Interactive Buyside Equity Research

January 21st, 2014

PINECREST ENERGY INC. Thesis Overview

Pinecrest Energy (PRY) is a Toronto Venture Exchange listed oil and gas exploration and production company focused on Alberta Canadas Slave Point region. In less than two years an aggressive growth strategy led to Pinecrest becoming a dominant player, one of the largest land owners in the area, and a favorite among oil and gas investors, touted by insiders and analysts for the coveted region, managements previous proven abilities, and the oil potential Slave Point offered. Over the past year, however, cracks in the thesis began to show as numerous setbacks and a growing debt balance shed light on managements rosy projections and failed attempts to deliver results. A consistent pattern of overpromising and under delivering, while avoiding/hiding problems, created a loss of confidence among investors and material shareholder declines ensued. Within the companys short history management has effectively caused a Class IV hemorrhage through irresponsible use of leverage, poor guidance, and an aggressive capital spend program worth hundreds of millions. As a result, shareholder losses have been absolutely absurd; over 80% of equity value being destroyed within roughly one year of the companys three year existence. In situations such as this, one of three things can take course. First, a huge overhaul can be conducted, with incompetent board members and management stripped of their duties, pegged to the wall of shame, and replaced. Second is a company sale. Third is bankruptcy. In this report we argue for a company sale because Pinecrest possesses valuable characteristics yet, given that the board and management have proven their inexcusable ineptness to responsibly run the business, and the fact that they have leveraged operations to a position where debt balance coupled with a low stock price offers grim opportunities for the company to lift itself out of current problems, a company sale seems to be the proper decision, providing any remaining value back to owners. Since 2010 PRY has spent just under $500 million on land, development, and equipment and now sells for a fraction of that value. Additionally there is roughly 2,300 boed of 97% light oil in production that does not take into account any additional water flood potential. The company remains in a desirable location, with a land base difficult to replicate, and number of companies competing throughout the region. With a strategic purchase PRY could potentially fetch between 50% and 100% higher than current enterprise valuation. This report is separated into two parts. Part 1 outlines Pinecrests history and managements audacious, irresponsible behavior that ultimately led to dramatic shareholder destruction. Part 2 discusses the companys remaining value.

Stock Rating Catalyst Category Price Target Price (1/21/14): $0.20 Upside/(Downside): 50% Ticker: PRY.V Exchange: Toronto Venture Industry: Oil & Gas

BUY Special Situation $0.30

Trading Stats ($USD millions) Market Cap: $29 Enterprise Value: $180 Price / Book: 0.52x Dividend Yield: 0% EV / 2013E EBITDA: 10.5x
Source: Company filings, Wall Street Consensus

Price Performance 52 Week range: $0.19 - $1.46 Analyst Details IB Username: APACapM Employer: Private Hedge Fund Job Title: Analyst Analyst Disclosure PRY Position Held: Yes

Interactive Buyside Equity Research

January 21st, 2014

PART 1: Overview
Company History
Pinecrest Energy dates back to September 2006 when Testudo Oil & Gas Exploration Ltd completed its IPO as a Capital Pool Company under the leadership of Joseph Worobec as President and CEO and Greg Leia as CFO. By mid 2009 the company had entered into a non- arms length qualifying transaction, acquiring the outstanding shares of Batoche Energy and changing names to Antler Creek Energy. By April 2010 Antler Creek had entered into a reorganization and investment agreement with Wade Becker, Dan Towers, Bill Turko, and Korby Zimmerman that would effectively remove current management and put Wade and his team in place, initiating the process of what would soon become Pinecrest. By August 2010 Pinecrest had completed a financing arrangement and began its acquisition of Slave Point assets. Management grew Pinecrest through a series of bought deals and credit facility arrangements, effectively raising over $400 million between May 2010 and May 2012.

Source: Company Reports

The CAPEX picture below highlights the enormous capital expenditure program between 2010 and 2012 and a breakdown per section of where the money was allocated.

Interactive Buyside Equity Research

January 21st, 2014

Notice roughly $115 million goes into property acquisition, 75% of which is unproved, and the remaining $350 million is spent on exploration and development costs. Digging further allows us to get a glimpse of the amount that is being spent on a per acre basis.

This asset purchase equates to roughly $1,500 per acre in 2010, a figure to revisit in Part 2.

