Rex Energy is a $1B independent oil & gas company. In many ways it is similar to other independent E&Ps (mediocre track record of value creation/destruction, high insider pay, constantly raising capital, etc. etc.). Its most recent secondary offering was a year ago in 2012 when it sold shares for $9.25/share (for proceeds of $8.81 before dilution from the over-allotment option). The current share price is $19.07.
While its balance sheet is not as deceptive/aggressive as Miller Energy or TransGlobe Energy, Rex has large liabilities that look a little suspicious.
The trade is a little crowded as 15.6% of the float is sold short.
Did Rex sell its future?
On May 29 2012, Rex sold its 28% stake in Keystone Midstream to its partner Sumitomo. It received $128.1M in cash and recorded a gain of $99.4M. This would imply that it made $99.4M on a $28.7M investment, which is a 346% gain. Perhaps Rex made a really smart investment in midstream assets. However, I think that Rex has sold its future and engaged in a piece of financial engineering that inflates short-term profits.
- The minimum net obligations for “Natural Gas Gathering, Processing and Sales Agreements” jumped from $70.4M in YE2011 to $441.3M in YE2012 (+527%). This suggests to me that the midstream sale was tied to a contract that locked Rex into massive payments in the future.
- The cost of transporting and marketing the company’s hydrocarbons has shot up from $4.6M to $9.0M year over year (95.7%). This is higher than the 20.3% growth in oil/NGL/gas revenue and 72.7% growth in mcfe produced.
- The minimum commitments rapidly will grow to $32.5M in 2017. This is well above the $9.0M spent in YE2012. Again, this suggests to me that the midstream sale was tied to future costs.
- The rapid growth in minimum commitments doesn’t seem to make too much sense from an economic perspective. It would make sense to (mostly) match the commitments to expected future production. From 2013 to 2017, the commitments grow at 40.3%/year. It is unlikely that actual production will grow so fast, especially when shale gas wells decline very rapidly in their first few years of production. It is not realistic to expect a shale company to grow production at 40.3%/year.
From the latest 10-k:
Natural Gas Gathering, Processing and Sales Agreements
During the normal course of business we have entered into certain agreements to ensure the gathering, transportation, processing and sales of specified quantities of our oil, natural gas and NGLs. In some instances, we are obligated to pay shortfall fees, whereby we would pay a fee for any difference between actual volumes provided as compared to volumes that have been committed. In other instances, we are obligated to pay a fee on all volumes that are subject to the related agreement. In connection with our entry into certain of these agreements, we concurrently entered into a guaranty whereby we have guaranteed the payment of obligations under the specified agreements up to a maximum of $406.4 million, which is larger than our estimated minimum obligations due to certain contracts which have minimum commitment volumes and other contracts which contain provisions that require payment on all volumes delivered.
For the years ended December 31, 2012, 2011 and 2010, we incurred expenses related to the transportation and marketing our oil, natural gas and natural gas liquids of approximately $9.0 million, $4.6 million and $0.1 million, respectively.
Minimum net obligations under these sales, gathering and transportation agreements for the next five years are as follows ($ in thousands):
Total 2013 $ 8,411 2014 12,495 2015 19,584 2016 26,712 2017 32,552 Thereafter 341,576 Total $ 441,330
It looks like Rex has taken a quick short-term cash injection at the expense of future cash flows. The $441M liability is massive for a company that has only sold $134.6M in hydrocarbons in YE2012. It seems like the company has committed to rapidly-escalating future costs. This would explain how it was able to have a 346% return on the sale of its Keystone midstream assets. It recorded a gain of $99.4M but faces an additional $370.9M in future commitments. (*It is unclear to me how much of the additional future commitments are due to the sale of the Keystone midstream assets.)
First of all, the company has oral (not written) agreements for related party transactions. This is crazy.
Secondly, the use of corporate aircraft is probably an example of corporate waste.
Thirdly, it may be possible that the company overpaid for aircraft purchased from insiders. The company has purchased a Cessna model 550 for $1.2M in total. A similar Cessna model 550 (Citation II built in 1988) is listed online for an asking price of $0.995M. I can’t figure out the answer because Rex doesn’t state the age of the airplane it purchased (or other basic valuation information on the airplane). From the 10-K:
We have an oral month-to-month agreement with Charlie Brown Air Corp. (“Charlie Brown”), a New York corporation owned by Lance T. Shaner, our Chairman, regarding the use of two airplanes owned or managed on our behalf by Charlie Brown. Under our agreement with Charlie Brown, we pay a monthly fee for the right to use the airplanes equal to our percentage (based upon the total number of hours of use of the airplanes by us) of the monthly fixed costs for the airplanes, plus a variable per hour flight rate that ranges from $400 to $1,850 per hour. In September 2010, we purchased an undivided 50% interest in one of these airplanes, a Cessna model 550 from Charlie Brown for approximately $0.6 million. In April 2011, we purchased the remaining 50% interest in this aircraft for approximately $0.6 million. The purchase of the aircraft has been recorded as Other Property and Equipment on our Consolidated Balance Sheets. For the years ended December 31, 2011 and 2010, we paid Charlie Brown $0.2 million and $0.4 million, respectively, for the use of the aircrafts, including the variable per hour cost in addition to pilots fees, maintenance, hangar rental and other miscellaneous expenses. For the year ended December 31, 2012, the amounts paid to Charlie Brown were negligible.
