As busy as Petroplus has been since new management took over, the company is, in our view, well positioned for its next transaction. The company recently completed a successful rights offering that raised $630 million, leaving it with the firepower to pursue one of the nine or so European refineries known to be on the market.
Meanwhile, the macro environment for refining has continued to be supportive. Crack spreads have remained high despite adequate crude oil supply, as refining capacity throughout the world has been tight following years of underinvestment. Exacerbating the near-term supply problem has been increasingly tough specifications for refined products and greater unexpected downtime as refineries show wear and tear from being run all out. In addition, we find refiners are more focused than ever on safety following several high profile accidents over the last couple years.
Over the longterm, supply is expected to increase, but escalating costs and the ever-present “not-in-my-backyard” issue suggest to us the pace of growth will be moderate. At the same time, despite record high prices throughout much of the world, demand for refined products has continued to grow, led by emerging markets— especially China. Thus, we see the supply/ demand balance remaining tight for the foreseeable future, and we think refiners with strong management like Petroplus should be rewarded in the form of high free cash flow.
AECOM Technology (market capitalization: $2.4 billion) (ACM, Financial)
Following the tragic bridge collapse in Minnesota and steam pipe explosion in Manhattan earlier this year, we believe there will be a renewed focus on safer, more modern infrastructure in this country. One company at the forefront of designing and planning for these sustainable needs is AECOM. With $3.5 billion in revenue, AECOM— the “AE” signifying Architects & Engineers — is the largest pure design & engineering firm in the world. The company is a leader in providing technical and architectural planning and support services for a broad range of clients, from blue chip corporations to state and local governments. In simple terms, before any new bridge, highway, subway tunnel or airport terminal can be constructed and made operational, it needs to be designed, planned, and engineered. That’s what AECOM’s team of 30,000 engineers do everyday around the world. The company’s strengths lie, we think, in its end market focus, specifically transportation infrastructure and environmental facilities, sectors which have been seeing rapid growth, its geographic diversity with operations in 60 countries that allow for sharing of best practices, and a prestigious client roster, for whom it works on some of the most complex and notable projects.
Our investment thesis on the company is four-fold: 1) AECOM has leading market share in its respective niches: transportation and environmental engineering projects. We believe these end markets are well positioned to grow, as global growth, especially among developing nations in Asia, India, and the Middle East, have fueled tremendous infrastructure and capacity needs. In addition, the increased urbanization of cities and focus on sustainable environmental buildings has generated demand to design greener, more energy efficient facilities. Healthy state and local budgets and the nearly $300 billion of earmarked federal funding for transportation projects will also in our opinion, help sustain growth for years. 2) AECOM’s global diversity is, we think, unique among its peer group and it is seen as the acquirer of choice in a fragmented industry. The company enjoys significant cross-selling synergies from having offices spread across sixty countries, where it has been able to leverage the expertise from past projects in certain locales toward winning contracts in new geographies. 3) Unlike most engineering firms which tend to have construction arms, AECOM is singularly focused on front-end design work, a lower risk strategy in our view with less exposure to fixed-price contracts and cost overruns. The result is a debt-free business model with healthy free cash generation. 4) The company’s size and leading reputation has led to work on many iconic and high-profile projects. Over the next decade, the company has exclusive contracts for the master planning services for the London 2012 Summer Olympics, program management services for the Second Avenue New York City Subway, renovation of the Pentagon, design of the World Trade Center Path Terminal, and development of Hong Kong’s elevated roadways. The fact that AECOM tends to work on technically interesting and sought after projects, we think, helps it recruit and retain the best employees, a key advantage in the tight labor market for skilled engineers.
Although the company recently came public, it has a long operating history and experienced management team. Current CEO John Dionisio started out as a field engineer at one of the predecessor companies over twenty years ago. In fact, the ten most senior members of the executive team have an average of twenty years experience at the firm. With a proven track record of growth— 20% compounded revenue over ten years and 24% net income over five — combined with the visibility of a $3 billion backlog, we believe AECOM offers a unique way to capitalize on the growth in global infrastructure over the next several decades.
