NEW YORK, Oct 22 (Reuters) - Standard & Poor’s Ratings Services placed its ‘B-’ long-term corporate credit rating on Houston-based Halcon Resources Corp. on CreditWatch with positive implications. Upon completion of the transaction (which we expect in December), we expect to raise the corporate credit rating on the company to ‘B’.
At the same time, we assigned our ‘CCC+’ issue rating and ‘6’ recovery rating to the company’s proposed $700 million senior unsecured notes. The ‘6’ recovery rating indicates our expectation of negligible (0% to 10%) recovery for lenders in the event of a default. We revised our recovery rating on Halcon’s existing senior unsecured notes to ‘6’ from ‘5’, which resulted in no change to our ‘CCC+’ rating. These issue-level ratings reflect the anticipated capital structure at the closing of the acquisition and are not on CreditWatch.
The rating action follows the announcement that Halcon plans to acquire Williston Basin properties from Petro-Hunt LLC and Pillar Energy LLC in a transaction with a substantial equity funding component. The transaction materially increases the company’s reserves and production in properties contiguous to existing operations and lowers debt leverage on a pro forma basis.
At the close of the acquisition, we expect to raise the corporate credit rating to ‘B’. Pro forma the transaction, Halcon will have approximately 115 million barrels of oil equivalent (mmboe) of proved reserves and production of approximately 26,500 barrels of oil equivalent per day (boe/d), which is comparable with peers with higher ratings. Oil and natural gas liquids account for 79% of reserves and 49% are characterized as proved-developed, the lowest-risk category. We view both a high liquids proportion and high proved-developed percentage relatively favorably, although proved-undeveloped reserves can provide opportunities for growth. Historical operating costs (lease operating expense, production taxes and general and administrative costs) are high at about $26 per boe reflecting the mature nature of a substantial portion of Halcon’s producing assets, which require artificial lift to produce. We expect costs to improve to below $20 per boe as Halcon adds new production, and that internal reserve replacement will be adequate as the company develops its extensive acreage holdings.
Halcon will derive about 60% of pro forma production from major liquids-rich resource plays that offer attractive growth prospects: the Bakken Shale in Montana and North Dakota and the Woodbine formation in Texas. Properties in the Eagle Ford formation will be divested to comply with management’s non-compete agreement. The remaining portion of production comes from conventional assets located mainly in Texas, Louisiana, and Oklahoma. We expect the company to focus on optimizing production and reducing costs at these relatively mature properties. Halcon also holds leases for more than 700,000 net acres in more prospective areas including the Wilcox, Mississippi Lime, and Utica Shale formations as well as areas where it has existing proved reserves and production. Concerns about the level and source of capital required to develop this broad collection of properties are reflected in the ratings on Halcon.
The company intends to issue $750 million of equity to the seller and to use the proceeds from the note issuance to fund the balance of the acquisition price. In addition, Halcon entered into an agreement whereby Canada Pension Plan Investment Board will purchase $300 million of equity from the company. Pro forma debt leverage following the acquisition and additional equity will be approximately 4.7x debt to EBITDA, which we view as acceptable for a ‘B’ rating. We annualize pro forma EBITDA for the first half of 2012 for this calculation. We expect leverage to decline to below 4.0x debt to EBITDA in 2013 as improved cash flow, caused by higher liquids production, more than offsets higher debt. Halcon plans to hedge a significant portion of its expected production, providing a measure of cash flow protection.
We estimate that the company will need $1.4 billion of external funding (inclusive of borrowings under its credit facility) through 2013 to fund growth plans. We think Halcon will generate modest funds from operations (FFO) in 2012 at our current price deck (which for West Texas Intermediate (WTI) oil is $85 for the remainder of 2012, $80 in 2013, and $75 in 2014 and thereafter--and for natural gas is $2.50 for the remainder of 2012, $3.00 in 2013, and $3.50 in 2014 and thereafter). Cash flow will likely benefit from increased production and cost reduction in 2013, but we expect capital spending to exceed internally generated cash flow again by a wide margin. Pro forma for the proposed acquisition and financing, Halcon has no borrowings under its $1.5 billion credit facility with an $850 million borrowing base.
We characterize Halcon’s liquidity as “less than adequate”. Our assessment incorporates the following expectations and assumptions:
-- We project that 2012 FFO will approximate $60 million;
-- The company’s capital budget for the year is $1.1 billion. We expect that the 2013 budget will be meaningfully higher in the context of a larger asset base;
-- The $850 million borrowing base will be undrawn at the close of the Williston Basin acquisition.
-- We project that Halcon will need approximately $1.4 billion of external capital, inclusive of credit facility borrowings, to fund its spending plans through 2013, which exceeds the current borrowing base.
-- We expect the company to use some combination of asset sales, equity, and debt issuance to fund its capital needs while maintaining liquidity. However, the execution risk associated with this assumption is a significant factor in the rating.
-- We view management’s track record of building E&P companies as favorable for Halcon’s ability to attract funding.
The ratings on the proposed $700 million of unsecured notes that will be issued to fund a portion of the transaction reflect the increased borrowing base and our assessment of the company’s corporate credit rating following the acquisition. For the full recovery analysis, please see the recovery report on Halcon to be published on RatingsDirect following the release of this report.
We will resolve the CreditWatch upon the closing of the Williston Basin acquisition. If the transaction is completed through substantially similar terms to those we currently expect, we will raise the corporate credit rating to ‘B’.
Related Criteria And Research
Key Credit Factors: Global Criteria For Rating The Oil And Gas Exploration And Production Industry, Jan. 20, 2012
Standard & Poor’s Raises Its U. S. Natural Gas Price Assumptions; Oil Price Assumptions Are Unchanged, July 24, 2012
Criteria Guidelines For Recovery Ratings, Aug. 10, 2009.
2008 Corporate Criteria: Analytical Methodology, April 15, 2008
Ratings On CreditWatch Positive
To From Halcon Resources Corp. Corporate Credit Rating B-/Watch Pos/-- B-/Positive/-- Revised Recovery Rating
To From Senior unsecured notes CCC+ CCC+ Recovery Rating 6 5
New Rating Senior Unsecured US$700 mil sr nts due 2021
Recovery Rating 6