What do you get when you combine an activist investor like Paul Singer with an oil and gas company that seems to have its fingers in everything? Change.
And it couldn’t have at a better time. Hess (HES), the 80-year-old energy business founded by Leon Hess in 1933, has had a rough couple of years on the markets, losing 43% between the start of 2011 and the end of 2012.
Singer took a 4% interest in the company, and slowly things began to change. Despite the stock’s 39% jump year-to-date through, there’s still plenty more work to do. Should you buy its stock now or wait for the rest of the changes? Let’s take a look.
Upstream Focus
The gist of Elliot Management’s Jan. 29 letter to Hess shareholders was that the company needed to make better capital allocation decisions — both in terms of growing its business and rewarding shareholders. Singer and his team made the case that Hess needs to focus on its upstream assets both in the U.S. and internationally while selling off its laundry list of midstream assets that includes everything from gas stations to fuel cell technology and even hedge funds.
In addition to selling its midstream assets, Singer recommended that it spin off its premier acreage in the Bakken along with holdings in the Eagle Ford and Utica into its own independent resource company focusing exclusively on the U.S. His third recommendation is to streamline its oil assets in the Gulf of Mexico, North Sea, West Africa and Southeast Asia into some sort of cost effective undertaking.
As it stands now, Singer argues, Hess management are simply wasting money without any kind of accountability or consideration for return on investment.
In a deal reached hours before Hess’s annual meeting, the company agreed to replace five existing directors with five new ones more palatable to the activist investor along with three of its own. In addition, Hess appointed Mark Williams, a former executive at Royal Dutch Shell (RDS.B) as non-executive chairman. The reconstituted board provides shareholders with a significant upgrade when it comes to oil and gas experience. That will come in handy as it carries out its transformation.
Since May
HES hasn’t exactly caught fire … up 2.4% from the day before its general meeting through July 22. And some institutional investors believe the board, which is almost two-thirds new, will come up with another plan different from the one proposed by Singer. Elliot’s plan is a good one, so I doubt there will be any major changes in its direction … but it’s still possible for there to be a few surprises.
By the end of this transition there could be cash proceeds from asset sales totaling more than $7 billion, which would go to rewarding shareholders and paying down debt. Barron’s July 20 issue discussed the future of Hess, suggesting its share price over the next 12 months could be anywhere from the $80 all the way past $100, depending on how aggressive it gets with asset sales. Considering Elliott Management’s letter to Hess shareholders projected a $126.24 share price based on their three main changes, I find it difficult to ignore the potential value in its stock. At $74, the stock has a 70% upside on the way to that projected price. Even if it did this over three to five years, shareholders should be happy.
Verdict
Given what Elliott Management wants to see happen at Hess, I don’t think there’s any question that investors should be buying its shares now, before more asset sales take place or a spinoff is announced. The spinoff itself is estimated to be worth almost $29 per share. Hess already has sold $3.4 billion in assets in the first quarter with some oil large fields and its gas stations still on the block.
The downside risk here has everything to do with execution. Elliot Management assumes the streamlining of its oil assets outside the U.S. along with the spinoff of its domestic assets will generate $22.2 billion of incremental value to its stock. That’s a best-case scenario. The worst case sees an increase of $13.1 billion. But that’s only if it does all that it needs to do in order to successfully obtain this increase in the incremental value of its stock. Life is never a sure thing; the same goes for business.
At the end of the day, even though you’ve missed out on a big chunk of gains YTD, there’s still plenty of room for Hess to run. Elliott Management is right — Hess can be much more efficient and profitable. The new board’s job is to apply the focus it’s been sorely lacking. If it does that, shareholders will be just fine.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.