Carrizo Oil & Gas (market capitalization: $1.1 billion) (CRZO)
Carrizo Oil & Gas is actively engaged in the exploration and production of oil and natural gas primarily in proven onshore trends along the U.S. Gulf Coast and the Barnett Shale area in North Texas. The company’s focus is on areas where it can grow production through a repeatable relatively low-risk drilling program (“gas manufacturing”), utilizing advanced 3-D seismic techniques to identify potential oil and gas reserves. Carrizo has grown rapidly over the last five years ending 2006 with proved reserves of 210 billion cubic feet equivalent as compared to 59 billion cubic feet equivalent at the end of 2001, which represents a 29% compound annual growth rate over that period.
The bulk of Carrizo’s current value is in its sizable acreage position in the Barnett Shale of North Texas — the most active natural gas play in the United States. The company was early to recognize the potential of the Barnett Shale and began acquiring acreage in 2003. Today it has almost 87,000 net acres in the Barnett, the majority of which it acquired for an average cost of about $300 to $400 per acre. Similar acreage today goes for 10 times that or more. Since first entering the play in 2003, Carrizo has grown production in the Barnett to about 30 million cubic feet per day at present out of total company production of about 50 million cubic feet per day. With many years of drilling inventory left, we think production in the area should continue to ramp, since recent wells have been prolific. Importantly, we think the economics of a Barnett well are attractive with a development cost of about $1.50 to $1.75 per thousand cubic feet and relatively low lifting costs of about $1.00 per thousand cubic feet.
Beyond the core Barnett and Gulf Coast properties, which we believe support a solid return from the current stock price, we think Carrizo offers great option value through other plays it is pursuing. The largest of these is the Floyd Shale in Alabama and Mississippi, where the company has amassed 137,000 net acres at an average cost of about $75 per acre, which would be worth about $300 per acre today and we think potentially much more in the future. The Floyd Shale is a new area for gas exploration with very little operational data to look at to determine the potential of the play, but Carrizo is hopeful given the many similarities to the Barnett including the age, geology and depth of the shale rock it is targeting. If it is successful in the Floyd Shale, it could be a game changer for Carrizo given its current acreage position not to mention that there is still a significant amount of unleased acreage in the play for the company to go after.
In addition to the Barnett and Floyd Shales, Carrizo has accumulated acreage in several other shale plays that hold potential including the Fayetteville Shale, the Barnett/Woodford Shale of West Texas and the New Albany Shale. None of these are as significant in size and/or as prospective as the previously mentioned shale plays, but together they cover over 107,000 acres that we think could someday be valuable to Carrizo and for which the stock receives no value today. Of course, exploration can be a risky business, and a recently drilled high impact well known as Mega-Mata in South Texas appears to be non-commercial. On the other hand, another recent well in the North Sea was a success, and our preliminary estimates suggest it could add at least $6.00 per share to Carrizo’s net asset value. If any of Carrizo’s emerging opportunities are successful, in our view it would be icing on the cake to what should be a solid growth story out of the North Texas Barnett Shale alone.
Fontainebleau Resorts (market capitalization: $1.3 billion)
During the quarter, we invested an additional $20 million in privately held Fontainebleau Resorts. We made this investment through an oversubscribed secondary offering at a 20% premium to the price we paid last year. This offering was intended to raise money for the company’s expansion and renovation projects in Miami and Las Vegas. PBL, a large international casino resort developer purchased $250 million in the offering under the same terms and conditions that we were offered. We believe the company’s $500 million Miami Fontainebleau renovation and expansion project remains on schedule to open in mid-2008 and should provide strong returns for the company. The Fontainebleau’s prime oceanfront real estate in South Beach offers significant competitive advantage in our opinion. The Miami Historical Preservation Society is not permitting buildings along the beach to be torn down and redeveloped which we think should put the classic and iconic Fontainebleau property in a strong competitive position.
