Description

Thesis

Greenhunter Resources (GRH) is essentially a Ponzi scheme masquerading as an oil field services company. The Company uses various different stock promotion stories to raise capital in order to pay for marginal capital projects, questionable acquisitions, and preferred dividends. With a stretched balance sheet, significant operating cash burn, large potential capex projects and sizable monthly preferred dividends, GRH has hit a wall. In the next 6 months, the company will be forced to either do a large equity offering or halt preferred dividend payments crushing the company’s primary means of accessing the capital markets. With negative common book equity per share and trading at over 12.7x very aggressive sell side estimates for $8.7MM of 2014 EBITDA, GRH shares have substantial downside from current share prices. We recommend a short position as the stock’s 99% increase in July has provided a compelling entry point.

Overview

Greenhunter was founded and seeded by Gary Evans the CEO of Magnum Hunter Resources (MHR.) Greenhunter was originally formed in 2006 as a vehicle to pursue investments in the alternative energy space. The company bought an idled Biomass plant and a small wind turbine and raised equity capital under the idea of becoming the next big alternative energy company. After the financial collapse in 2008/2009 the company switched gears and repositioned itself as an oil field water handling company. For the past 6 quarters the company has been rolling up small oil field fluid handling companies by selling common and preferred stock.

Greenhunter describes itself as a leading provider of water management solutions and clean energy products as it relates to the oil and gas industry in unconventional resource plays. Basically the company owns trucks which haul waste water from well sites and the company owns some salt water disposal wells.

In the last year and a half the company has been on an acquisition binge in order to build out its fluid handling businesses. In February 2012, the company bought Hunter Disposal from MHR for $9.9MM in cash and stock. In April 2012, the company bought Blue Water Energy Solutions for $2.9MM in cash and stock. In November 2012, the company acquired Virco Realty for $2.3MM in cash and stock. In December 2012, the company acquired White Top Oilfield Construction and Black Water Services for $2.9MM in cash and stock. In March 2013, the company acquired a 10.8 acre barging terminal in Wheeling, WV for $750,000 in cash.

After all of these acquisitions, the company’s footprint can be seen on slide 14 of the company's pitchbook (http://media.corporate-ir.net/media_files/IROL/21/219127/GreenHunter%20Energy%20(NYSE%20Amex%20GRH)%20Investor%20Presentation.pdf)

On June 10^th the company sold a salt water disposal well in South Texas for $5.2MM. The company also entered into an agreement with the same buyer for the sale of 2 additional salt water disposal wells in South Texas for $7.5MM. This transaction has yet to close.

Over the past week the stock has been involved in a coordinated stock promotion scheme from such reputable outfits as topstockmillionaire.com (http://topstockmillionaire.com/todays-best-stocks-to-buy/the-best-way-to-profit-from-tighter-fracking-laws/) and Sierra World Equity Review(http://www.sierraworldequityreview.com/2013/07/21/as-the-cfo-retires-a-new-chapter-begins-for-greenhunter-resources-grh-as-acquisition-talks-to-star-in-early-august-in-texas-predicts-sierra-world-equity-review-watch-for-the-share-price-to-continue/). The stock promoters have pushed the stock up 99% this month and 43% over the last 3 days on relatively high volume.

Capital Structure

Using street consensus estimates for 2014 EBITDA of $8.7MM, the company is levered 6.6x through the preferred stock. The preferred stock currently yields 13.1% and pays its dividends monthly.

In addition to the 33.4MM shares outstanding the company has significant amounts of out of the money stock options, warrants, and convertible notes.

Shares of common stock underlying the following items were not included in dilutive weighted average shares outstanding for the three month periods ended March 31, 2013 and 2012, as their effects would have been anti-dilutive.

The warrants are roughly equally split between $1.50/share and $2.50/share strike prices.

The company has been very generous with its equity compensation. Existing outstanding stock options would increase the share count by 35% if they were exercised. In February, the company authorized the issuance of an additional 7 million common shares under long term incentive plans.

