Is Billionaire Paul Singer Making A Mess At Hess?

Marshall is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Paul Singer, a billionaire investor and founder of one of the oldest hedge funds, Elliott Associates, is looking to shake things up at Hess (NYSE: HES). Singer wants to acquire up to $800 million in shares, or about 3.46% of the company, and seek board representation. Following the news, the stock soared around 15% (check out all of Singer's stocks).
Hess recently announced plans to sell its oil storage network and exit the refining business, in the hopes of focusing on the more profitable upstream operations. Singer doesn't believe this is enough. The hedge fund manager has voiced his opinion that along with the company's planned exit of storage and refining, the oil and gas company should also spin-off its U.S. shale assets. Singer suggested that the company should spin off its Bakken assets, as well as positions in the Eagle Ford and Utica shales. 
The one cavet to Singer's great plans is that the company may well disagree. Hess has a leading position in the Bakken territory, and Bakken productivity holds a lot of promise per the company's belief. Hess remains upbeat on its U.S. shale acreage and expects its oil output in the region to double in the next few years.
Per Elliott's letter to Hess, he indicates that...
We are convinced that tremendous value is trapped inside the Company as a result of poor oversight by a board of directors lacking both the experience and independence to set a clear, shareholder-focused, value-creating strategy.
Hess does trade on the low end of the integrated oil and gas companies on both a price to sales and price to operating cash flow basis: 
<table> <tbody> <tr> <td colspan="1" rowspan="1"><span> </span></td> <td colspan="1" rowspan="1"><span><strong>Hess</strong></span></td> <td colspan="1" rowspan="1"><span><strong>Exxon</strong></span></td> <td colspan="1" rowspan="1"><span><strong>Chevron</strong></span></td> </tr> <tr> <td colspan="1" rowspan="1"><span>Price to Sales</span></td> <td colspan="1" rowspan="1"><span>0.56</span></td> <td colspan="1" rowspan="1"><span>0.99</span></td> <td colspan="1" rowspan="1"><span>1.06</span></td> </tr> <tr> <td colspan="1" rowspan="1"><span>Price to Operating Cash Flow</span></td> <td colspan="1" rowspan="1"><span>4.58</span></td> <td colspan="1" rowspan="1"><span>7.03</span></td> <td colspan="1" rowspan="1"><span>6.14</span></td> </tr> </tbody> </table>

Going a step further, Hess trades at a 40% discount on a P/S basis and a 30% discount on a P/CF basis to Exxon and Chevron, two of the biggest supermajors in the business:

<table> <tbody> <tr> <td colspan="1" rowspan="1"><span> </span></td> <td colspan="1" rowspan="1"><span><strong>Price to Sales</strong></span></td> <td colspan="3" rowspan="1"><span><strong>Price to Operating Cash Flow</strong></span></td> </tr> <tr> <td colspan="1" rowspan="1"><span>Peer Averages (Exxon & Chevron)</span></td> <td colspan="1" rowspan="1"><span>1.03</span></td> <td colspan="3" rowspan="1"><span>6.59</span></td> </tr> <tr> <td colspan="1" rowspan="1"><span>Hess' Discount to Peers</span></td> <td colspan="1" rowspan="1"><span>45%</span></td> <td colspan="3" rowspan="1"><span>30%</span></td> </tr> </tbody> </table>

The upstream E&P business has proven to be more profitable in general, and so ConocoPhillips and Marathon Oil are two other major oil and gas companies that have completed a similar spinoff of refining operations. Another notable activist hedge fund that has gotten its hands on the integrated oil and gas industry is Third Point. The hedge fund, lead by activist investor Dan Loeb, pressured Murphy Oil to spin-off its retail segment in late 2012. Billionaire Paul Singer is not the only hedge fund manager that's had its eye on Hess; both billionaires Steve Cohen and Ken Griffin were shareholders at the end of the third quarter (check out all the hedge funds owning Hess).

How have the recent spin-offs fared? 

Since the July 2011 spin-off from Marathon Oil, its refinery business, now trading as Marathon Petroleum (NYSE: MPC), has outperformed Marathon Oil by 67% and the S&P 500 by 57.5%. 

May 2012 marked the spin-off of Phillips 66 (NYSE: PSX) from Conocophillips, and since then Phillips has outperformed Conocophillips by 73.5% and the S&P 500 by 75.5%.

Both of these refiners still trade below top refiner Valero Energy on a multiples basis: 

<table> <tbody> <tr> <td colspan="1" rowspan="1"><span> </span></td> <td colspan="1" rowspan="1"><span><strong>Price to Earnings</strong></span></td> </tr> <tr> <td colspan="1" rowspan="1"><span>Valero</span></td> <td colspan="1" rowspan="1"><span>21.9</span></td> </tr> <tr> <td colspan="1" rowspan="1"><span>Marathon Petroleum</span></td> <td colspan="1" rowspan="1"><span>9.0</span></td> </tr> <tr> <td colspan="1" rowspan="1"><span>Phillips 66</span></td> <td colspan="1" rowspan="1"><span>7.0</span></td> </tr> </tbody> </table>

Overall, it appears the spin-offs have performed much better than the surviving exploration and production companies. Worth noting is that the majority of the expected unlocked value is priced into the stock before the actual spinoff occurs. Thus, waiting until the spin-off takes place might be too late. The question is, is there enough value left in Hess shares to prompt an investment? 

Uncovering the true value

Under Singer's plan, Hess would keep its offshore assets in the Gulf of Mexico, Norway, and others. Elliott believes these international operations could would generate $2 billion to $3 billion in cash annually for upwards of 15 years. At a 10.8% discount rate, the mid-range ($2.5 billion) of that cash flow stream is worth around $53.57 per share. That's just the international operations alone and does not account for the refining and other onshore value. 

Elliott believes that a spin-off of Hess' Bakken, Eagle Ford, and Utica shale assets would add $28 per share in value. That puts the potential value, including future cash flow from international operations and spinoff value of onshore assets, to $81.50 per share. That's 20% higher than the current trading price and gives investors the refining business for free.

Elliott believes the total value of Hess could be as much as $126 per share, almost an 85% upside from current trading levels, if it spun-off its refining and U.S. shale businesses.

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