I just got done reading Greenlight’s Q3-2015 Investor Letter. The fund was down 17% YTD as of the end of Q3 so David Einhorn had a bit of explaining to do and he did. Three holdings have performed “abysmally” for Greenlight: SunEdison (SUNE), CONSOL Energy (CNX) and Micron (MU). The letter provides a detailed update on each of these – I thought CNX was the most compelling and so bringing it to your attention. Here is what Greenlight had to say about it:
CNX is an Appalachia-based coal and natural gas production company. From its most recent high of $33.34 on May 8, the shares have traded down gradually to $9.80, where they ended the quarter. There was no single moment where the shares fell sharply; it was essentially an orderly collapse. Yes, coal and natural gas prices both fell modestly during the decline. Yes, the company’s effort to bring its coal assets public in a separate vehicle was greeted coolly by the market. Yes, there is an oversupply of natural gas in the region, which has caused local realizations and quarterly earnings to fall below plan. We could have mitigated a portion of our loss by hedging natural gas, but with the price already near a historic low, we made the incorrect decision not to hedge the commodity risk.
However, CNX has had plenty of overlooked good news. The company went through a significant cost-cutting effort and cut its capital spending budget aggressively. In July it reported fantastic drilling results and a significant success at a test well in the Utica Shale. Ordinarily, the market responds favorably to positive drilling news. In the current environment, it has responded more like a child receiving socks as a birthday present, “Gee, just what I always wanted… more, cheap natural gas.” We believe the market has undue concern about the near-term prospects for Appalachian coal and natural gas, leading it to discount the company’s long-term resource value far beyond anything we anticipated.
CNX’s financials do not lend themselves to easy analysis. Right now, CNX is transitioning from one of the country’s biggest coal producers into a natural gas company. CNX’s financial statements combine both operations, which makes it challenging to properly analyze either of them. Gas analysts looking at CNX could see a low-cost, growing natural gas business with enormous resources combined with a worthless legacy coal business. Coal analysts aren’t looking at CNX – they’re looking fro new jobs. Having dissected the financials, we see two businesses with significant upside.
Even at lower commodity prices, capital discipline, cost cutting and much more efficient drilling economics should enable CNX to be cash flow breakeven or better from here on out, which is a significant improvement from our original expectation of about $1 billion of cash burn through 2017. In 2016, we expect CNX to generate cash while growing its production and proved developed reserves. There are very few midsize energy companies achieving similar success. And yet, CNX trades as if it is at the cusp of financial distress. Of course, we wish we were entering the position now rather than at the higher prices we paid.
Co-incidentally, on July 20, 2015, Southeastern Asset Management had filed a 13D on CNX disclosing a 48.2M share (21% of total shares outstanding) position. In the filing, here is what Southeastern had to say:
While Southeastern applauds many of the actions of the board and management of the Issuer over the last two years, in our view it is now time for the Company to accelerate its efforts to build and realize value per share. Southeastern intends to discuss with third parties as well as management and the board of the Issuer a potential monetization of its E&P assets. We believe these assets alone are worth demonstrably more than the Company’s total equity capitalization today, and they are unique qualitatively in comparison to peers given the Company’s fee ownership of many acres. This monetization could take the form of a spinoff or a sale of these assets. Southeastern will also work to help the Issuer realize value for its many other valuable assets: thermal coal, met coal, pipelines and the Baltimore terminal. As a result of the extremely discounted prices of the Issuer’s equity and debt, Southeastern also intends to discuss bond and share repurchase with the Company. To obtain the flexibility to discuss all options, including but not limited to any of the actions or transactions enumerated in clauses a through j of Item 4 of Schedule 13D, with the Issuer’s management, board of directors and/or with third parties, Southeastern is hereby converting its ownership filing on Schedule 13G to a filing on Schedule 13D.