In Las Vegas, Fontainebleau Resorts is building the $2.8 billion Fontainebleau Resort on 24.5 acres of land on the north end of the Las Vegas Strip. We regard its location between the Riviera and the recently announced Crown property as prime. The company acquired the land seven years ago at a price of $6 million an acre. We believe this land could be worth as much as $20 million to $30 million an acre based on recent transactions for Las Vegas Strip land. We believe once the hotel opens in November 2009, its results should be boosted by management’s ability to market not only to domestic customers but also to higher end Australian and Chinese customers. This is because the company’s largest investor, James Packer of the Australian Media Company PBL, is an important worldwide casino resort owner/developer. In addition, given the property’s location northwest of Las Vegas’ convention center, we believe many conventioneers will keep the property occupied at high rates mid-week. Bill Velardo, the president of the property and former president of Mohegan Sun, the popular tribal Indian casino in Uncasville, Connecticut, is we think a strong operator.
The company is run by Glen Schaffer, the former COO of Mandalay Resort Group, whom Ron Baron has probably known and invested with for nearly twenty years, and Jeff Sofer, the CEO of Turnberry Associates, a large and successful residential condominium developer. Jeff is developing properties for Kerzner International, the private company in which four Baron Funds have an important investment. As a side note, Jeff was introduced to my dad about two years ago by Butch Kerzner at breakfast and the two of them hit it off immediately.
Gartner, Inc. (IT)
Gartner is the leading independent provider of research and analysis on the information technology industry. The company’s core research business employs a team of 650 analysts who track, evaluate and quantify technological developments in the IT (information technology) space and convey their findings to customers through published reports and phone/in-person meetings. Typical users of Gartner research include technology end-users, technology vendors, professional service firms, and investors. The company also offers strategic consulting services and hosts events and expositions for the IT community. We believe that the Gartner brand is highly valued in the IT community, as evidenced by its over 80% customer retention rate and its frequent citations in the mass media as the leading expert on IT trends. Gartner currently has about 50,000 subscribers to its research product out of an estimated 1 million U.S.-based IT managers who control a discretionary budget, implying to us that Gartner’s research user base continues to be significantly underpenetrated.
Gartner’s new management team is in the midst of restructuring its core research offering, which we expect will result in improved revenue growth. This platform, now branded as Gartner for IT Leaders, segments research users by their role in an organization and is designed to become the user’s first stop for all technical information and analysis related to his or her specific job. The research is accessed via a role-specific website, which also includes “must read” articles, a list of most viewed articles, blogs, podcasts, market news, and several analytical templates. A subscription to Gartner for IT Leaders costs more than twice as much as the legacy research offering, and since almost no new content will be created, we believe that margins could be higher than the legacy product. Over the longer term, we expect Gartner to further subdivide the roles in its Leaders program, and to launch roll-based offerings for its vendor, consultant, and investor client bases.
In addition to robust revenue growth from its restructured product line, we believe that Gartner’s EBITDA margins are poised to increase due to both a renewed focus on long term value creation and significant operating leverage. During the tech downturn, Gartner’s strategy was to focus on customer retention at the expense of long term value creation. However, a 2004 management change has resulted in several strategic adjustments designed to better capture the value inherent in the Gartner product. These changes include the elimination of significant discounts (up to 60%) off of core research list prices, annual price increases of 3% to 5% following six years of stagnant pricing, the elimination of “enterprise” contracts that granted unlimited research access for a fixed price, increased monitoring of customer usage to reduce subscription sharing, and aggressive sales force expansion to appropriately cover new and underserved accounts. We believe that Gartner’s business model also has operating leverage which should help earnings growth exceed revenue growth. We believe that Gartner’s main sources of operating leverage include its analyst staff, which we think does not need to expand significantly to support the expected growth in sales, and the electronic delivery of its research product.