Then there’s the company’s second airplane, a Eclipse 500 that was purchased brand-new for $1.7M in June 2007 (a month before Rex’s IPO). Rex is borrowing money from the bank at LIBOR plus 2.5% to finance the aircraft. Previous to the bank loan, the company was borrowing $50,000.00 from Mr. Shaner at 7% to finance the aircraft. The related party loan at 7% is more expensive than LIBOR plus 2.5%, which suggests to me that insiders are getting a really good deal on lending money to the company. The 10-K describes the bank loan:
We own a 25% membership interest in Charlie Brown Air II, LLC (“Charlie Brown II”). Shaner Hotel Group Limited Partnership, a Delaware limited partnership controlled by Mr. Lance T. Shaner (“Shaner Hotel”), and an unrelated third party each own 25% and 50%, respectively, in Charlie Brown II, which owns and operates an Eclipse 500 aircraft, which was purchased for approximately $1.7 million.
Charlie Brown II has a loan from Susquehanna Bank, formerly Graystone Bank, to purchase the aircraft that was originally $1.5 million at its inception in June 2007. The loan matures on June 21, 2017 and bears interest at a rate of LIBOR plus 2.5%. The loan required payments of interest only for the first three months of the loan. Thereafter, Charlie Brown II has been required to make monthly payments of principal and interest utilizing an amortization period of 180 months. The Company and Shaner Hotel each guarantee up to twenty five percent, or $0.4 million, of the principal balance of the loan. The balance of this loan as of December 31, 2012 and 2011 was approximately $1.3 million and $1.4 million, respectively. For the years ended December 31, 2012, 2011 and 2010, we paid Charlie Brown II approximately $0.2 million each year, respectively, for loan interest, services rendered and retainer fees.
The IPO prospectus: describes the related party loan:
On June 21, 2007, we obtained a 24.75% limited partnership interest in Charlie Brown II Limited Partnership, a Delaware limited partnership (“Charlie Brown II”), and a 25% membership interest in its general partner, L&B Air LLC, a Delaware limited liability company (“L&B Air”). Charlie Brown II has ordered and agreed to purchase a 500 Eclipse Airplane for approximately $1,700,000. The airplane is scheduled to be delivered from the manufacturer to Charlie Brown II in January of 2008. Shaner Hotel Group Limited Partnership, a Delaware limited partnership controlled by Mr. Shaner (“Shaner Hotel Group”), owns a 24.65% limited partnership interest in Charlie Brown II and a 25% membership interest in L&B Air, and Charlie Brown, an entity owned and controlled by Mr. Shaner, owns a .1% membership interest in Charlie Brown II. The remaining 49.50% limited partnership interest in Charlie Brown II and 50% interest in L&B Air is owned by an unrelated third party. On June 21, 2007, we made capital contributions to Charlie Brown II and L&B Air in the amount of $49,500 and $500, respectively. To fund these capital contributions, we borrowed $50,000 from our Chairman, Lance T. Shaner. This loan is evidenced by a promissory note dated June 21, 2007 and bears interest at the rate of 7% per annum. The promissory note is payable upon the demand of Mr. Shaner and may be prepaid in whole or in part without penalty. We believe that the terms of this loan are comparable to terms that could be obtained at an arms’ length basis from unrelated lenders. We expect that the outstanding principal amount of this loan will be repaid in full after the completion of this offering.
You also have to wonder why a company needs corporate aircraft so badly in the first place.
Not surprisingly, Rex’s G&A seems fairly high. In YE2012, G&A as a percentage of revenue was 15.8%. (This metric was higher in previous years.)
I’m not sure how much of this can be explained by corporate waste. There may be other reasons (unknown to me) why G&A is so high (e.g. Rex is not a well managed business).
Rex seems like it is intentionally taking on tail risks in its hedging program. For example, the company uses three way collars. This is like a normal collar except that a far-out-of-the-money put option is sold on top of the collar. Selling far-out-of-the-money put options exposes the company to tail risks and excessive trading costs.
I don’t think this strategy is a good idea.
Since the company’s IPO in June 2007, the company has largely failed to generate GAAP earnings. As of the latest quarter (Q3 2013), Rex has retained earnings of -$27M versus $455M in capital raised. If you strip out some of the $99.4M gain on the sale of midstream assets, the company’s track record doesn’t look as good. At the current rate, it looks like the company is poorly managed and will slowly destroy shareholder capital.
Valuation-wise, the company trades at a price/book ratio of 2.33. I believe that book value is equal to or higher than the market value of the company (in a private transaction)… though this is hard to prove. At the end of the day, you have a bad company trading at a high valuation.
*Disclosure: Short REXX common.