Good Hunting

When legendary oilman Haroldson Lafayette (H.L.) Hunt sold his gambling hall in Arkansas in the 1920s and reinvested the proceeds into the emerging oil patch, he set into motion a near century-long saga of events that would make the East Texas wildcatter one of the world’s richest men and inspire a hit TV show.

Some 83 years later this past September, Hunt’s heirs sold Hunt Petroleum Corp. to Fort Worth explorer XTO Energy Inc. for $4.2 billion, signifying a change to a new guard in the oil and gas sector, and a curtain call for a large portion of the Hunt family oil dynasty. Hunt Oil Co., a separate E&P owned by H.L.’s son Ray L. Hunt, continues to operate.

“This was a good sale for both parties,” says former Hunt Petroleum chief executive John Creecy, who still works with the Hunt organization. “It was a good move for Hunt Petroleum, and it was a good move for XTO.” The $4.2-billion price tag was the largest upstream transaction in 2008. The timing couldn’t have been more fortuitous for Hunt as record commodity prices were driving toward a peak when the deal was struck in the spring of 2008.

The Deal

The Hunt deal was the grand finale in a year-long spree of acquisitions by XTO that included $1.5 billion in the Barnett, $600 million in the Marcellus, $900 million in the Fayetteville, $200 million in the Woodford, $400 million in the San Juan Basin, $300 million in East Texas and $1.8 billion in the Bakken shale. Hunt’s 1.05 trillion cubic feet equivalent of proved reserves increased XTO’s base almost 10% and included 919,000 net acres for exploration and exploitation.

“You don’t get an opportunity to buy great properties a second time,” says XTO chief executive Keith Hutton, who characterized the deal as “one of the better ones we’ve done,” in spite of being negotiated at the top of the market. “We buy some of our best acquisitions when prices are higher. They don’t sell those types of property bases when prices are on the floor.”

XTO paid $2.6 billion of the purchase price in cash from debt issuances and 23.5 million in shares valued at the time at $1.6 billion. The cash-plus-stock structure gave the Hunt heirs a tax-efficient sale and an opportunity to stay exposed to oil and gas vicariously through the producer, and it kept XTO’s balance sheet at investment grade, a stated goal.

The key to an acquisition of this size, says Hutton, is to hedge the first two years of production, and XTO did that at $120 oil and $11 gas, protecting the economics of the deal in front of the then-unforeseen, breathtaking price pull-down. The hedges guarantee operating cash flow of about $1.1 billion annually.

“If you can hedge, you can pay a higher price than you would think,” he says. While the acquisition metrics may appear high at $3.90 per thousand cubic feet of proved gas reserves, he emphasizes that not every single reserve was booked. Plus, “Hunt has at least 2 Tcf (trillion cubic feet) of upside over and above the 1 trillion that we bought.” At $1.20 to $1.50 per thousand cubic feet to develop, “that’s how your finding costs for the acquisition actually approach $2 in reality.”

About 70% of Hunt’s booked reserves were in the East Texas and northern Louisiana region, many directly offsetting XTO’s existing positions in its core Freestone trend area. Within such proximity, XTO had kept a watchful eye on the closely held private E&P, while coveting its positions.

“We were drooling over their properties to get to buy them,” Hutton admits. “When they came up for sale, we knew there was more upside than they identified, and that we could exploit them faster.”

Owned as an investment by Hunt family trusts, and a self-described conservative E&P, Hunt Petroleum kept debt low and drilled within cash flow, leaving a lot of untapped upside on the table. “A lot of the upside existed because of the way Hunt was run. They were not trying to increase volumes rapidly, but in an orderly manner,” he says.

Built on buying underdeveloped properties, XTO recognized the potential. Hundreds of drilling locations remained undeveloped, and recompletion opportunities abounded in wells shooting one zone where four to five additional zones might exist. “Regular singles and doubles,” Hutton calls them.

“The nice part was you had shale as the wild card.”

Haynesville shale, that is. The up-and-coming play was only announced after the data-room process had begun, was yet unproven, and was not given any credit in Hunt’s reserve reports by its outside consultants.

With the advantage of operational knowledge of certain Hunt properties, XTO pounced. Hunt offered its assets in three packages—U.S. onshore that included the Texas and Louisiana properties; offshore U.S. in the Gulf of Mexico; and international offshore with North Sea producing assets and exploratory prospects. Not wanting to risk losing the deal even though it had no offshore track record, XTO gambled and made a “sweet” bid, placing an offer for the entire corporation.

“You typically lose if you bid on only one,” Hutton says. “We looked at their U.S. offshore and their North Sea and determined these were not bad properties to own. They are not a large component of the value, so why would you risk losing the East Texas piece when you can just buy the whole thing?”

Says Hunt’s Creecy, “They came in with a fair and straightforward offer that we were absolutely willing to take.”