Over Hyped, Under Delivered

From the get go management and analysts had high expectations for PRY, and with Slave Point being a buzz word amongst oil and gas enthusiasts starting around 2008 and the fact that PRY originated from essentially noting the company and its future potential was an easy sell during the early stages. PRYs debt and equity growth can be summed up as follows. Buy some producing/non-producing land, tout investment potential, and issue a bought deal. Buy more land, start developing, and reiterate investment potential, do another bought deal, then repeat, taking on a credit facility along the way. Given that PRY started from nothing, this method allows management to play the records game, highlighting activities like record profits, boe/d, and projections, because any growth will be record growth when you start at roughly zero. Over time targets and projections became increasingly lofty, and all the while management continued its bought deal and credit facility financing arrangements until, of course, the music stopped. Below are some captions from news releases and MD&As, outlining in bold the selling points and increasingly audacious projections. News Release April 2011- Pinecrest and its partner are implementing a waterflood project in the Evi field located on the west side of the greater Red Earth area. Government approval has been received, and injection is expected to commence in Q2 2011. The Company expects to see results of this waterflood prior to the end of calendar year 2011. NOTE: Touting water flood from the get go; this was a common sell in the Slave Point region. News Release July 2011- Pinecrest is anticipating results from its Evi water flood project in approximately 3 -6 months, in line with response times to water injection observed in analogous Slave Point pools in the immediate Red Earth area. Pinecrest is very excited with its water flood opportunity base and continues to plan for the implementation of additional water injection locations. Pinecrest believes water flooding will result in significantly lower decline rates and materially improve overall oil recovery over primary recovery rates.

News Release Aug 2011- exit guidance has remained unchanged at 3,000 - 3,200 bbls/d of light sweet crude oil

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January 21st, 2014

News Release Nov 2011- performance on the Companys initial non-operated waterflood has been affected by minor implementation issues which are in the process of being remedied. Looking forward, the water flood scheme will benefit from increased and more consistent injection volumes. Response to the flood is anticipated within the next two to six months. At this time, Pinecrest has identified and is in the process of applying for two additional operated water flood schemes and it is anticipated that initial water injection should commence early in the third quarter of 2012. NOTE: In April 2011 results were said to be seen prior to end of the year. Obviously, now management pushes time line back by six months. One would assume that additional applications for more water flood schemes means there is significant benefit to this procedure. News Release May 2012- Current production is approximately 3,500 boe/d (99% light oil). Pinecrest is not altering its 2012 forecasted capital program and remains committed to its previously stated guidance of achieving year-end production of 5,000 5,200 barrels of light oil per day .

NOTE: Lofty projections begin around this time. Prior to this they have done a decent job of growing. Gi ven steep decline rates of the Slave Point region and the Q1 average boe/d of 3,358, management must be projecting significant production increases or significant benefits from water flood outcomes, or very likely both. News Release August 2012- Pinecrest is not altering its 2012 forecasted capital program and is confident in its ability to achieve the previously stated year-end production guidance of 5,000 - 5,200 barrels of light oil per day. NOTE: Q2 average boed is 2,951, roughly half of target exit. News Release Nov 2012- Company is maintaining its exit production guidance of 5,000 - 5,200 boe/day. NOTE: Q3 average boed is 2,748 well below target. YE 2012 MD&A- March 2013- 2013 production is tracking our budget and we are confident we will meet or exceed our year end exit estimate of 6,000 boe per day (99% oil). With our 2012 top decile netback and strong recycle ratio, the Company is well situated to continue strong growth regardless of fluctuations in commodity pricing NOTE: Exit guidance of 5,000+ boed was not achieved. Average boed for Q4 was 3,510, 30% below the low target of 5,000. Q2 2013 MD&A- August 2013 Current production is approximately 3,200 boed, with approximately 300 boed shut in due to field conditions. The Company expects to average 3,100 - 3,200 boed for the third quarter, while the Company performs a midAugust battery turn around and converts seven producing wells to injectors, all affecting production NOTE: Failed to meet last years target exit of 5,000 boed, now touting 6,000 boe/d, and back to similar situation as this time last year; production is roughly half of target exit. Q3 2013 MD&A- November 2013 Current production is approximately 2,650 boed, with approximately 350 boed shut in due to field conditions. For the balance of the year the company expects to invest minimal capital as it awaits the response of its water floods. NOTE: No mention of incredible estimate shortfall. Obviously declines are kicking in, the company is drastically moving away from its 6,000 boed exit guidance, and water flood is not panning out. There are obvious problems here yet management does not seem to address the issues well, if at all.

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January 21st, 2014

News Release January 2014- Based on field estimates, average production for the fourth quarter of 2013 was approximately 2,580 boepd (97% oil and liquids). Average production for the month of December, based on field estimates, was 2,308 boepd, below the Companys budget and previous guidance. Current production is estimated to be 2,300 boepd (97% oil and liquids). NOTE: Terrible guidance for a seasoned team; two years of guidance, both missed by a substantial margin. Over time management seems to have highlighted good points and avoided the problems, failing to notify or adequately addressing negative events to shareholders in a timely manner. The graph below shows management miss history on a numerical and percent basis in terms of actual average boed production versus target guidance.

