Tidying Up at Magnum Hunter

 | Jul 15, 2013 | 11:00 AM EDT  | Comments
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mhr

After the market close on Friday, Magnum Hunter Resources (MHR) filed an 8-K which revealed the final details of the company's sale of its Texas Eagle Ford Shale assets to Penn Virginia (PVA).

MHR CEO Gary Evans noted on the company's analyst call last week that once the 8-Ks were filed, the company would be able to bring all cumulative preferred dividends current. I expect a press release with the details of the resumption and "catch-up" payments for MHR's three preferred share series in the next few days.

Looking through Magnum Hunter's 8-K, a few nuggets stand out. The Eagle Ford assets were providing a significant portion of MHR's revenues and cash flow. Replacing those dollars quickly is the essence of MHR's decision to focus on Appalachia (Marcellus and now Utica shales) and the North Dakota/Saskatchewan (Bakken shale) regions.

Evans is gambling that losing 33% of both revenues and EBITDAX (as of first quarter 2013 proforma numbers released in the 8-K) will pay off in much higher production rates from the faster growing shales -- especially the Utica. (Exploration and production companies add exploration/abandonment expense to the normal measure of earnings before interest, taxes, depreciation and amortization to judge operating cash flow.)

The balance sheet is significantly improved as MHR received a very healthy price for the assets. They also wisely took 10% of the purchase price in Penn Virginia shares, which have appreciated 20% since MHR received them. MHR gave up $18.4 million in EBITDAX but gained $420 million in value, which we derive by taking (a) debt repaid (b) cash added and (c) PVA shares held. That's the equivalent of a 22.9x EBITDAX multiple for the asset; a significantly higher multiple than "core" MHR is getting in the markets.

The bottom line: MHR's 3/3/12013 book value was $5.09 pro forma for the deal as opposed to the $3.92 that was reported. We believe that this "puts a floor" on the stock near $4 per share after its annus horribilis. But as mentioned in my column last week, the next hurdle for MHR management (and common shareholders) is the Eureka Hunter pipeline divestiture.

Evans noted on the call that they (MHR owns 60% of the pipeline; private equity firm ArcLight owns the other 40%) will wait until September to begin marketing the pipeline. The rationale is that 2014 numbers will be more visible as current pipeline throughput increases. And the numbers that Evans threw out for Eureka Hunter on last week's analyst call -- 2014 EBITDA approaching $50 million and a 20-25x EBITDA multiple--would actually indicate a valuation of $1 billion to $1.25 billion for Eureka Hunter, or a net to MHR of $600 million to $750 million.

Evans tends to be "off the cuff" with his calculations, but that would be a huge payoff for MHR, and represent almost all of the current market cap of Magnum Hunter Resources, which stood Friday at $673 million.
At Portfolio Guru, LLC, our clients have significant stakes in Magnum Hunter's preferred stock issues (MHR-C and MHR-D.) Explaining to them why their MHR preferred dividend payments would not be arriving in April, May and June--clients are given a detailed record of monthly cash flows--was uncomfortable.

We didn't make the classic investors' mistake of selling at the bottom when news of the delayed 10-K/10-Q filings and MHR's decision to fire PwC as auditors first hit the tape. Clearly, though, this was an avoidable situation, and MHR's decision to fortify the CFO position with Joseph Daches -- who has 20 years of accounting/reporting/compliance experience -- is more important to us than any daily drilling results.

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