The following is a summary of stock options outstanding at March 31, 2013:

History of Significant Cash Burn

Over the last 3 quarters, GRH has burned over $21.3MM in cash between oversized capex projects, operating cash burn, preferred dividends and cash payments for acquisitions. Since acquisitions are an integral part of the company’s growth strategy I include the cash payments for acquisitions in my definition of free cash flow for the company. GRH has financed this cash burn by issuing copious amounts of common and preferred stock.

We expect this significant cash burn to continue as the company’s operations due not generate sufficient cash flow to finance both working capital and the preferred stock dividends. Note, the company current has a working capital deficit of $11.8MM driven by $15.8MM in accounts payable. Even using the overly rosy sell side EBITDA estimates, no cash paid for acquisitions, and only modest paydown of the company’s high payables balance, the company’s EBITDA is not sufficient to pay the interest on its debt as well as the preferred dividend payments and working capital. The company will inevitably have to halt payment of dividends on the preferred stock in order to stay afloat.

Note: GRH has not released a formal capex budget for 2013 due to the company’s current lack of capital. That said, the company has maintenance expenditures of roughly $4MM per year (mostly truck repairs) and has indicated a desire to spend $10.5MM this year drilling salt water disposal wells in the Bakken.

Perpetual Financings

GRH spent the majority of 2012 and H1 2013 scrambling to raise additional money to fund the continuous cash burn.

During the last 15 months, the company had the following issuances of its Series C preferred stock:

On February 17, 2012, we issued 22,000 shares of our 10% Series C Preferred Stock as partial consideration in our acquisition of Hunter Disposal. On April 25, 2012, we changed the stated liquidation value of our 10% Series C Preferred Stock from $100 per share to $25 per share. As a result, the 22,000 shares of our 10% Series C Preferred Stock issued in connection with the acquisition of Hunter Disposal were converted to 88,000 shares of 10% Series C Preferred Stock. See Note 6–Acquisitions and Divestitures, for additional information. The Series C Cumulative Preferred Stock earns 10% dividends paid monthly and is not convertible into common shares of the company except for under certain circumstances in the event of a change of control.

On April 27, 2012, the Company issued 20,000 shares of our 10% Series C Preferred Stock as partial consideration in the closing of the Blue Water Acquisition. See Note 6–Acquisitions and Divestitures, for additional information.

On June 29, 2012, the Company issued 16,000 shares of our 10% Series C Preferred Stock as partial consideration in the closing of four permitted disposal well sites for the Eagle Ford Water Hunter Joint Venture.

On July 31, 2012, the Company closed a public offering of 425,000 shares of its non-convertible 10% Series C Preferred Stock (liquidation preference of $25.00 per share) at a public offering price of $21.00 per share. The net proceeds to the Company from the offering were approximately $7.9 million, net of underwriter discounts, commissions and estimated offering expenses.

On November 27, 2012, the Company issued 91,425 shares of our 10% Series C Preferred Stock as partial consideration in the closing of the Virco Acquisition. See Note 6–Acquisitions and Divestitures, for additional information.

On December 31, 2012, the Company issued 41,000 shares of our 10% Series C Preferred Stock as partial consideration in the closing of the White Top and Black Water Acquisition. See Note 6–Acquisitions and Divestitures, for additional information.

On December 11, 2012, the Company closed a public offering of 300,000 shares of its non-convertible 10% Series C Preferred Stock (liquidation preference of $25.00 per share) at a public offering price of $21.00 per share. The net proceeds to the Company from the offering were approximately $5.9 million, net of underwriter discounts, commissions and estimated offering expenses. We sold an additional 2,183 shares through our At-The-Market (“ATM”) facility for net proceeds of $42,941 in December 2012.

During the year ended December 31, 2012, the Company issued 232,536 shares of our 10% Series C Preferred Stock upon conversion of $5.2 million in principal along with accrued interest of $602 thousand on our Series B Debentures.

