Red Mark At Red Fork - Update

Apr. 2.14 | About: Red Fork (RDFEY)

Summary

RDFEY sold 10% of total acreage for $11 million, read on total asset value.

Breached financial covenants on $100 million Guggenheim loan.

Possible fire sale situation ahead if management doesn't act fast to right ship.

With yesterday's announcement that Red Fork Energy (OTCPK:RDFEY) sold about 10% of their total acreage position for $11 million we now have a "mark" that can be used to estimate the total value of the company's assets. Unfortunately as predicted in my previous article, the situation is confirmed as dire.

At first glance $11 million for 7,400 undeveloped acres would seem like a good price. At $1,500 per acre this compares favorably to historically high trades in the play. However this headline price is less attractive when you dig deeper into the implications.

In CEO David Prentice's November 29, 2013 letter to shareholders he estimated that the company would be on target to have 49% of acreage held by production (OTC:HBP) by December 31, 2013. According to yesterday's press release the sale of undeveloped acreage was outside of the HBP acreage. Therefore it would appear that the company considers half (37,500) of their acreage to be undeveloped.

Presumably the buyer of this acreage picked through what was available and bought the most prospective undeveloped acreage but I will make the generous assumption that all 37,500 are equally prospective. Therefore the remaining 30,000 undeveloped acres are worth up to $45 million based on yesterday's sale price. Add in the previously estimated $83 million value of the proved developed producing (PDP) reserves and you arrive at a (admittedly conservative) $128 million asset value.

This is significantly lower than the estimated 1P value of $277 million from the company's December 31, 2013 third party reserve report. However if my assumption that 70% of that value is proved undeveloped (PUD) reserves then this is explained by the fact that generally buyers today aren't willing to pay the full value of PUD reserves. I'll make the assumption that a buyer might pay 50% of PUD value or in this case about $100 million. Therefore on a proved reserve basis a buyer might pay $183 million which is probably a more realistic price for RFE's assets and about equal to the current enterprise value.

According to Mr. Prentice's own comments in his November 29 letter the acreage sold yesterday had a net present value of $25,000 per acre and he complained that at the time the company was trading on an EV/acre basis of "just" $3,600 per acre. Prior to yesterday's sale the company was trading on an EV/acre basis of ~$2,000 per acre. So by the CEO's own estimation selling acreage at $1,500 per acre is a bad deal for shareholders.

Another way to look at it is that the company sold the equivalent of just one year's interest payments (minimum $10.5 million per year) for assets management claimed might be worth as much as $185 million when fully developed.

Besides the sale of acreage announcement the company also released their 2013 annual report. I haven't had a chance to fully digest the report but one comment immediately stood out and investors should take note. On page 47 of the report the company said it "anticipates it will be in breach of certain covenants at 31 March 2014 and accordingly it has obtained a waiver from Guggenheim in respect of those anticipated breaches as of that date." Management mentions two key financial covenants on the loan including a minimum interest coverage ratio and maximum leverage ratio (see page 68). It wasn't immediately clear if the company breached one or both of these ratios. Readers may remember I presumed this to be the case in my earlier Seeking Alpha article.

Based on yesterday's acreage sale and the announcement that the company had breached covenants on its $100 million loan with Guggenheim it is clear that RDFEY is in dire straights. Unfortunately as of now it doesn't appear they have many options available that are attractive to equity holders.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

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