What: After shares surged more than 60% yesterday following its oil rally, shares of Magnum Hunter Resources (NYSE: MHR) sank by as much as 20% today following the announcement that it has signed a letter of intent to farm out some of its nondeveloped acreage in the Utica shale formation to a private equity.
So what: Magnum Hunter is one of the poster children for companies that take on too much debt to try to fuel massive oil and gas production when prices are high, only to find themselves strapped for cash when prices crash. Over the past year, shares of Magnum Hunter are down more than 80%. Now, the slightest change in oil and gas prices will swing Magnum Hunter's stock in wild directions.
On top of this immense oil and gas volatility, the company announced today that it is agreeing to farm out 9,500 acres of its undeveloped acreage in the Utica formation to a private equity company. Under the deal, Magnum Hunter will receive a small cash injection and the private equity company will retain the rights to drill up to $400 million worth of wells on that acreage. Once the private equity company generates a 12% internal rate of return, the wells will then be returned and any residual production will go to Magnum Hunter.
Now what: Chances are, today's movement is much more related to oil and gas prices rather than the announcement of this private equity deal, because this deal is likely a good thing for the company. It allows Magnum Hunter to monetize the asset and turn it into a producing asset further down the road once private equity gets its cut. It will likely be lower-production, but it's almost free development. Also, the $25 million in cash the company will get to complete this deal is much needed for a company that has only generated $14 million in operational cash flow over the past 12 months.
Magnum Hunter's road will likely remain a rocky one for a while. This deal might help smooth things over for a while, but it doesn't do much to alleviate the long-term issues of too much debt and not enough operational cash to support its day-to-day operations. Long term, it's still probably best to shy away from this stock until it puts itself on more stable financial footing.