During the three months ended March 31, 2013, the Company issued the remaining common stock and Series C preferred stock under its current registration statement. The net cash proceeds received upon issuance of these securities were approximately $5.2 million for the issuance of 221,946 shares of common stock and 265,436 shares of Series C Preferred Stock through our At-The-Market (“ATM”) facility.

In the last 15 months, the company issued common stock in the following transactions:

On February 17, 2012, the Company issued 1,846,722 shares of common stock with a fair market value of $3.3 million based on stock price of $1.79, as partial consideration in the acquisition of Hunter Disposal. See Note 6–Acquisitions and Divestitures, for additional information.

On June 27, 2012, the Company issued 247,876 shares of our common stock valued at $512 thousand (based on a closing price of $2.11 per share as of June 27, 2012) as partial consideration for entry into the joint venture agreement with Blue Water Energy Solutions, LLC.

On June 29, 2012, the Company issued 242,471 shares of our common stock valued at $506 thousand, (based on a closing price of $2.04 per share as of June 29, 2012) as partial consideration for the acquisition of four permitted disposal well sites for the Eagle Ford Water Hunter Joint Venture.

On December 20, 2012, the Company amended a public offering to include issuance of common stock, par value $0.001 per share, as well as 10% Series C Preferred Stock (liquidation preference of $25.00 per share) at a public offering price of $21.00 per share. The shares are to be sold from time to time at market.

On December 31, 2012, the Company issued 589,657 of our common stock valued at $955,244 (based on a closing price of $1.62 per share as of December 31, 2012) as partial consideration for the acquisition of White Top and Black Water.

During the year ended December 31, 2012, the Company issued 1,111,111 shares of common stock to Gary C. Evans for payment of a Board of Director and Stockholder approval fee for providing a line of credit to the Company for up to $2 million. The shares were valued at $2.0 million based on the closing price of $1.81 per share on November 26, 2012, the date the transaction was approved by stockholders. The Company also issued 111,848 of our common stock valued at $202 thousand based on the closing price of $1.81 per share, to executive officers of the Company for deferred and bonus pay approved by the stockholders at our annual meeting on November 26, 2012.

During the year ended December 30, 2012, the Company issued 70,000 shares of common stock upon exercise of 70,000 of our $1.50 warrants.

During the three months ended March 31, 2013, the Company issued 12,500 shares of common stock upon exercise of 12,500 of our $1.50 warrants.

Valuation

The company has guided to revenues of $35.1MM for 2013 (sell side estimates are $34MM), implying the company is trading at 3.2x 2013 revenues. The Street estimates 2013 EBITDA of $1.6MM implying an EV/EBITDA multiple of 69.2x. Since the company needs new capital to do capex or additional acquisitions, the street’s 2014 estimates are way too high at this time.

In contrast, GRH’s most direct comp, Nuverra Environmental Solutions (NES) trades at 1.9x 2013 sell side Revenue estimates, 1.7x 2014 revenues and 7.4x 2013 street EBITDA estimates and 6.2x 2014 EBITDA.

At 2x 2013 sales of $35MM, GRH common would be worth $0.37/share.

GRH has negative common equity of $0.76/share.

GRH’s Balance Sheet is Very Stretched

Greenhunter has significant negative common equity value of $25MM and currently has negative net working capital of $11.8MM. In spite of all of the company’s equity offerings over the past 18 months, net debt has been growing and the outstanding payables have been growing.

Recent Financial Results have been very weak

While the company’s acquisitions have been able to grow revenues over the past year, margins have collapsed and ebitda has become negative. Q1 EBITDA was negative $1MM down from negative $85k in Q4 and +$1.1MM in Q3. Gross Margins fell to 9.5% in Q1 from 41.8% in Q4 and 49.4% in Q3. SG&A of over 26% of sales remains bloated.

A collection of recent red flags

CFO Retirement

On July 12, David Krueger announced his retirement as CFO of the company. Mr. Krueger had been the company’s CFO since 2006 (basically since inception) and before that was the Chief Accounting Officer at the previous incarnation of Magnum Hunter. Mr. Krueger has worked for Mr. Evans since 1997. To have one of Evans’s chief lieutenants leave for no apparent reason is a major red flag.

