Magnum Hunter Resources (NYSE: MHR ) took advantage of its position in the hot Eagle Ford Shale to unload most of its acreage at a premium price. In a deal with Penn Virginia (NYSE: PVA ) , Magnum Hunter is selling approximately 19,000 net acres in the Eagle Ford Shale for $401 million. Included in the deal are 49 producing wells with another 11 wells in various stages of completion.
This is a big deal for both companies, both in terms of size and what it means for each company's respective future. The deal represents a big chunk of capital for Penn Virginia when you consider that its market capitalization is just $200 million. To pay for the deal, the company is planning to tack on another $400 million in debt through a senior notes offering. Pro forma, the company will have over a billion dollars in debt on its balance sheet. However, these assets are mostly adjacent to its current Eagle Ford position which yields both synergy and scale. It's really a transformational deal for the company, but given that the acres are in the oil window it appears to be worth the risk.
For Magnum Hunter, this deal is about cashing in on a high-value asset so it can reinvest into what it believes will become higher-value assets. The company is getting a good price and locking in a solid overall return. It entered the Eagle Ford in 2009 when it spent $2.35 million to acquire a small operator, after investing another $263 million in capital to develop the play, it has already yielded $80 million in cash flow. When you add it all up, that's a three-year internal rate of return over 80%. Given that the Eagle Ford represented its smallest acreage position, it makes sense to cash out and move on.
Initially, Magnum Hunter plans to use the funds to reduce its debt. However, the company had just $115 million of liquidity against a $300 million planned capital budget so one way or the other these funds will be plowed back into its business. That capital budget is split pretty evenly between its Williston Basin and Appalachian assets with a focus on growing its liquids rich production.
It reminds me of the blueprint that Chesapeake Energy (NYSE: CHK ) has famously followed. The company is constantly cashing in on its acreage to fund the development elsewhere in its portfolio. In fact, Chesapeake currently has some of its own Eagle Ford acreage up for sale and the price Magnum Hunter received bodes well for Chesapeake's fortunes.
The bottom line here is that this deal gives Magnum Hunter a little more financial flexibility to fund the opportunities it sees in both the Bakken and the Uitca. The company remains an interesting growth story, with production expected to leap this year from just over 14,000 barrels of oil equivalent per day to a range of 18,500-20,000 barrels of oil equivalent per day. Even better, an increasing mix of this production will be oil and natural gas liquids, which has been an important shift for the company over the past few years.
The company still has a heavy debt load which has short sellers piling in. Unloading the Eagle Ford, even at a great price, just provides some temporary relief. The company still needs to continue to maximize the value of its assets if it wants to send those shorts running for the hills.
I see a lot of similarities between Magnum Hunter and Chesapeake Energy. Because energy investors would be hard-pressed to find another company trading at a deeper discount than Chesapeake Energy, it might be your better play. Its share price depreciated after negative news surfaced concerning the company's management and spiraling debt picture. While the debt issues still persist, giant steps have been taken to help mitigate the problems. To learn more about Chesapeake and its enormous potential, you're invited to check out The Motley Fool's brand-new premium report on the company. Simply click here now to access your copy.