The Decision

Unlike other private companies, Hunt Petroleum was unique in that it was wholly owned by—as well as the single-largest asset of—two trusts established by founder H.L. Hunt. The Margaret Hunt Trust held the fortunes of his first daughter, and the Haroldson L. Hunt Jr. Trust held interests for his first son known as Hassie.

As trustee for both family trusts that owned Hunt Petroleum, Tom Hunt, the nephew of H.L. Hunt who took the helm of the company in 1955, essentially was “the shareholder.” His office was literally across the hallway in downtown Dallas from Creecy and former Hunt Petroleum vice president Brett Ringle.

“How many CEOs in this business have their shareholders sitting in their office every day?” asks Ringle. “We were very much aware of our shareholders’ needs. I don’t think Bob Simpson (XTO chairman) had all of his shareholders sitting in his office.”

In the summer of 2007, the company faced a growing challenge forced upon it by external circumstances. In Creecy’s eight-year tenure at the helm, the company had experienced significant growth via $1 billion in acquisitions and organic growth. It was time to consider a reorganization.

“It’s one thing to grow when you’re a 400-Bcf (billion cubic feet) company, but when you get into the Tcf range, that’s a different growth model,” says Creecy. “Just replacing reserves every year becomes a different challenge.”

In addition, “the game was changing in every sense” in the company’s search for hydrocarbons as trends were toward more technically difficult and geopolitically risky operations. “We had to decide if we wanted to make the investments to do these exotic and more costly things,” Ringle says. The intellectual drought plaguing the industry also made keeping and finding qualified staff more difficult, adding to its challenges.

“We were looking at more than reorganization. We were looking at becoming a fundamentally different company,” Creecy says.

The catalyst came when Margaret Hunt Hill died in June 2007, two years following brother Hassie. With primary beneficiaries of each trust gone, Creecy acknowledged, “things were going to change. It was a good time to stop and consider where we were going as a business.”

In the fall of 2007, the board of Hunt, chaired by Tom Hunt, initiated a strategic review process, hiring Goldman, Sachs & Co. to consider all options available. “Everything was on the table.”

Goldman reviewed several options: a reorganization to continue the growth model; going public; downsizing through asset sales then rebuilding; and an outright sale of the company. Without recommending any option, Goldman presented an analysis of each to the board. Unanimously, the board agreed to maximize shareholder value through a sale.

In spite of hearsay, Ringle assures that the decision to sell was initiated through a corporate process and not at the influence of any Hunt family members. “All along, we maintained that we wanted to make sure this was truly Goldman’s analysis and not influence them to come up with any decision or any specific tactic.

“We were aware the company was part of the Hunt family and we were aware of the history, but our job was to increase the value for the shareholders. Then, it’s up to the shareholders what to do with that.” As for chairman Tom Hunt’s role, “he got the same reports we all got as a board,” says Creecy. “He didn’t have a predetermined directive.” To the contrary, Tom was a lifelong oilman, Creecy points out, and “this was a tough decision for him.”

The Process

Once the decision was made to consider a sale, the company wasted no time going to market. Goldman, which was “head and shoulders above other investment bankers” in Hunt’s analysis, was re-engaged in December 2007 as financial advisor to market and coordinate bids and negotiations for the sale. Tristone Capital, which had impressed Hunt when encountered in other data rooms as selling agent, was hired as technical advisor to put together the data room and to analyze the entire reserve base.

In Hunt’s case, preparing the data room was challenging. Rob Bilger, managing director with Tristone, said the assets were high quality with tremendous upside potential, but the amount of information was staggering, even for a firm as experienced with large packages as Tristone.

“The most important thing was to identify and capture all of the upside potential on the various assets in the different basins. To capture that value in the bids took a strong technical team and technical effort to put all of that together.” Plus, being a closely held company for decades, Hunt had not prepared itself for sale. “It wasn’t on the radar screen for them for a long time,” says Bilger. Netherland, Sewell & Associates prepared the reserve report—Hunt’s first ever to measure all of its reserves, proved, probable and possible.

Although Hunt preferred a corporate sale, Tristone split the assets into the three packages to maximize value in the event the assets were too diverse for most buyers.

Bidding was aggressive. “Hunt had impeccable timing as far as pricing and market conditions,” says Bilger. “When we started the process in the spring, prices were hitting their peak and the credit markets were fully open.”

XTO’s substantial and essentially unqualified bid for the entire company, combined with its reputation as an able acquirer, sealed the deal. “As Goldman’s memorandum to potential bidders stated, we preferred a stock sale of the company,” Creecy says.

“Financially, we felt like they would close. They were a solid buyer and they had a history of having closed their deals. Culturally, we felt like they were a good fit with our employees.”

And XTO, Ringle says, consists of “the kind of people you feel like you could have done a handshake deal with and they would have honored it. They get high marks for integrity.”

