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Morningstar | Halcon's Touch-and-Go Liquidity Sparks Major Sell-Off. See Updated Analyst Note from 16 May 2019

Halcon Resources' shares have plunged more than 75% in the last week due to cautionary management commentary on the firm's precarious liquidity. Halcon's bank credit was recently slashed by $50 million owing to concerns from lenders about the company's creditworthiness. Management has engaged advisory firms to evaluate strategic alternatives, including the outright sale of the business, asset divestitures, and securing external financing.

In the hands of a well-capitalized midsize operator, Halcon's Permian acreage could be worth $3-$5 per Halcon share, in our view. The firm cannot extract that value itself due to its limited scale; its unit costs are much higher than what peers are paying. But its profitability will improve as it grows, enabling it to reverse its fortunes and start generating free cash flows within two to three years. The question is whether it has enough liquidity to fund its drilling operations until it gets to that point. We estimate the $120 million available on its revolver will see Halcon through the end of 2021, putting it within striking distance of self-funded growth. But management said on a recent conference call that this liquidity will enable it to complete the ongoing strategic review, implying--but not explicitly stating--that a positive outcome from that review process is necessary to maintain going-concern status.

Halcon's high operating and financial leverage makes its equity sensitive to modeling assumptions. Though management reiterated its guidance and intent to continue running two rigs, we now assume that the firm will drop a rig this year (without penalty) to preserve its liquidity. We have also ratcheted our cost of debt assumption to 10%. These changes reduce our going-concern valuation to $1.25 per share from $3. We discount this by 50% to reflect the possibility of imminent restructuring, which could wipe out shareholders completely. That brings our updated fair value estimate to $0.65 per share.