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More merger insight…

I hope you all enjoyed the weekend. Here’s to hoping this Monday gives us a reprieve (however short lived it might be) from the sauna of July in Central Illinois. As John mentioned last week, I will be adding some comments on our current investment management while Mark is out of town. This is my first posting to the blog, so please bear with me.

In several of the postings from late May to mid-June, we discussed that we were adding back a good percentage of the cash we had raised. As the graph of the overall market posted on Friday shows, this has worked out pretty well to this point. The market has generally trended up over this time period, with the general theme being one or two pretty good up days in the market, followed by a day or two of profit taking by market participants.

We have recently started to accumulate some cash. Fortunately, this has been caused by a few recent mergers involving some of our holdings. John touched on these Friday, but I thought I would go a little more in depth on the Petrohawk/BHP Billiton merger.

Petrohawk’s (HK) merger agreement with BHP Billiton (another holding of ours) is somewhat bittersweet. We have held HK for almost exactly one year (our first purchase was 7/20/2010). We originally bought HK as part of a small basket of natural gas exploration and development companies (the other main holding being Range Resources (RRC)) with the idea being that over the medium to long term, U.S. based natural gas would begin to replace some of the imported oil we currently use. The problem for most natural gas companies is that this shift occurs over the long term and there is a good chance that several of the companies in the industry will not survive until this happens, enter HK and RRC.

We focused quite a bit on HK for three reasons, which ultimately worked out very well for our clients. (See the one year chart below).


One, HK had (has) one of the lower production costs in the industry, as well as a huge holding of long-term leases on very productive land. We found this very important because, in the commodity extraction business, low production cost is one of the best advantages a company can have. If a company has low production costs and a large area to reinvest the profits, even better.

The second attraction to HK was the history of the CEO. Floyd Wilson (CEO) has built and sold several energy companies in his career, and our research on HK gave us the feeling that it was being built to sell also. (This obviously turned out to be the case).

The final piece of the puzzle for our investment in HK was its size. You may have noticed through reading parts of this blog from time to time that we tend to favor mid-cap companies. HK was small enough to be acquired by a big company (BHP has an equity value of roughly $250 Billion) and large enough to make a difference for a company the size of BHP.

I hope the review of HK gives you some insight into the research we do on our holdings. It is a pretty good example because it fits a couple of our favored investment criteria; a good industry, a medium size company, and a good and growing company managed by great leaders.

Our current feelings are that there will probably continue to be quite a few acquisitions in the next six to twelve months due to the very cheap borrowing costs for large, stable companies. If interest rates stay low, our smaller and mid-cap companies should continue to be beneficiaries of the merger activity.

For now, we will look for places to redeploy the recent cash inflows and see how earnings season plays out. So far, earnings for our companies have generally been pretty good.

We will keep you updated as things progress.