The company is intent on further significant equity raises

From the March 10-Q:

“Our current capital expenditure plan for the next twelve months is dependent upon our ability to raise additional equity capital and, to a lesser extent, additional debt. We plan to raise significant new equity funds from the sale of either common stock or our 10% Series C Preferred Stock.

For 2013, we have not adopted a formal corporate capital expenditure budget due to our current lack of capital resources. We have formulated specific budgets for ongoing projects and will adopt a formal corporate capital expenditure budget upon securing necessary financing commitments. “

Going Concern Warning in the 10-Q

“We have continued to experience losses from ongoing operations. This raises substantial doubt about our ability to continue as a going concern. We received a number of capital advances in 2011 and 2012 from our Chairman in exchange for promissory notes, all of which have been repaid through March 31, 2013. We have a letter of guarantee from the Chairman of the Company for up to $2.0 million of credit support if needed to fund future operations which expires on December 31, 2013, all of which is available as of March 31, 2013. “

Poor Acquisition History

On December 31^st, GRH acquired Eagle Ford Shale oilfield water services and construction companies White Top and Black Water for $1,200,000 cash, 41,000 shares of preferred stock, and 589,657 shares of common stock. The $2.9MM purchase price of the acquisition included $2.8MM of goodwill. On March 31^st, the company wrote off all of the goodwill to 0.  

The company has trouble paying its bills

Accounts payable were over $15.8MM at the end of Q1 vs. cash of $1.2MM. The company has negative net working capital (current assets minus current liabilities) of $11.8MM and this metric has been getting worse over the past 2 quarters. GRH has been sued several times over the last couple of years for late payment or nonpayment.

ABB, Inc., Plaintiff v. GreenHunter Resources, Inc., Defendant, In the Superior Court of California, County of Imperial, Case No. ECU07002. ABB, Inc. was a subcontractor to Crown Engineering for the work done at our Mesquite Lake plant in Imperial County, California. GreenHunter Resources, Inc. had a construction contract directly with Crown Engineering only. On or about January 18, 2010, GreenHunter entered into a settlement agreement with Crown Engineering settling any disputes between the parties regarding the work done at our Mesquite Lake plant. Green Hunter performed all of its obligations under the settlement agreement. ABB is attempting to enforce payment of its claim, approximately $327,555 by asserting it is a third party beneficiary under our settlement agreement with Crown Engineering. Management is actively defending this claim and we believe we will ultimately prevail on the merits.

Glen Pasak, Clint Howard and Manuel Rodriquez, Plaintiffs v. GreenHunter Water, LLC and GreenHunter Energy, Inc., Defendants, in the 23rd District Court of Wharton County, Texas, Case No.: 46,749 filed May 16, 2013. This lawsuit has not yet been served on Defendants. Upon information and belief, the lawsuit alleges as follows: On December 31, 2012, Plaintiffs sold their interest in Blackwater and White Top to Defendants. As part of the transaction, Plaintiffs allege that Defendants agreed to be responsible for all debts and liabilities of Blackwater and White Top including the debts and liabilities which were personally guaranteed by Plaintiffs. The assumption of this liability was material to the sales transaction and Plaintiffs relied on multiple representations by Defendants that the debt would be assumed completely by Defendants. As the Defendants have not yet been served, no answer or response is due at this time. GreenHunter Resources and GreenHunter Water believe this case has no merit and the Defendants will ultimately prevail on all matters arising under this lawsuit.

Heckmann Water Resources, Plaintiff v. Hunter Disposal LLC and GreenHunter Energy, Inc., Defendants, In the Court of Common Pleas, Washington County, Ohio, Case No.120T233, filed July 16, 2012. Heckmann Water Resources alleges a breach of contract against Hunter Disposal for failure to pay for certain transportation services on behalf of Hunter Disposal. Heckmann alleges GreenHunter made representations to Heckmann that GreenHunter would make any payments on Hunter Disposal’s behalf. On February 20, 2013, Heckmann amended its complaint to state that as of the date of the amended complaint Hunter Disposal has failed to pay for services in the amount of $77,706. Hunter Disposal has recently made all disputed payments to Heckmann and the parties are currently preparing a dismissal of the complaint.