The Assets

While XTO gained production of some 260 million cubic feet equivalent per day from the purchase, the true prize is the upside. Hunt’s measured pace of drilling up cash flow without using debt meant hundreds of locations remained untapped.

“We try to buy properties that have not been drilled real hard with a lot of upside remaining, and we try to do a bolt-on in an area we know more about than the operator who’s selling it,” says Hutton. “Hunt fell into both of these advantages.”

Hunt held about 15,000 acres in Robertson, Limestone, Leon and Freestone counties in Texas on the Freestone trend, surrounded by XTO holdings. Where XTO was drilling on 20- and 40-acre spacing, Hunt drilled on 160- to 320-acre spacing. And where

Hunt targeted the traditional East Texas Cotton Valley, Travis Peak and James lime formations, XTO had two wells directly offsetting Hunt properties into the deeper Cotton Valley lime brought on at 13 million cubic feet a day.

“We knew they were not doing what we were doing. We are drilling deeper wells than they were, shooting more zones, drilling on tighter spacing and drilling horizontals in places where they didn’t. We knew we could exploit it a lot faster.”]

At the time Hunt Petroleum came to market, the Haynesville shale had not yet become headline news. Hunt’s assets included 65,000 acres in Shelby, Panola and Harrison counties, Texas, and in DeSoto and Caddo parishes in Louisiana. During the data-room process Chesapeake Energy announced the Haynesville as the “mother lode,” but “Hunt didn’t necessarily believe them because the data wasn’t out there yet,” says Hutton.

Hunt had actually drilled two verticals to test the Haynesville and concluded it was not economic. “Hunt is not the type of company that’s going to drill $9-million horizontal wells,” says Hutton. “They were more focused on the shallow.” But XTO had evidence from its offsetting properties to conclude the acreage was ripe for Haynesville.

XTO didn’t put any value for the Haynesville in the purchase metrics. “We paid for the normal Cotton Valley sand and Travis Peak-type production. The wild card that makes this a big home run is the deep pay—the Haynesville and the Cotton Valley lime.”Hutton believes the Hunt acreage acquired will support more than 800 wells on 80-acre spacing, and estimates some 1.5 Tcf equivalent of upside just from the East Texas and Louisiana properties alone.

The “different piece” of the purchase was the offshore, but “once we looked at it, those were really good properties,” Hutton says. “The offshore surprised us in that it held better-quality reserves and reservoirs than we would have thought.”

Hunt’s offshore U.S. assets fell into three main areas—a 25% working interest in Mobile Bay, operated by ExxonMobil; South Marsh Island 40, 41 and 44; and West Cameron 485 and 507. The fields have enough upside and a shallow decline rate so that “offshore looks a lot like what you would buy for good onshore properties,” Hutton says. And, representing about 3% of total company production, “it’s not like we went offshore real hard.

“We could see a way to sustain offshore production for three to four years using 30% to 35% of cash flow, which is as good as onshore properties in most cases. That’s a very strong property.”

Labeled a cash cow at the time XTO announced the deal, Hunt additionally owned a 5% interest in a Dutch North Sea field producing 10 million cubic feet of gas per day, along with 300,000 exploration acres. Hutton says all options are open for these assets, but acknowledges they will not be a new focus for the company and could become divestiture candidates in time.

Post-Closing

Dragged down with the fall of oil and gas prices and with Wall Street, the XTO shares representing some 40% of the purchase price fell in value from $67.50 at the time of the announcement to between $30 and $40 a share currently, about a 50% drop. Would Hunt have structured the deal differently today?

“We feel very good about the XTO stock,” says Ringle. “If we were doing this deal today, the market wouldn’t support the numbers we got when we did. From XTO’s standpoint, the deal had built into it some protection if something happened in the market like what did happen. From Hunt’s standpoint, this is a long-term issue; we’re not in a day-trading business.”

The two Hunt family trusts contain a 21-year termination clause following the death of the primary beneficiaries. If not in 2008, a sale was imminent anyhow. Says Creecy, “As the termination date approaches, your bargaining position can only weaken.”

During the data-room phase of the transaction, Tom Hunt was diagnosed with cancer. He died in November, two months after closing, at the age of 85 and after a 58-year tenure with Hunt Petroleum, but not before negotiating one of the most significant deals in the Hunt family history. Both Creecy and Ringle are named as successor trustees of the trusts, representing the new beneficiaries, including Al Hill Jr., Alinda Wikert and Lyda Hill.

H.L. Hunt gambled everything on an East Texas oil field in the 1930s and won big. His heirs gambled it all again by attempting to monetize the family jewel with prospects in the same region—and won big too. Is the sale the end of a legacy for the Hunt family?

“No, it’s just the opposite,” says Ringle. “It is a beginning. It’s a chance for other family groups to build their own legacies. The trusts that owned Hunt Petroleum were not going to go on in perpetuity. Further generations have other goals, other desires and other needs. The beneficiaries of these trusts now have the opportunity to proceed down other paths.”