Wilbur Ross is a man of large appetites. He doesn’t nibble around the edges with his investments — he consumes them with abandon.#-ad_banner-#

At various points in his career, he’s committed almost all of his capital to one major investment, whether it’s distressed steel-making, out-of-favor textile making, or any other business that is flirting with bankruptcy but represent deep value through a corporate restructuring.

His most famous move, as we noted last year: “Ross picked up numerous steel and mining ventures that had gone bankrupt. He sold his steel holdings for $4.5 billion in 2005 to ArcelorMittal, making $2.5 billion for (his firm) WL Ross and $300 million for himself.” That and other moves once led New York magazine to call Ross the “Bottom-Feeder King.”  

These days, Ross has been unable to identify any major assets on the cusp of bankruptcy — the economy has been too healthy for that. Instead, he’s acquiring sizable stakes in companies that he views as severely undervalued.

Though that approach continues to serve him well, one of his investments has been an utter disaster. Back in the third quarter of 2010, Ross bought nearly 2 million shares of energy driller Exco Resources (NYSE: XCO), at an average price of $14.50 a share. He kept buying on the way up, eventually owning 21 million shares two quarters later as the stock moved above $20. 

Trouble is, he kept on buying, even after Exco plunged in value, and his average purchase price of $15.85 is now deeply underwater. By the second quarter of 2012, Ross decided to sit tight and hang onto his 31.5 million-share stake — without making any further purchases.

Yet in recent weeks, Ross has had an apparent change of heart. As part of a rights offering (which gives existing shareholders the right to acquire more shares), “Ross increased his holdings by a massive 62%,” according to Jonathon Moreland, who tracks these transactions at InsiderInsights.com. Moreland notes that Ross now owns 18.6% of the company. As a bit of a salve to his wounded pride, Ross was at least able to pick up these shares at just $5 a piece.

Ross isn’t alone in backing this beleaguered energy driller. Oaktree Capital now owns 16.6% of Exco, and Canadian fund manager Prem Watsa recently boosted his stake in the company to 6.4%. (You may know about Watsa from his aggressive moves to take control of BlackBerry (Nasdaq: BBRY).)

The question for investors: If Ross thought this stock was appealing when it was back in the mid-teens, should you find appeal now that it trades below $6?

To be sure, this stock is unlikely to zoom back to $20 anytime soon, simply because natural gas prices are unlikely to revisit past peaks. In addition, the share count is now 25% larger now, thanks to the recent $250 million rights offering.

Exco is known as a “gassy play,” with more than 90% of its output derived from natural gas and relatively little exposure to more valuable crude oil. Yet Exco, which spent too much money on land leases when gas prices were higher three or four years ago and ended up with too much debt and not enough cash flow, is starting to get its act together. 

For starters, the rights offering greatly reduces the risk that the company will see deep financial distress. In addition, Exco is starting to partner with investment firms such as KKR (NYSE: KKR), which reduces upfront capital spending costs as new acreage is acquired.

Now, the company needs to focus on execution, delivering more predictable cash flow. Operating cash flow likely fell to $345 million in 2013, according to Goldman Sachs. That’s the lowest in six years. But that figure should begin rising again as production volumes increase: Goldman Sachs sees it exceeding $400 million in 2014 and $500 million by 2016. 

Returning to the question of why Wilbur Ross would commit so much fresh capital to Exco, a clue may be found in the November resignation of the company’s CEO. With three major investors now controlling more than 40% of the company, the board is likely under pressure to seek ways to unlock value. That could set the stage for a buyout. 

To be sure, it’s hard to come up with a target price for an energy driller like this. Analysts like to talk about current production run rates or EBITDA (earnings before interest, taxes, depreciation, and amortization) multiples, but hedge funds and mutual funds are more interested in the relative value of a company’s real estate and the longer-term potential of the firm’s energy fields. 

Is Exco worth $6 or $7 a share? By taking such large stakes, Ross, Watsa and Oaktree are likely presuming the upside is much greater than that.

Risks to Consider: With its heavy exposure to natural gas, investors need to be concerned about a fresh slump in gas prices. The current rally in gas is unlikely to last, but gas isn’t likely to plunge back towards the $3 per thousand cubic feet (Mcf) mark either. A range of $4 to $4.50 looks feasible, and for Exco, that would be a welcome price. 

Action to Take –> Wilbur Ross isn’t standing by Exco for charitable reasons. He has had ample opportunity (and ample reasons) to unload his stake at far higher prices. Instead, he’s stood tight and actually deepened his ties to the company. Recall that he snapped up various distressed steel assets a decade ago and then turned a quick 125% profit on those moves. Don’t expect such a fast turnaround this time, but the recent buys by Ross, Prem Watsa and Oaktree Capital provide a clear value signal to investors.

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