Description

Long Halcon (HK US Equity)

Cap pro forma for asset sales and assuming exercise of Ward option.

Preface

We have spent some time surveying post-reorg E&Ps. Like others, we have generally concluded that most of the re-emerging E&Ps went BK due to low asset quality as opposed to simply over-levered balance sheets. We struggle with many of these situations due to weak asset portfolios and management teams, implying unattractive look-forward economics.

For that reason, Halcon stands out to us. We think that the asset portfolio is better than most, and that Floyd is aligned and has one more good run in him.

We don’t have a strong view on commodity prices.

Thesis

We see 50% upside in HK at prevailing oil prices as the company de-levers the balance sheet and builds scale over the next 12 – 24 months. We see management as well-aligned, and likely to create strategic value through savvy deals while minimizing operational value leakage. The stock trades at a discount to peers on both cash flow and NAV metrics, which management also recognizes and is seeking to rectify. At current prices, we believe that investors are getting the Permian assets for free, with the Bakken more than covering the current TEV. The company’s assets have attractive look-forward economics, which should allow HK to accretively grow production at current oil prices.

We acknowledge that this is 1) an E&P, 2) with leverage, 3) that will probably do deals, 4) run by an aggressive CEO. There is risk here, some can be hedged and some can’t.

Assets

Without going too far down the rabbit hole here, we will say that HK has 1) more than sufficient inventory depth for a company of its size, 2) attractive returns that warrant capital at strip in both the Bakken and Delaware.

The Delaware acreage was recently acquired at what we believe was an attractive valuation. HK was able to acquire the acreage at ~$20k / production adjusted net acre while other transactions have occurred at $30k / acre and public pure-play peers trade at significant premia to this. The acreage is blocky which will allow the company to drill longer laterals and affords operational synergies. Single well IRR math is notoriously easy to manipulate, so we will just state that we think returns are quite attractive with payouts well under 2 years. There are numerous other data points that highlight the attractiveness of the Southern Delaware Basin including: public peer commentary, continued M&A deals, more capex dollars being allocated to the basin by multi-asset companies (APC, DVN, majors), and PE firms / SPACs putting money to work in the basin.

We will acknowledge that the Ward acreage is somewhat fringey. Thus far, pushing the boundaries of the basin has yielded positive results for peers, but this is certainly an area of uncertainty. Jagged Peak has adjacent acreage that is similarly cuspy. We believe that the market is giving JAG credit for the acreage, and JAG could therefore be an attractive hedge. Additionally, thus far HK has only entered into an option to acquire the acreage, so if the land is total garbage HK could simply ditch the package.

What many investors don’t realize is that Bakken and Eagle Ford half-cycle well returns in the cores of the plays are generally as attractive as those in the Permian. The main issue is core inventory depth, with many E&Ps unexcited about non-growth assets with < 5 years of inventory. HK’s Bakken fits this mold. The company’s Fort Berthold acreage is core, offering attractive economics, but with only 200 net locations left. We believe that those locations are worth $5 – 10mm each and will provide an attractive baseline of production while the company scales its Permian asset over the coming years.

Management

At one point in time, investors thought that Floyd Wilson could do no wrong. He was a darling after he sold his prior company, Petrohawk, to BHP for $12b. With Petrohawk, Floyd pioneered shale development and “discovered” the Eagle Ford. Prior to Petrohawk, Floyd built and sold 2 other companies for ~$1b in total: Hugoton and 3Tec.

Unfortunately, Floyd got caught by the downturn with a heavily-levered Halcon. The company was forced into bankruptcy to reduce the leverage profile of the business, and many investors now question Floyd. We don’t believe that the BK reflects on his capabilities, but understand that some of the luster is gone.

There are a lot of articles online about Floyd that are worth reading in the Oil and Gas (Financial) journal, Forbes, etc.

Recent conversations with management have been positive, with 3 things of particular interest to us. 1) Management told us that they think they could sell the Bakken assets today for the entire TEV of the company. 2) The game plan here is to build something and sell it like they have in the past. We like E&P management teams that are ultimately sellers, particularly when the stock screens inexpensive. 3) Management has substantial ownership of the PF company, doesn’t receive much salary, and has most compensation in the form of equity so they are well aligned with investors.

More than anything, we think that Floyd wants one last good run to regain his reputation.

Valuation

There are a lot of paradigms to valuing E&P companies. Permian investors currently like EV / EBITDA and $ / acre, which are both flawed but worth examining. Pure-play Permian comps generally trade at 9x EBITDA and ~$40k / net acre. HK trades at a large discount to both of these, and we expect the company to ultimately pivot the portfolio towards the Permian, ultimately warranting peer multiples.

A less flawed valuation methodology is a liquidation value based on recent transaction comps and PDP blowdown valuations for the production. Using this methodology we see 50% upside. It’s worth noting that a decent amount of the upside is due to leverage on an undervalued TEV.

Risks

We will be the first to acknowledge that this is higher-than-usual risk proposition:

HK is still highly levered and dependent on the capital markets, which can be a tough recipe for an E&P

HK is more highly dependent on oil prices than others (we don’t have a strong view, we would hedge with peers, shorting the strip, etc.)

The Delaware acreage is somewhat unproven, particularly the Ward County package (JAG could be an attractive hedge for this)

Catalyst

Post-reorg re-listing / sellside initiation dynamics

More deals pivot the portfolio towards the Permian (Bakken sale and / or Permian M&A)

Production and cash flow growth organically de-lever and de-risk the story

Floyd ultimately sells the company