Magnum Hunter (MHR) CEO Gary Evans delivered a bombshell Thursday with an 8-K and a speech at the DUG East conference in Pittsburgh.
Magnum plans to sell all of its remaining stake in Eureka Hunter Holdings. MHR currently owns 45.53% of Eureka.
Short-term liquidity has been the greatest worry driving the plunge in MHR shares, and when it hit a low of $1.22 in last Friday's trading, clearly the shorts were betting Magnum wouldn't make it. But perception and reality are often very different things.
Liquidity has been an issue for MHR and the company has received multiple extensions from its lenders on the deadline required to raise $65 million in liquidity, a condition to MHR continuing to pay dividends on its three preferred series.
Last Friday, MHR filed an 8-K noting it had raised $55.6 million of the required $65 million, with $33.6 million of expected proceeds from an acreage sale to Antero Resources (AR) and $22 million in proceeds from "other actions." MHR has previously noted in other SEC filings that it has been issuing shares through an at-the-market registration.
So, yes, if MHR was selling stock at less than $2 a share when Evans' own corporate PowerPoint shows an internal calculation of net asset value for MHR shares of $9 to $15 a share, short-term liquidity has indeed been an issue. The deadline to raise the remaining $9.4 million of liquidity has been pushed back to July 10, and I would expect Magnum to complete one or two smaller transactions by then.
But, there is a difference between liquidity and solvency, and while MHR shares were getting crushed by the shorts, I kept looking at my screen and exclaiming, "Don't these people realize Magnum owns 45% of a pipeline that's worth a billion dollars?"
Well, I was wrong. Based on the estimates contained in MHR's Thursday 8-K, Eureka is actually worth $1.4 billion. MHR estimated its share of gross proceeds from a full sale of Eureka at $600 million to $700 million (Morgan Stanley Infrastructure owns the vast majority of the other 54.5%), implying a valuation range for Eureka of $1.3 billion to $1.5 billion. Eureka Hunter Holdings also includes ownership in TransTex Hunter, a company that leases and sells gas processing and treating facilities, but clearly the pipeline is the crown jewel here.
Magnum had been selling down its stake in Eureka at amounts that valued the whole at $1 billion to $1.1 billion. Clearly the decision to sell was driven by management's acceptance of a fuller valuation for Eureka as a whole.
Evans' speech in Pittsburgh and subsequent Q&A revealed the background for the decision to sell all of Eureka instead of MHR continuing to slowly sell down its stake:
-- Eureka received an unsolicited offer from an industry competitor.
-- The bidder is an MLP, although, not surprisingly, Evans declined to reveal which one.
-- The fuller valuation for Eureka is underpinned by a new, large commitment from a major Utica shale gas producer. Evans declined to name the new customer.
-- Eureka's new business win allowed management much greater visibility on through-put levels for future years, and thus their feeling of a greater level of clarity on Eureka's fair valuation.
-- Evans noted that Magnum's proceeds from a Eureka deal would be used to "pay down debt" and "restart our drilling program."
So, in one presentation, all of Magnum's solvency questions were answered and intermediate-term liquidity issues were addressed. Magnum stock did "pop" to over $2/share Thursday, but that is still well below the levels of one year ago.
To use an oil industry term, this transaction would completely de-risk Magnum Hunter. The company's three preferred series are still trading at ridiculous levels, made even more bizarre by the potential receipt of $600 million to $700 million (before taxes.)
Magnum's annual fixed charges (interest plus preferred dividends) amount to $121 million by my calculations, and a $600 million transaction would -- excluding any taxes owed -- cover five years of fixed charge payments.
So, where's the risk? It doesn't exist, and on the flipside, one has to consider that Magnum could call at least one of its preferred series (the C and D are currently callable and the E becomes so in November) with proceeds from a Eureka deal. That would offer a buyer huge upside given the three series' current discounts to par:
-- Series C (72 cents on the dollar; current yield 14.2%)
-- MHR-D (57 cents on the dollar; current yield 14%)
-- MHR-E (57 cents on the dollar; current yield 14.1%)
So, I'm aggressively buying MHR-C, MHR-D and MHR-E for my clients, and will continue to do so until the gap between their market prices and par values narrows considerably.