HighPoint Resources Corp (NYSE:HPR) is a Colorado-based oil and gas producer that is now at a crossroads. HPR stock is an extremely unique merger arb deal that I estimate is worth at least 58% more than today’s price.
Here is the situation in a nutshell. It all relates to a Nov. 9 announcement by HighPoint.
The Merger Rub
However, there is a rub. If 97.5% of the noteholders agree to the deal, the company will do an exchange offer and no bankruptcy would be filed.
In that case, existing HPR stock owners would get 1.6% of the new company. But if the level of acceptance is short of 97.% HighPoint would file for Chapter 11. In that case, HPR stock would be worth nothing.
The good news is that HighPoint said in a related presentation on page 7 that 83% of noteholders already say OK to the deal. So that puts a good probability that the deal could go through.
But what is HPR stock actually worth today, if all the owners receive only 1.6% of the combined company?
Estimating Value for HPR Stock
One of the more interesting presentations relating to this merger deal is not on the company’s website. It is called a “Cleansing Materials” Presentation and is listed as Exhibit 99.2 in the SEC filing on Nov. 9.
On page 5 of that presentation, the company projects out its cumulative free cash flow (FCF) over the next five years. By the fifth year, its cumulative FCF will be $491 million. We can use this as the basis for estimating the value for HPR stock.
For example, first we have to discount the cumulative FCF to the present value (PV). Using a 15% discount rate the PV factor is 49.7%. That means $491 million in five years of FCF is worth $244 million.
Now using a 5% FCF yield, that means HPR stock is worth $4.88 billion. However, HPR stock owners will get only 1.6% of this amount. That is worth $78.1 million. That is 85.5% higher than its present $42.1 million market capitalization.
Today (Nov. 27), HPR stock is at $10.94 per share. So it is worth 85.5% more or $20.29 per share.
But we are not finished. The deal is not fully agreed upon. We will use probability analysis to estimate its true value.
Let’s say that there is an 85% chance that the deal goes through and a 15% chance that it fails. That would happen if not enough noteholders would accept the exchange offer and HPR stock owners get nothing.
So 85% times $20.29 is $17.25 per share. Adding to the 15% chance there would be no return, the result is $17.25, or 58% above today’s price of $10.94.
What to Do With HPR Stock
You might be asking why any of this analysis matters? I will just wait until the deal is finalized and then buy the stock. In the case that the exchange goes through HPR stock will become BCEI stock for 1.6% of your holdings.
Or if you are not a shareholder now you just buy BCEI stock. However, I highly suspect that the stock will rise to between $17 and $20 as soon as Bonanza Creek or HighPoint announces there was 97.5% acceptance.
The point is there is no time limit. They will simply announce when acceptances hit the threshold or when HighPoint files for bankruptcy. At that point, HPR stock will probably dip close to zero or maybe around 50 cents.
So you see the conundrum. That is what merger arbitrage funds do. They try to get as much legal inside information as possible and make an estimate.
For most investors, the easiest path is the wait after the merger closes or wait until there is a bankruptcy. At that point reassess the value. But for investors willing to play the merger arb game my best estimate is that HPR stock is worth $17.25 now, or 58% over today’s price.
On the date of publication, Mark R. Hake did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.