Petroplus Holdings AG (PEPFF.PK)
Petroplus Holdings is one of the largest independent oil refiners in Europe. We first began acquiring shares in the company’s initial public offering in November 2006, and we have added to our position since then. Refining is an inherently cyclical business, and while we have a positive outlook on refining margins in general, what made Petroplus stand out to us is its management team. The company is led by the same team that built and ultimately sold both Tosco Corporation and, later, Premcor, providing excellent shareholder returns in both cases. In fact, Baron Growth Fund and Baron Small Cap Fund initially invested in Premcor in April 2002 at the IPO price of $24 per share, and the company was acquired a little more than three years later for over $89 per share.
Having created great wealth for both himself and his shareholders, Petroplus CEO Thomas O’Malley could have retired after the sale of Premcor, but as a noted workaholic and dealmaker, he was soon back at work. He found his next challenge in the form of a sleepy little European energy trading and refining company, Petroplus, which was controlled by private equity in search of dynamic leadership for its investment. When O’Malley came to Petroplus, he brought the same strategy that had worked well at Tosco and Premcor— only this time he was going to apply it in Europe instead of in the United States. Rather than be daunted by the change of scenery, O’Malley signaled his confidence in the company by investing over $30 million of his own money when he joined and buying more stock in the IPO.
The game plan at Petroplus is fairly simple: sell-off non-core assets to become a pure-play refiner, operate refineries as efficiently as possible and pursue growth through high-return, quick-payback internal investments while looking for acquisition opportunities that will be significantly accretive. Since O’Malley and team joined in May 2006, it has, in our view, successfully followed through on this strategy. Most remaining non-core storage and trading assets were sold in August last year, and Petroplus today is a pure-play crude oil refiner and wholesaler of the products it produces. In addition, the new operating team has been hard at work to maximize operating synergies and to more efficiently secure crude oil supplies. Finally and most important, the company has completed two transforming refinery acquisitions over the last six months.
In April, Petroplus closed on the acquisition of ExxonMobil’s refinery in Ingolstadt, Germany for $628 million. The transaction was negotiated shortly after O’Malley’s arrival at Petroplus, and his long-standing relationship with the top management at ExxonMobil was a key, in our view, to winning the deal. Ingolstadt was Petroplus’ fourth refinery, and its 110,000 barrels per day of capacity increased the company’s total refining capacity by 37% to about 405,000 barrels per day. In early June, Petroplus closed on the $1.6 billion acquisition of BP’s Coryton refinery near London, which we expect to be over 60% accretive to EPS.
This is a large (172,000 barrels per day throughput capacity), highly complex refinery, and we think it offers excellent synergies with two of the company’s nearby refineries. Once again, this deal was made possible in part by the CEO’s strong relationship with the top management at BP. As busy as Petroplus has been since new management took over, the company is, in our view, well positioned for its next transaction. The company recently completed a successful rights offering that raised $630 million, leaving it with the firepower to pursue one of the nine or so European refineries known to be on the market.
Meanwhile, the macro environment for refining has continued to be supportive. Crack spreads have remained high despite adequate crude oil supply, as refining capacity throughout the world has been tight following years of underinvestment. Exacerbating the near-term supply problem has been increasingly tough specifications for refined products and greater unexpected downtime as refineries show wear and tear from being run all out. In addition, we find refiners are more focused than ever on safety following several high profile accidents over the last couple years.
Over the longterm, supply is expected to increase, but escalating costs and the ever-present “not-in-my-backyard” issue suggest to us the pace of growth will be moderate. At the same time, despite record high prices throughout much of the world, demand for refined products has continued to grow, led by emerging markets— especially China. Thus, we see the supply/ demand balance remaining tight for the foreseeable future, and we think refiners with strong management like Petroplus should be rewarded in the form of high free cash flow.