7000 6000 5000 4000 3000 2000 1000 0

0% -10% -20% -30% -40% -50% -60% -70% -80%

Source: Company Reports

Target boed Exit for YR Avg boed % Miss Avg boed/Target Exit

Over time, misses became increasingly important as management continued to employ leverage, adding debt up to the point where production started its decent, and positioning PRY with very little room for capital structure flexibility if share prices were to fall, as they did .

160000000 140000000 120000000 100000000 80000000 60000000 40000000 20000000 0 -20000000 -40000000

5000 4500 4000 3500 3000 2500 2000 1500 1000 500
Source: Company Reports

Total Debt & WC Avg boed

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January 21st, 2014

The black arrow points to the time frame for the final bought deal of $60 million at $3.25 per share and an increase in credit facility from $75 million to $125 million, completed in Q1 2013, right around the time that average boe/d starts its major descent. Coincidental?

Aggressive Leverage
For stable operations with predictable cash flows, as equity grows additional debt can be taken on to create a well-balanced capital structure. This method, however, is incredibly risky for junior E&Ps where CAPEX and operational uncertainty is high, and Pinecrest epitomizes this risk. Stock vicissitudes of the junior space coupled with consequences of audacious/inadequate projections or unanticipated events can quickly turn a moderately leveraged business into a financial disaster, and it seems that PRYs management, whether knowingly or unknowingly, irresponsibly leveraged operations at the expense of shareholders. This was extraordinarily poor judgment for a group with so many years of experience, and only recently, after spiking debt to roughly 70% of enterprise value, does management come out with a news release issued Jan 2014 that has any emphasis on debt reduction issues.

50000 40000 30000 20000 10000 0 Q1-11 Q2-11 Q3-11 Q4-11 Q1-12 Q2-12 Q3-12 Q4- 12 Q1-13 Q2-13 Q3-13 -10000 -20000
Source: Company Reports

Avg boed Debt/Avg boed

One only needs to look at the chart above to raise the question of whether, and if so why, management set up PRY for an unsustainable debt problem.

Summary: Part 1
To summarize Part 1, it seems management successfully raised capital after putting Pinecrest on a very high pedestal, yet failed to meet projections, spent enormous sums, and leveraged the business in an irresponsible manner, and all the while paying themselves in highest 1% of United States wage earners at the expense of shareholders. These actions were very unprofessional and regardless of whether any were intentional it solidifies that this group is not fit to run the operation, and arguably the board is not fit to monitor what is going on.

Interactive Buyside Equity Research

January 21st, 2014

http://en.wikipedia.org/wiki/Household_income_in_the_United_States

PART 2: Value
At 20 cents PRY has an enterprise value of roughly 180 million, 70% debt 30% equity.

PRY is now low enough that it can be analyzed from a fundamentals perspective and two factors highlight value. The first factor has to do with the companys net land acres and millions spent on infrastructure and development; second is the companys 2,3 00 boe/d of 97% light oil currently in production. Pinecrest currently has 176,210 net acres of land and 275 net sections located in the highly desirable Slave Point region of Alberta Canada. This puts PRY in the top decile of net acres owned by companies operating throughout the region, and right next to heavy weights such as Penn West. The Slave Point region is a tight oil play, a carbonate formation from the stratigraphical unit of Middle Devonian age in the Western Canadian Sedimentary Basin. The area has been drilled since the 1960s, with peak interest around the 1980s. Modern

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January 21st, 2014

drilling technologies allowed further exploration and the region caught investor interest after Lone Pine drilled its first horizontal well at Evi in 2008. Since that time the region has been highly sought after and per arce prices have commanded a significant premium, some areas selling for as much as $2,000/acre. As discussed in Part 1, PRY made initial land purchases for around $1,447 per net acre, on average, and according to Macquarie Slave Point region prices went for roughly $1,200 in Red Earth region throughout 2012.

https://www.macquarie.com/dafiles/Internet/mgl/com/macquarietristone/current-mandates/Border-PetroleumGroup/border_om.pdf Considering these figures, Pinecrests land could be valued between 17% and 47% higher than the companys enterprise value, and perhaps higher if a strategic buyer takes into account the scale of acres, sections for available drilling, and the fact that to date PRY has drilled at 100% success rate. PRY has 275 net sections and at 7 or 8 wells per section that equates to between 1,925 and 2,200 wells, and to date the company has drilled fewer than 80 so lots of potential oily assets. In addition to raw land value, Pinecrest has spent roughly $350 million in exploration and development expenses. These expenses include costs of licenses, legal fees to set up production sharing contracts, G&G studies, and facility equipment costs, among others. Many of these will be sunk costs, worthless to any potential buyer. However, others could be quite valuable. Considering a quarter of the $350 million CAPEX has value to a potential acquirer, this would add $87 million in value to the raw land, putting value at between 66% and 95% higher. Additional savings that could also occur, depending on the strategic acquirer, include lowering or elimination of overhead costs through consolidation and tax savings from net losses and tax pool structures.