Numerous Related Party Transactions

The company paid Gary Evans $32k in Q1 for use of his personal jet. The company is owed $51k for “pilot expenses” from another of Mr. Evans’ companies – this receivable has been on the books for several quarters and hasn’t been paid down. In 2012, GRH paid Mr. Evans $115K for use of his corporate jet.

In Q1, roughly half of the $6MM YoY increase in revenues came from transactions with MHR. The company has a $2.1MM receivable from MHR vs. $3.1MM in quarterly revenues from MHR.

Material Weakness in Internal Controls Related to Accounting Personnel

GRH was unable to get its 10-K or its March 10-Q filed on time. From the March 10-Q:

“In connection with the preparation of the financial statements included in this report, management identified the following material weakness: we have a lack of sufficient, qualified personnel to design and manage an effective control environment. Due to the lack of sufficient, qualified personnel, we do not have the appropriate level of accounting knowledge, experience and training in US GAAP to assess the completeness and accuracy of our accounting matters. In addition, we did not maintain effective controls over the period-end financial reporting process, including controls with respect to the preparation, review, supervision and monitoring of accounting operations. Specifically, we did not maintain effective controls to provide reasonable assurance that monthly account reconciliations were reviewed on a timely basis and that monthly and quarterly financial information was prepared and reviewed timely. We had insufficient segregation of duties and insufficient controls that would mitigate conflicting roles within the control environment to prevent material misstatement. Finally, we were unable to file this quarterly report timely.”

Risks

Successful launch of MAG TANK system

GRH’s most recent story is centered around the company’s potential opportunity to sell modular above ground fluid tanks. The company claims to have a proprietary design which allows the fluid tank to have a flexible footprint – which would be helpful for areas with uneven terrain like the Marcellus Shale. We doubt that GRH has any truly proprietary technology as the company spent a grand total of $470,000 doing research and development for this product.

High Insider Ownership

Mr. Evans owns 16MM shares (48% of the shares outstanding.) While Gary’s investment in MHR is more meaningful to him, his high ownership interest in GRH gives him an incentive to help in the promotion of the stock.

Noncore Asset Sales

GRH has several noncore assets it can sell to help raise some additional cash. The company has the agreement to sell 2 SWDs in the Eagle Ford for $7.5MM which has yet to close. The company also has the Biomass project which likely could be sold for scrap metal for around $1-$2MM. The company owns its corporate headquarters – the company sold the adjacent building to MHR for $1.7MM in 2011 – suggesting that it might be able to sell the remaining building for around $1.5 to $2MM.

Catalysts

Given the company’s dire financial position we expect the company to either do a highly dilutive common stock offering or to stop dividend payments on the preferred and then equitize the preferred stock. GRH has a history of halting preferred dividend payments. In December 2008, the company stopped paying dividends on its $8.1MM in Series A preferred stock and its $9.8MM in Series B preferred stock. The Series B preferred stock was eventually exchanged for 2.45MM shares of common stock – essentially giving the preferred stockholders a recovery of 56% of par.

The day traders and stock promoters go away.

Other

CEO Jonathon Hoopes prior job was as a managing director in equity research at ThinkEquity covering the alternative energy space.

Catalyst

Given the company’s dire financial position we expect the company to either do a highly dilutive common stock offering or to stop dividend payments on the preferred and then equitize the preferred stock. GRH has a history of halting preferred dividend payments. In December 2008, the company stopped paying dividends on its $8.1MM in Series A preferred stock and its $9.8MM in Series B preferred stock. The Series B preferred stock was eventually exchanged for 2.45MM shares of common stock – essentially giving the preferred stockholders a recovery of 56% of par.

The day traders and stock promoters go away.

Financial results continue to remain weak.