AECOM Technology (market capitalization: $2.4 billion) (ACM, Financial)
Following the tragic bridge collapse in Minnesota and steam pipe explosion in Manhattan earlier this year, we believe there will be a renewed focus on safer, more modern infrastructure in this country. One company at the forefront of designing and planning for these sustainable needs is AECOM. With $3.5 billion in revenue, AECOM— the “AE” signifying Architects & Engineers — is the largest pure design & engineering firm in the world. The company is a leader in providing technical and architectural planning and support services for a broad range of clients, from blue chip corporations to state and local governments. In simple terms, before any new bridge, highway, subway tunnel or airport terminal can be constructed and made operational, it needs to be designed, planned, and engineered. That’s what AECOM’s team of 30,000 engineers do everyday around the world. The company’s strengths lie, we think, in its end market focus, specifically transportation infrastructure and environmental facilities, sectors which have been seeing rapid growth, its geographic diversity with operations in 60 countries that allow for sharing of best practices, and a prestigious client roster, for whom it works on some of the most complex and notable projects.
Our investment thesis on the company is four-fold: 1) AECOM has leading market share in its respective niches: transportation and environmental engineering projects. We believe these end markets are well positioned to grow, as global growth, especially among developing nations in Asia, India, and the Middle East, have fueled tremendous infrastructure and capacity needs. In addition, the increased urbanization of cities and focus on sustainable environmental buildings has generated demand to design greener, more energy efficient facilities. Healthy state and local budgets and the nearly $300 billion of earmarked federal funding for transportation projects will also in our opinion, help sustain growth for years. 2) AECOM’s global diversity is, we think, unique among its peer group and it is seen as the acquirer of choice in a fragmented industry. The company enjoys significant cross-selling synergies from having offices spread across sixty countries, where it has been able to leverage the expertise from past projects in certain locales toward winning contracts in new geographies. 3) Unlike most engineering firms which tend to have construction arms, AECOM is singularly focused on front-end design work, a lower risk strategy in our view with less exposure to fixed-price contracts and cost overruns. The result is a debt-free business model with healthy free cash generation. 4) The company’s size and leading reputation has led to work on many iconic and high-profile projects. Over the next decade, the company has exclusive contracts for the master planning services for the London 2012 Summer Olympics, program management services for the Second Avenue New York City Subway, renovation of the Pentagon, design of the World Trade Center Path Terminal, and development of Hong Kong’s elevated roadways. The fact that AECOM tends to work on technically interesting and sought after projects, we think, helps it recruit and retain the best employees, a key advantage in the tight labor market for skilled engineers.
Although the company recently came public, it has a long operating history and experienced management team. Current CEO John Dionisio started out as a field engineer at one of the predecessor companies over twenty years ago. In fact, the ten most senior members of the executive team have an average of twenty years experience at the firm. With a proven track record of growth— 20% compounded revenue over ten years and 24% net income over five — combined with the visibility of a $3 billion backlog, we believe AECOM offers a unique way to capitalize on the growth in global infrastructure over the next several decades.
Carrizo Oil & Gas (market capitalization: $1.1 billion) (CRZO)
Carrizo Oil & Gas is actively engaged in the exploration and production of oil and natural gas primarily in proven onshore trends along the U.S. Gulf Coast and the Barnett Shale area in North Texas. The company’s focus is on areas where it can grow production through a repeatable relatively low-risk drilling program (“gas manufacturing”), utilizing advanced 3-D seismic techniques to identify potential oil and gas reserves. Carrizo has grown rapidly over the last five years ending 2006 with proved reserves of 210 billion cubic feet equivalent as compared to 59 billion cubic feet equivalent at the end of 2001, which represents a 29% compound annual growth rate over that period.
The bulk of Carrizo’s current value is in its sizable acreage position in the Barnett Shale of North Texas — the most active natural gas play in the United States. The company was early to recognize the potential of the Barnett Shale and began acquiring acreage in 2003. Today it has almost 87,000 net acres in the Barnett, the majority of which it acquired for an average cost of about $300 to $400 per acre. Similar acreage today goes for 10 times that or more. Since first entering the play in 2003, Carrizo has grown production in the Barnett to about 30 million cubic feet per day at present out of total company production of about 50 million cubic feet per day. With many years of drilling inventory left, we think production in the area should continue to ramp, since recent wells have been prolific. Importantly, we think the economics of a Barnett well are attractive with a development cost of about $1.50 to $1.75 per thousand cubic feet and relatively low lifting costs of about $1.00 per thousand cubic feet.