Interactive Buyside Equity Research

January 21st, 2014

In addition to land, Pinecrest currently has around 2,300 boed in production and 16,241 Mboe of Proved and Probable Reserves. A quick analysis of Slave Point region competitors shows that the average competitor trades for 40% higher on P+P basis and Pinecrest has a higher 32% higher oil weight, 97% versus 74%.

Below are a couple of transactions that occurred over the past few years in the Slave Point region Dec 2011- Surge acquires private company in Slave Point Terms: 106 million for 1,200 boe/d= $83,000/ boe March 2012- Renegade acquires assets in Slave Point Terms: 11 million for 50 boe/d= $220,000/boe Obviously the terms of these deals vary significantly, but whats important to note is there are numerous companies selling f or much higher on EV/boe/d basis and integrating PRY could be quite advantageous given the companies land base and net sections available for drilling.

Interactive Buyside Equity Research

January 21st, 2014

Baytex and Surge are two easily identifiable names selling for higher EV/boe/d. Additionally, Penn West has announced that they plan to unload non-core assets within the region. A number of companies, including Surge, have expressed interest, signifying demand continues to remain strong for assets in this location.

Summary: Part 2
Part 2 summarizes the overall value Pinecrest continues to possess. Land value alone could be worth between 20% and 50% higher than current enterprise value. Factor in benefits such as CAPEX value, overhead reductions through consolidation, and tax loss/ tax pool structures and PRY could add between 50% and 100% to current prices.

Conclusion
The conclusion to this report is quite simple. The board and management of Pinecrest were given an opportunity to develop, oversee, and run a sustainable oil and gas E&P company in a highly sought after region of Canada; they blew it. Management over projected, under delivered, failed to update when problems surfaced, and ultimately ruined confidence in operations. The board of directors is expected to monitor management actions and guide management in the best interest of shareholders, which they seem to have failed to adequately do. Collectively this group has run Pinecrest into the ground. Given the groups inept ness and the now troubled balance sheet, PRY has very little flexibility to maneuver itself out of its problems. The company is now in a state of distress, with a capital shortfall, little ability to raise further capital without severe equity dilution, and a large debt balance. For these reasons, the company should ultimately be sold and funds returned to owners, shareholders. Shareholders should demand a sale occurs quickly because the Slave Point area is still an attractive region, Pinecrest continues to possess significant value over its current enterprise valuation, and considering managements track record of destroying value additional time will likely cost additional shareholder money. A strategic sale should be able unlock 50% to 100% more than the companys current enterprise value and it is shareholders rights to demand what remaining value is left be returned.

Interactive Buyside Equity Research

January 21st, 2014

Financial Overview
($ in millio ns, except per share data & B OED)

FY end Dec 31: Operational Stats BOE/D Financial Stats Sum m ary Incom e Statem ent Oil Sales % Growth Total Revenue % Growth COGS % of Sales Gross Profit Gross Margin % Operating Income % of Sales EPS EPS Growth %

2010

2011

2012

LTM

162

1,348

3,142

3,529

1.2

46.9 $ 98.2 NM 109.4% 46.9 $ 98.2 NM 109.4% 4.4 9.4% 38.1 81.2% $ 7.5 7.6% 25.9 26.4% 33.7 34.3%

$ 29.0 (60.5%) $ 29.0 (60.5%) $ 4.1 14.1% 25.0 86.2% 5.4 18.6%

1.2

0.2 12.5% 1.0 84.2%

$ (2.5) $ 12.3 (208.3%) 26.2% $ (0.14) $ 0.04 (128.6%)

$ 0.13 225.0%

$ 0.02 (48.0%)

Sum m ary Cash Flow EBITDA EBITDA M argin Cash Interest Capital Expenditures Other Free Cash Flow as % Sales

$ 14 $ 31 1191.7% 66.5% (0) 0 29 164 -

72 73.1% 1 212 -

17 58.6% 2 40 -

$ (14) $ (133) $ (141) $ (25) (1166.7%) (284.3%) (144.0%) (87.4%)

Sum m ary Balance Sheet Cash & Equivalents Total Debt Net Debt / EBITDA

$ $

26.9 0.9x

$ $ 100.2 1.4x

$ $ 122.0 7.2x