- Reuters/Steve Sisney
Harold Hamm, the founder of the energy company Continental Resources, is mad at a short seller for targeting his company.The short seller, Jim Chanos, said Hamm’s capital-intensive business needed to spend a lot of money to make a little and would have to raise debt to survive. This is all well and good while interest rates are low. But when rates go up, the story will change for the worse.
With Washington driving all the news, things have been boring on Wall Street.
For proof, look no further than the spat between two billionaires that started this week.
The gentlemanly disagreement is between Wall Street’s foremost short seller, Jim Chanos of Kynikos Associates, and Harold Hamm, the founder of the oil and gas company Continental Resources.
They are about to fight over whether an expensive business will ultimately require investor money to survive, which in today’s market is like fighting about whether the sun rises in the east and sets in the west.
Here’s how it all started.
On Tuesday, Chanos told a crowd of investors at CNBC and Institutional Investor’s Delivering Alpha Conference to short Continental Resources. The reason is simple: The company’s capital expenditures constantly gobble up its revenue, so it ends up having to restructure and raise debt toward the end of the year. Investors don’t like this, so the stock slumps.
Hamm, on Thursday, disputed Chanos’ thesis in a particularly catty billionaire way by saying:
“First of all, I can say, who? Who is this guy? Short sellers, OK you know, they’re always out there. They operate under a little different regulatory environment than we do as CEOs – we’re required by the SEC to tell the truth and be totally transparent. That’s exactly what we do. Those numbers are all out there. For anybody to even put forth the suggestion we haven’t had great expansion and wealth creation in this industry with horizontal drilling and all the technology that’s come about the last 10 years, I mean, it’s totally ridiculous.”
- Markets Insider
Of course, Chanos wasn’t suggesting any of that. In fact, during his presentation he said the industry was looking better than it had in a while. He was simply suggesting – as is his wont – that there’s an accounting story to be told here. It’s the story of an industry that needs to spend too much money to make too little money.
And there are other stories here – stories we should come to expect as people who watch money work.
On the one hand it’s the “bust” part of the “boom and bust” story of what happens to capital-intensive commodities businesses when prices are low – a story of balancing production with cost cutting to stay afloat. In Continental Resources’ case, Chanos says a 60% increase in capital expenditures is now resulting in a fractional revenue bump. Since 2014, the company has been cash-flow positive in only the third quarter of 2016 and the first quarter of this year.
- Bloomberg, screenshot
On the other hand it’s the story of how long a company can survive in this cycle when interest rates are low. When interest rates are low, companies like Continental Resources can raise more debt and live to fight another day. Chanos is not the only person on Wall Street who has pointed this out. David Einhorn made this whipsaw business model the center of his 2015 presentation at the Sohn Investment Conference in New York City.
“We object to oil fracking because the investment can contaminate returns,” Einhorn said back in 2015. He was zeroing in on another “MotherFracker” (as he called the company in his presentation), Pioneer.
Last month Hamm promised investors on a conference call that Continental Resources would be raising “absolutely no new debt.”
“That’s part of our plan, the strategic plan going forward to knock our debt down,” he said.
But its cash position is looking weak. It spent over $879 million on capital expenditures – equipment, explorations, etc. – in Q3. It ended the quarter with $17 million in cash and cash equivalents after a net loss of $63 million.
Last year at the same time, the company spent $517 million, and it ended the period with just over $16 million in cash after a $317 million net loss.
This sounds terrible, but we’re sure Hamm will be fine. He’ll get more cash to continue operations, he’ll pay down some debt, and the story will begin in 2018 yet again.
The sky is blue. Interest rates are low. The earth revolves around the sun.