Beyond the core Barnett and Gulf Coast properties, which we believe support a solid return from the current stock price, we think Carrizo offers great option value through other plays it is pursuing. The largest of these is the Floyd Shale in Alabama and Mississippi, where the company has amassed 137,000 net acres at an average cost of about $75 per acre, which would be worth about $300 per acre today and we think potentially much more in the future. The Floyd Shale is a new area for gas exploration with very little operational data to look at to determine the potential of the play, but Carrizo is hopeful given the many similarities to the Barnett including the age, geology and depth of the shale rock it is targeting. If it is successful in the Floyd Shale, it could be a game changer for Carrizo given its current acreage position not to mention that there is still a significant amount of unleased acreage in the play for the company to go after.
In addition to the Barnett and Floyd Shales, Carrizo has accumulated acreage in several other shale plays that hold potential including the Fayetteville Shale, the Barnett/Woodford Shale of West Texas and the New Albany Shale. None of these are as significant in size and/or as prospective as the previously mentioned shale plays, but together they cover over 107,000 acres that we think could someday be valuable to Carrizo and for which the stock receives no value today. Of course, exploration can be a risky business, and a recently drilled high impact well known as Mega-Mata in South Texas appears to be non-commercial. On the other hand, another recent well in the North Sea was a success, and our preliminary estimates suggest it could add at least $6.00 per share to Carrizo’s net asset value. If any of Carrizo’s emerging opportunities are successful, in our view it would be icing on the cake to what should be a solid growth story out of the North Texas Barnett Shale alone.
Fontainebleau Resorts (market capitalization: $1.3 billion)
During the quarter, we invested an additional $20 million in privately held Fontainebleau Resorts. We made this investment through an oversubscribed secondary offering at a 20% premium to the price we paid last year. This offering was intended to raise money for the company’s expansion and renovation projects in Miami and Las Vegas. PBL, a large international casino resort developer purchased $250 million in the offering under the same terms and conditions that we were offered. We believe the company’s $500 million Miami Fontainebleau renovation and expansion project remains on schedule to open in mid-2008 and should provide strong returns for the company. The Fontainebleau’s prime oceanfront real estate in South Beach offers significant competitive advantage in our opinion. The Miami Historical Preservation Society is not permitting buildings along the beach to be torn down and redeveloped which we think should put the classic and iconic Fontainebleau property in a strong competitive position.
In Las Vegas, Fontainebleau Resorts is building the $2.8 billion Fontainebleau Resort on 24.5 acres of land on the north end of the Las Vegas Strip. We regard its location between the Riviera and the recently announced Crown property as prime. The company acquired the land seven years ago at a price of $6 million an acre. We believe this land could be worth as much as $20 million to $30 million an acre based on recent transactions for Las Vegas Strip land. We believe once the hotel opens in November 2009, its results should be boosted by management’s ability to market not only to domestic customers but also to higher end Australian and Chinese customers. This is because the company’s largest investor, James Packer of the Australian Media Company PBL, is an important worldwide casino resort owner/developer. In addition, given the property’s location northwest of Las Vegas’ convention center, we believe many conventioneers will keep the property occupied at high rates mid-week. Bill Velardo, the president of the property and former president of Mohegan Sun, the popular tribal Indian casino in Uncasville, Connecticut, is we think a strong operator.
The company is run by Glen Schaffer, the former COO of Mandalay Resort Group, whom Ron Baron has probably known and invested with for nearly twenty years, and Jeff Sofer, the CEO of Turnberry Associates, a large and successful residential condominium developer. Jeff is developing properties for Kerzner International, the private company in which four Baron Funds have an important investment. As a side note, Jeff was introduced to my dad about two years ago by Butch Kerzner at breakfast and the two of them hit it off immediately.
