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Thursday, November 19, 2015

Analyst: Magnum Hunter's Problems Raise Questions About the Resource Play Business Model

From Seeking Alpha:
In many respects, Magnum Hunter's situation is not unique. The company has deserved investors' broad recognition for its entrepreneurial culture and ability to build significant assets from scratch. The current default notwithstanding, the company's assets portfolio in impressive and, under normal circumstances, would provide multiple options for future growth. 
Thinking of the drivers behind the credit crisis that many participants in the U.S. E&P industry are currently facing, it is important to recognize that the resource play business model in the E&P space in the past decade was based not only on growing cash flows from operations but also - and in some cases predominantly - on value creation through the capture of assets early in their life cycle with a subsequent resale upon partial delineation or development. 
By capturing large tracts of prospective acreage at low cost, proving up that acreage - often with a limited number of wells - and moving on to the next project upon partial or full monetization, operators have been able to lock in significant gains for their shareholders. Sponsoring midstream MLPs was one of the forms of leveraging future cash flows from the resources in the ground. 
Value-creating potential of such business model was recognized not only by developers and speculators, but also by institutional investors, senior lenders, overseas capital providers, analysts, etc. In fact, the model worked very well for a long time. 
The problem, of course, is that the market's appetite and capital available for asset purchases dried up in step with the decline in commodity prices. Magnum Hunter is not the only company that is effectively "stuck" with a portfolio of assets that just a year ago appeared to be a cash equivalent but now cannot find a buyer at any reasonable price. 
The obvious danger of the resource play business model is that it has become heavily dependent on "resource play lending." At the trough of the cycle, when a significant portion of the captured assets becomes idle, there is not enough value left to support loans priced for the cyclical peak. 
Unfortunately, in the event the current commodity price environment persists, several more companies in the E&P sector may ultimately find themselves with no liquidity-enhancing options left. It is also important to note that once liquidity shortages develop, events begin to unfold with remarkable speed. The following paragraphs from Magnum Hunter's latest 10Q filing - which I included in full - is a remarkable illustration to pressures that companies face during the liquidity crunch and a must read for investors in the sector.
Read the whole article by clicking here.

So, as MHR seems to be headed for bankruptcy, it's fair to wonder how many similar stories we may hear as the low oil and natural gas prices continue.

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