Halcón Resources is pushing up against its net leverage covenant as it continues to burn through cash, raising the prospect of asset sales to shore up its balance sheet, according to six sources familiar with the company.
Earlier this month, S&P downgraded Halcón to CCC+, citing the possibility of the company breaching the 4x total net leverage ratio covenant in its recently amended revolving credit agreement, as it burns through cash in pursuit of production growth.
Last Thursday (24 January), Moody’s also changed its outlook on the company to negative, citing concerns around liquidity and the company’s need to invest in its asset base to grow production.
Under the definition specified in its revolver—which was recently amended, allowing the borrower to annualize EBITDA—Halcón’s total net leverage is 3.56x, according to two buyside sources familiar with the company.
From the beginning of 1Q19, the company is only allowed to net out USD 50m of unrestricted cash from this leverage calculation, sources noted—a condition written into the original revolving credit agreement.
Pro forma the sale of its Delaware Basin water infrastructure assets to WaterBridge Resources for USD 200m in December, Halcón’s gross leverage is 6.07x, based on pro forma total debt of USD 625m and LTM 30 September EBITDA of USD 102.85m.
Net of USD 145m of remaining cash proceeds from the asset sale, leverage is 4.7x.
The company is projected to grow production in 2019 by roughly 55% year-over-year, to an average of 22.1 Mboed, said one of the buysiders. But that growth is expected to come at a cost, particularly amid recent volatility in commodity prices.
“We expect the company to outspend internally generated cash flow by a wide margin to achieve growth targets,” said S&P in its downgrade report.
Halcón is expected to burn USD 170m-USD 218m of cash in FY19, based on USD 151m-USD 320m of adjusted EBITDA, USD 300m-USD 450m of capex and USD 42m of interest expense, according to two sources following the company and Street estimates.
The cash burn is expected to ease slightly to USD 104m in 2020, according to Street estimates.
In light of the company’s looming net leverage covenant, investors will be watching Halcón’s first-quarter earnings report closely for any signals of asset sales, the proceeds of which could be used to buy back debt to stop the company from breaching its covenant, sources said.
A sale of the entire company—which investors including Fir Tree Partners have pushed for in the past—is also an option, the sources added.
“I think they’ll try to sell some of the businesses on forward-looking, improved performance or maybe even sell the company, like they’ve been talking about for so long,” said an analyst.
Proceeds of further asset sales would add cash to be balance sheet. But the restriction on netting cash out of its covenant leverage calculation means using sale proceeds to pay down debt would be more likely, the sources said.
Halcón has now amended its covenant terms six times since emerging from bankruptcy in 2016. In light of the recent commodity volatility, investors are becoming less amenable to amendments, further increasing the pressure for asset sales, sources said.
“Investors are willing to give them more rope, but the closer we get to a recession and the more times they ask for an amendment, the less likely investors will give it to them,” one of the sources said.
Halcón’s business has three segments: oil (87% of LTM revenue as of 30 September), natural gas (3% of revenue) and liquid natural gas (9% of revenue). Through the end of 2018, the company operated three rigs: Monument Draw, Hackberry Draw and West Quito Draw.
In response to recent price volatility. Halcón announced in December that it intends to run only two of those three rigs—both in the Permian basin—for the majority of 2019.
Liquidity is USD 418m through cash and USD 275m of revolver availability on its recently amended credit facility due 2022, less USD 2m of letters of credit, according to company documents.
Halcón could use some of this liquidity to soothe its cash burn, sources noted. However, assuming it wants to keep USD 50m of unrestricted cash on the balance sheet to net out of leverage, it would have to significantly increase EBITDA in 2019 to avoid breaching its revolver covenant.
Up for sale
To generate cash to pay down debt, the company could sell minority non-operated working interests in its production assets—such as its flagship Monument Draw and West Quito Draw assets—to private equity buyers, said two analysts following the company.
In the midstream space, Halcón could also sell its liquid redox unit in 3Q19 once it has completed a few months of operations, one of the analysts added.
The redox unit is under construction at the company’s central processing facility in Monument Draw and is expected to come online by March 2019, said Jon Wright, Halcón’s COO, in the company’s 3Q18 earnings call.
The company could also put its crude and gas gathering, storage, compression or treatment assets up for sale, two sources said. An energy infrastructure sale could be worth at least USD 200m in roughly 18 months, Halcón’s management team said during its most recent earnings call.
If the market sees a rally in commodity prices, Halcón could also consider selling its non-core Hackberry Draw operating area, which is roughly 23,816 acres with 78% working interest, according to a buysider.
In terms of comps, sources pointed to 3.5x-levered Diamondback Energy and 3.8x-levered Chesapeake Energy. Both companies trader better than Halcón because they are larger and better positioned to withstand a downturn scenario, according to two sources.
Diamondback’s Ba2/BB+ 1.25bn 4.75% senior unsecured notes due 2024 traded today at 100.25 to yield 4.675%, up from a recent low of 95.375 to yield 5.69% on 26 December, according to MarketAxess.
Chesapeake’s B3/B- USD 1.3bn 8% senior unsecured notes due 2027 traded today at 96 to yield 8.679%, up from a low of 82.5 and 11.259% on 26 December, but down from trades in the par to 101 context in early November, according to MarketAxess.