Description

This will necessarily be a brief write-up, as this idea is part trade-part value investment.

Last year Magnum Hunter founder Gary Evans announced his retirement and essentially put the company up for sale. Magnum could never get the stock market valuations that it felt it deserved. Its acquisition of Prize Energy was viewed skeptically by the market. Management couldn’t “get no respect”, as the late Rodney Dangerfield would say.

Conversely, Cimarex, XEC, management has been viewed as the Can’t-Miss Kids. They just got an uber-glowing write-up in Barrons two weekends ago that caused a 10%+ pop in the stock. XEC management is viewed as savvy, conservative, and competent. One of the touts for the stock was that is a likely takeout candidate during this budding consolidation phase in the E&P sector.

Imagine all these newbie Barron’s buyers’ horror when they discovered that not only is XEC not selling themselves, but that they are actually buying someone else; and, gasp, it’s that ne’er do well MHR! And, they’re doing it with our beloved XEC stock too!

XEC gave back all the Barrons pop plus some. This is the genesis of our opportunity. I think that the market is not giving XEC management credit for knowing what they are buying. As we VIC members have learned in the past view years, when it comes to companies, and particularly energy companies, the three most important things are: management, management, and management. Unless one thinks that XEC mgmt has blundered spectacularly, and bought a pig in a poke, then their logic for the acquisition will pay off for today’s buyers, both as the market opinion swings on the deal and as the value created by the deal comes to fruition.

The deal makes sense for several reasons: it is immediately accretive to CF/sh and to NAV; it nearly triples XEC’s reserves and diversifies the asset base; significant operational over-lap in the Gulf Coast and mid-Continent regions; importantly, at this point, it provides a multi-year inventory of attractive drilling opportunities; transforms XEC into the leading mid-cap producer.

There is a great deal of uncertainty and turmoil in the non-large cap energy sector. Companies like PPP and KMG reporting disappointing puzzling results. I think this has contributed to a general lack of confidence in managements at this time. The market, especially after being blindsided after the Barrons piece, is taking XEC out and shooting it too. This presents an opportunity for trader and value investor alike. I am recommending the purchase of the MHR stock. I think the deal will go thru in a timely (2Q05) fashion and you will pick up the small arb spread plus the TELOZ stub. For those more risk averse, the XEC stock is also a comparable value.

Catalyst

Market overreaction/misunderstanding of the buyout has irrationally driven the price of XEC down. Market recognition of XEC's astute buy will cause both stocks to pop back, and thrive long term too.