In the past two months I've written three articles about concerns I have about GreenHunter's (NYSEMKT:GRH) financial situation. Most public companies would not directly publicly respond to such concerns. Bizarrely, not only did GreenHunter take the nearly unprecedented step of point by point disputing my concerns, it but also filed its response with the SEC.
In an 8-k filed on October 16, GreenHunter filed a response by Gary Evans to articles I have written about GreenHunter. Unfortunately, the response was incomplete and did not directly address some of the numerous concerns that have been raised, and did not provide full or complete responses to those concerns. And most importantly, it recognized GreenHunter's need to raise substantial capital in the near term: "Senior management and the Board of Directors of GreenHunter recognize the need for additional capital".
For example, the first point in the letter was that GreenHunter raised its revenue guidance on September 27th. However, the letter neglects to mention that GreenHunter had, only a month before, lowered guidance. This lowered guidance contrasted poorly to GreenHunter's original guidance for 2013. And when GreenHunter lowered guidance in August, it did not broadcast it via a press release, but merely included the lower forecast revenue number in slide 18 of the pitch-book.
This relates directly to the second point - there were $7.5 million of assets that had been held for sale that were no longer held for sale, leading to the increase in revenue guidance. Moving from "held for sale" to not held for sale means a failed asset sale. The letter does not address those properties, but merely focuses on other smaller asset sales that may have been completed at a premium to book value, but did not fill the $9.1 million in negative working capital as of the last filing.
Page 7 of the Q1 10-Q says GreenHunter had agreement to sell two Salt Water Disposal wells (SWDs) in South Texas for $7.5MM. "On June 10, 2013, the Company's wholly owned subsidiary, GreenHunter Water, LLC entered into an Asset Purchase Agreement with Sable Environmental SWD 4, LLC whereby GreenHunter Water agreed to sell to Sable Environmental SWD 4, LLC, two salt water disposal wells and associated equipment located in South Texas for $7.5 million. Also on June 10, 2013, the Company's wholly owned subsidiary, GreenHunter Water, LLC closed on the sale of a third saltwater disposal well and associated equipment located in South Texas, pursuant to an Asset Purchase Agreement with Sable Environmental SWD 4, LLC, for which the Company received $5.2 million."
The $7.5MM asset sale never closed and in the Q2 10Q GreenHunter indicated it no longer has an agreement to sell these assets but was only in discussions to sell (pg 7 of Q2 10Q) "The Company's wholly-owned subsidiary, GreenHunter Water, LLC is also in negotiations regarding the potential sale of up to three separate salt water disposal wells and associated equipment located in South Texas.
GreenHunter's third point is very cleverly worded: "We have continued to pay all dividends on our preferred stock on a monthly basis and we continue to pay principal and interest on our outstanding convertible note through internally generated cash flow." - note it clarifies that principal and interest on the convert are paid through "internally generated cash flow", but it does not address my concern that preferred may have been issued in order to fund dividends on the preferred stock. For example, the $3.2MM preferred issuance at the end of September likely provided the cash to pay the $390k preferred dividend payment due at the end of September.
To put the $5MM of annual preferred dividends into context, they represent 12.5% - 13.9% of the company's guided 2013 revenues. Nuverra's (NYSE:NES) EBITDA margins are roughly 20%. GreenHunter seems to have had negative EBITDA ytd. Add in $1MM/year of interest and $2MM/year of maintenance capital and the company's fixed cash expenses are over 20% of guided 2013 revenues.
This pattern of incomplete responses continues throughout the letter. GreenHunter's fifth point merits attention. GreenHunter says: "GreenHunter is nothing like either Nuverra or Poseidon Concepts. Our business models are totally different." And then proceeds to describe the similarities. Poseidon was a fraud, went bankrupt and also happened to be in the same business as GreenHunter's Mag Tank (perhaps not such a good business to attempt to grow into). And Nuverra is not "totally different" nor is it "nothing like GreenHunter" - both have acquired and currently operate salt water disposal wells.
GreenHunter's final point is that the company has "many options to choose from regarding additional capital", that the company is "SIGNIFICANTLY undervalued", and that the company is attempting to raise capital that is "minimally dilutive to the common shareholder". GreenHunter appears to be trying to convince people to purchase (or accept in return of an asset sale) its apparently overvalued stock in order to acquire sufficient assets to grow into its current capital structure. GreenHunter's current Enterprise Value of ~$108MM is ~2.8x the midpoint of its 2013 revenue guidance (competitors trade below 2x revenues.). Even if the company could achieve a 20% EBITDA margin (versus apparent negative EBITDA ytd) the company would trading at over 14x EBITDA (vs. competitors in the 6-8x range.)
Let's not forget that management stock, options and warrants outstanding are roughly 1/2 of the basic share count. GreenHunter says it is attempting to raise money with "minimal dilution" but it ignores the massive dilution that comes from the Chairman being paid large grants in stock.
Incidentally, the same day GreenHunter released this letter to shareholders, I had a conversation with an oilfield infrastructure executive. He pointed out that Mag Tanks cost $1 million each. The alternative is spending $20,000 to dig a hole in the ground and cover it with lining. He said it was no surprise that the only buyer so far of a Mag Tank was Magnum Hunter (MHR), which Gary Evans happens to be CEO of. The huge difference between the $1 million cost for a tank and the $20,000 cost for a hole in the ground is enough to call into question the business model (recall that Poseidon, which also offered above ground storage tanks, went bankrupt), and to raise questions about the procurement process by related parties (and corporate governance).
The letter could have been a great opportunity for GreenHunter to address its negative working capital situation, how that negative working capital may be funded, and how the company intends to fund the $5 million per year in preferred dividends. Unfortunately, that seems to be still up in the air, and with the availability on the shelf exhausted, contrary to GreenHunter's letter, its financing options appear limited and it may struggle to raise money without significantly diluting shareholders or "priming" (reducing the asset coverage of) the preferred stock.
Disclosure: I am short GRH. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.