October 22, 2018
Dear Members of the Board of Directors:
As one of Halcón’s largest shareholders, we are writing, first and foremost, to reiterate our strong support for Halcón’s initiatives to maximize shareholder value, including the $2.0 billion in asset sales to date and the successful development of, and recent announcement to divest, the midstream business. These were great first steps towards maximizing shareholder value, though we believe that more can be done.
First, in addition to divesting the midstream business, the Company should sell its Pecos County acreage given it does not compete for capital when compared to the plethora of inventory in Ward County. Second, the Company should use the proceeds from both this sale and the midstream divestiture to completely de-lever its balance sheet, which will leave the Company with a substantial cash position. Third, the Company should use the remaining cash proceeds to buy back a significant amount of its undervalued stock. Finally, the Company should accelerate its drilling pace in Ward County and, as the Company has stated before, ultimately look to sell the business.
Halcón is Undervalued
Despite the Company’s recent efforts, Halcón currently trades at a steep discount, resulting in a material disconnect between Halcón’s intrinsic value and its current public market trading value. The Company presently has a Total Enterprise Value of just 4.6x 2019 EBITDA (vs. peers north of 6x) and an implied market value of ~$6,500 per acre, which is dramatically lower than its peers1, whose implied market values average over $30,000 per acre. Fir Tree believes the near term steps outlined below will highlight the Company’s value and quickly close the valuation gap.
Sell Pecos Acreage
Halcón is fortunate to have two terrific acreage positions in Pecos and Ward County. While Pecos provides extremely high quality Permian acreage, it’s not the Company’s crown jewel. Rather, the Company has two decades of higher ROIC inventory to drill in Ward County. The Company does not have excess capital or scale to drill both counties simultaneously. Therefore, Halcón is left with three choices: lever up to drill its second best acreage, sit on the acreage and do nothing, or sell it.
Given the Company’s significant Ward County acreage and an undervalued stock, we believe the rational choice is for Halcón to sell its high quality Pecos acreage to generate substantial incremental cash. Pecos is more valuable in the hands of a larger producer who can use its operational scale and strong balance sheet to drill more efficiently. On slides 6 through 8 of our presentation, we provide more rationale on our recommendation to focus drilling efforts in the more prolific Ward County and sell Pecos County.
Reduce Debt and Buy Back Stock
We understand that asset sale prices are unpredictable and market dependent, but believe that selling both its midstream business and Pecos acreage will generate enough liquidity for Halcón to pay down all of its debt and be left with an abundance of cash. Having a significant net cash position (instead of net debt) will allow the Company to buy back a large portion of its market cap, and still have enough dry powder to continue its growth in Ward County. Slide 10 of our presentation provides a detailed asset sale and buyback analysis that we believe, if implemented, will lead to a meaningful re-rating of the Company’s equity.
Ward County Pure Play
Pro forma for the above transactions, Halcón will be transformed into a Ward County pure play with a pristine balance sheet. This will solidify the following benefits:
- Highest quality acreage
- Improved drill-bit returns
- Greater than 15 years of inventory at a 4-rig pace
- Improved balance sheet
- Massive buyback = increased shareholder value
- True pure-play
Strategically, one of the Board’s basic obligations to shareholders is to make decisions that optimize long-term shareholder value. With a net cash position, more than 30,000 premier acres in Ward County and decades of remaining inventory to exploit, we believe Halcón would better position itself by selling its Pecos assets, returning capital to its shareholders and growing production in a disciplined manner.
To discuss the foregoing views, Fir Tree wishes to meet with the Board of Directors in order to discuss these logical next steps, which we believe will help in the Company’s efforts to achieve its highest possible shareholder returns. We look forward to your reply and to working with you towards achieving these goals.
David Proman & Evan Lederman
Fir Tree Partners
1 Peers include Centennial Resource Development Inc. (CDEV), Diamondback Energy Inc. (FANG), Parsley Energy Inc. (PE), Jagged Peak Energy Inc. (JAG), and Callon Petroleum Company (CPE).
Link to Fir Tree Presentation: https://www.sec.gov/Archives/edgar/data/1056491/000090266418003797/p18-1799sc13d.pdf