Bloomberg had an interesting article last week detailing some of the risks investors face when owning shares of Magnum Hunter Resources (OTC:MHRCQ). One of the issues that the article pointed out is that the company has amassed a staggering amount of debt. The other really interesting item it pointed out was that the company has engaged in some questionable related party transactions, including renting the CEO's airplane. Is this an issue investors should be worried about?
Related party transactions are quite common
Bloomberg noted that Magnum Hunter Resources engages in a lot of related party transactions, including leasing a plane from the CEO and leasing office space and equipment from a company its CEO owns a large stake in. While this is certainly an issue that investors need to monitor, it's not uncommon in the energy industry. For example, Rex Energy (NASDAQ:REXX) engages in similar related party transactions with its chairman. In Rex Energy's annual report under related party transactions, investors will find the following disclosure:
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 $800 per hour.
In addition to the oral agreement for airplane services, Rex Energy also leases office space from an entity owned by Shaner. Further, it has previously purchased land adjacent to its headquarters from that entity.
There are countless other examples in the energy industry involving related party transactions. Gulfport Energy (NASDAQ:GPOR) for example, frequently engages in related party transactions. In fact, Gulfport Energy built much of its current portfolio through acquisitions from wealth management firm Wexford Capital that at one time owned a large stake in Gulfport Energy. Its annual report is filled with disclosures of transactions made with related parties.
This isn't to say these deals are always in the best interests of investors. Gulfport Energy's Utica Shale acreage acquisitions have typically been well above the going price. For example, last year it paid $10,000 per acre for acreage owned by Wexford Capital when other acreage deals were in a range of $1,000 to $8,000 per acre. While this was for acreage in the core wet gas portion of the play, the company certainly didn't get a discount. Further, a Reuters exclusive last year pointed out that Gulfport Energy's former chairman received millions of dollars in equity from Wexford Capital in companies that did business with Gulfport Energy. The concern is that the company's former chairman could have profited from the companies doing business with Gulfport Energy at the expense of shareholders.
Increasingly investors are becoming more concerned about the related business dealings of those in control of their energy companies. There have been a couple of high profile energy CEO's that were ousted by investors that were fed up with these inside deals. So, while these transactions aren't necessarily a reason to sell, it does at least raise a red flag.
That's why investors need to at least be aware of the inside dealing of those running the companies they've invested in. In many cases these deals are small and not even worth noting. Magnum Hunter Resources CEO Gary Evans certainly questioned it in the Bloomberg piece saying, "Are you serious?" Evans said. "We're talking about $150,000 a year on a company generating $400 million in revenues and you're asking me about a private plane?" That being said, despite how common and small these deals are, investors need to make sure those in charge of the companies they've invested in are being good stewards of that investment.