It has been a terrible year for investors in Energy XXI (NASDAQ: EXXI). The Gulf of Mexico-focused driller has seen its stock tumble nearly 60% in 2014, partly due to operational missteps. This was after it made a very large acquisition that has yet to deliver any cost savings. To make matters worse, Energy XXI's COO is heading for the exit. Oh, and now oil prices are plunging, causing the stock to accelerate its summer sell-off, as shown in the following chart.
This all certainly makes investors wonder if the bullish thesis surrounding this stock is all wrong. All that being said, Energy XXI estimates it is sitting on $7.6 billion of proved Gulf of Mexico oil and gas reserves using a PV-10 value. That suggests the company is very undervalued at its current $5 billion enterprise value. This combination of undervalued assets and underperformance makes it a prime target for activist investors.
What are activist investors?
An activist investor is an individual or group of investors that purchase a large number of shares in a public company in order to enact change. This can be achieved through corresponding with the company's board or even taking seats on the board to push for change from the inside. Activist investors usually target companies with solid assets that are underperforming due to mismanagement and high costs. Activists believe they can fix the company's problems and make it more profitable, thereby improving the value of the stock and make the activist a lot of money.
Why would activist investors be interested in Energy XXI?
Along with its massive oil reserve, Energy XXI is also sitting on a massive pile of debt that it used to acquire a number of mature oil fields in the Gulf of Mexico. Worse yet, the company's operating expenses per barrel of oil equivalent have been marching higher over the past year. Here's a look at its direct LOE costs and G&A costs per BOE over the past two years.
Source: Energy XXI and author's calculations.
Nearly all of the company's expenses on a per barrel of oil equivalent basis have been heading higher. That's a key signal to activists, who see surging costs like this as an area that can be fixed to improve profitability.
While no activist investors have stepped up yet to publicly call for change, Energy XXI has a couple big investors that could get vocal. Mount Kellett Capital Management is the top hedge fund investor in the company's stock, with 12.3% of its portfolio invested in Energy XXI, which makes the company the third-largest holding in its portfolio. Mount Kellett is a $6 billion hedge fund focused on distressed investing and special situations, so it's a name to watch here as Energy XXI's debt could cause distress if oil prices continue to fall.
The other hedge fund to watch is Hayman Capital, which is run by noted investor Kyle Bass. His fund now owns 3 million shares of Energy XXI, and it recently increased its position by 12%. Energy XXI now represents 9.68% of his fund's portfolio and is its third-largest holding. Hayman Capital could continue to increase its position in order to push the company to make needed changes.
That being said, Energy XXI is starting to take some steps to avoid any future confrontation with activist investors. The company plans next year to cut its direct LOE costs by 11%, its interest expense by 35%, and its net G&A expense by 28% as it begins to benefit from merger synergies after acquiring EPL Oil & Gas, as the following slide notes.
Source: Energy XXI (Bermuda) Investor Presentation.
In addition, the company intends to sell some assets to cut its debt, including 30 fields around the Gulf of Mexico Shelf starting in the second quarter of next year. This is exactly the type of move activist investors would have pushed the company to make, as its debt-to-capital ratio of 66.9% is well above the target ratio of 45%-60%. Only time will tell if this will be enough to keep activists away from the company.
Investor takeaway
Activist investors aren't yet publicly calling for change at Energy XXI. However, if it fails to deliver on its cost reduction and debt measures we can almost bet activists will target the company. It's sitting on too much oil, and its cost structure is too high, for activists not to be interested in the stock.
