One of the most intriguing challenges for investors in the know is how to identify the next Pennaco, or the next Evergreen. That is to say, it's hard to uncover the small companies, often startups, which are starting to show rapid growth and give hefty stock appreciation to investors who are savvy enough to get in early. From there, who knows which of these may grow into the next $500-million star? Right in its own backyard in Pontotoc County, in a mature oil-producing area about 90 miles south and a bit east of Oklahoma City, a small family-owned independent is chasing this dream. During the past two years, Pontotoc Production Inc., based in Ada, has been very busy. It has clocked nine consecutive profitable quarters since its February 1998 public debut through a reverse merger with a publicly traded shell, and has recently moved to the Nasdaq (PNTU). And it has also doubled in size via drilling, workovers and eight acquisitions. This summer it hired three additional technical people and a chief financial officer. "When you do everything yourself-well, maybe it was cute in the beginning, but it's not any more. I was getting too busy to look at the next deal," says president James (Robby) Robson Jr., who with his father, James Sr., and brother Todd, founded the company's predecessor in 1982. Perhaps most important to Pontotoc's growth plans, the company now is emphasizing shallow natural gas, even though traditionally its proved reserves have been about two-thirds oil. That's hardly a surprising strategy in this day of record-high gas prices-but the way Pontotoc is going about this change may be somewhat unusual. In a 40-mile radius of Ada, thousands of old wells produce a total of about 30,000 to 35,000 barrels of oil per day. Most are stripper wells from the 1950s, 1960s and 1970s that yield three to 10 barrels a day from Pennsylvanian reservoirs such as the Cromwell and Gilcrease formations. The area is characterized by dense drilling on 10-acre spacing. It is here that Robson sees a niche opportunity opening: some 80% of that production is owned by small enterprises, mostly sole proprietors with an average age of 60 to 70 years. Many lack the capital or the reason to fully develop their properties. "They have not used modern techniques in most cases, and clearly, they don't have an exit strategy. They are almost to the point where they produce the oil as a hobby. I know most of these people from having operated here for 18 years," says Robson. "Their homes are probably paid for; their kids are out on their own. At their age, growth just means more taxes. "Whereas, we operate our own pulling units and roustabout crews. We have our own trucks, and we do our own workovers and water hauling to control our costs. The niche for us is, we've created an exit strategy for them. We're the only game in town that's buying properties in any significant way." Pontotoc's game plan goes like this: it buys old oil wells based on some multiple of cash flow from existing production, expecting payout in 48 months. Then, it goes to work. Says Robson, "We apply aggressive management to reduce that to 36 or 40 months to improve the return. Then we rework the wells to bring to life the behind-pipe gas reserves that have never been pursued. We tried it first in 1998 when we perforated a well and it tested 1 million cubic feet a day and 20 barrels of oil." In 1999 the company and 25-year industry veteran Tim Jurek formed Pontotoc Gathering LLC to build a low-pressure gas gathering line that could be used to transport and market the company's new gas production from existing and future wells. Jurek is the ex-president of Mega Natural Gas Co. II (a subsidiary of Spring Holdings, which was in turn bought by Cross Timbers Oil Co. last year). He and Pontotoc each own 45% of the LLC and two employees of the LLC own the remaining 10%. Jurek also is on the parent company's board. The public Pontotoc receives 80% of the spot price less the cost of transportation; the LLC gets the remaining 20%. (What's more, the public company owns 45% of that). Before setting up this subsidiary, however, Pontotoc received 55% of the spot gas price less transportation charges. Says Robson wryly, "I didn't like the terms the other pipeline in the area was offering." Pontotoc plans to accumulate more well locations as it buys up numerous small holdings owned by area producers. More recently, it acquired 15-year lease rights to an abandoned 70-mile oil gathering system previously owned by Koch Industries that it is upgrading and converting to gas. It goes under a large portion of the field of old stripper oil wells that Pontotoc either owns or wants to acquire. Previously, there was no low-pressure market for any of the behind-pipe gas in the area. Controlling this system will allow Pontotoc to speed up its acquire-and-exploit strategy. To date, Pontotoc has done about 30 shallow gas recompletions on wells it acquired in 1998 and 1999. Initial production has ranged from 100,000 to 350,000 cubic feet of gas a day, at a cost of about $15,000 to $20,000 per well. Engineered reserves on 40-acre spacing average just under a quarter billion cubic feet of gas per well, resulting in development costs of less than 10 cents per thousand cubic feet (Mcf). "The average capex to recomplete two or three gas zones per well is $20,000 and return on that takes 40 days," Robson says. "The recoverable reserves per well are about 200 million cubic feet. At $3 gas that's $600,000 divided by $20,000, or a 30-to-1 return every time. This has exceeded our expectations. Developing this previously untapped resource is a primary focus for us going forward. We have 30 additional recompletions in inventory and we've been doing three or four a month." Given the evaluations and acquisitions it has under way, Pontotoc hopes to end up with 400 gas recompletions in inventory. This is based on the fact there are about 2,500 existing wells in the area, on 10-acre spacing, along the old Koch system. "We base this on the assumption that about two-thirds of the wells will have gas behind pipe. We plan to recomplete one well per 40 acres, which leaves us three wells per 40 in which to exploit the remaining oil." Why go public in 1998 after being a family-owned business for so long? "I felt that with all we had learned, we had essentially been in an 18-year market study. Without sounding corny, I knew who the people in this part of Oklahoma were and their stories, the reasons they might be ready to sell. That's when I realized that to really grow this company, we should be public and then, we'd be able to offer cash or stock," says Robson. Indeed, in two of the last eight acquisitions, Pontotoc did just that, paying some of the purchase price in shares. From a low of $1.625 per share in December 1998, the stock hit a high of $10.25 in July. At press time it was around $9. Management owns 40% of the outstanding shares. Having the stock available to use as another currency gives the company more choices and speeds growth. From 1982 to 1998, the company accumulated about $11 million of proved reserves. Two years after becoming public, the change is dramatic, Robson points out. Now it has $105 million in proved reserve value, and about $9 million in debt. The major boost came from two key acquisitions. In July 1998, Pontotoc purchased interests in 82 oil and gas wells in Pontotoc, Coal, Garvin and Seminole counties, along with two workover rigs, one drilling rig and miscellaneous other equipment, from Bill G. Cantrell for $2.75 million in cash and 402,360 restricted shares. In June 2000, the company purchased the operated production and related assets of Mike Cantrell and his company, Oklahoma Basic Economy Corp., and the working interests of OBEC's partners, for $9.8 million cash. The deal doubled the company's proved reserves to about 14.6 million barrels of oil equivalent. To lock in success, the company hedged 10,000 barrels per month for 24 months based on the current Nymex futures strip price, about $25 per barrel. The deal boosted daily oil production by almost 45% and provides a new set of recompletion and infill opportunities. Pontotoc will exploit both the shallow oil and untapped gas reserves many of the wells hold. Costs will be about six or eight cents per Mcf, versus 30 cents for Pennaco (another fast-growing public company that has garnered a lot of analyst attention in the past year). Says analyst Alex Montano of C.K. Cooper & Co., which specializes in following small-cap stocks, "We expect it will take Pontotoc time to absorb the OBEC acquisition. We don't anticipate any real increase in production until the third or fourth quarter of fiscal 2001 [December 2000 or March 2001]." However, the firm has raised its earnings-per-share estimates on Pontotoc to 83 cents per share from 67 cents and its risk-adjusted breakup value to $12.45 per share. "These estimates are based on a low commodity price of $20 oil and $2.10 gas," Montano says. He has Strong Buy on PNTU long-term, and, short-term, a Buy.