A coup of sorts is underway in Pittsburgh as two brothers brazenly push to take over EQT Corp., which became the nation’s largest natural gas producer after it acquired Rice Energy Inc. in a multi-billion dollar deal that helped transform the juggernaut and generated a windfall for the family.

Toby and Derek Rice are now trying to regain control of the assets their former company sold and the rest of EQT’s massive position across the Appalachian Basin in what’s proving to be an enthralling and audacious proxy fight. The brothers, who own more than seven million shares or roughly 3% of the company, came forward publicly last month to say EQT is grossly undervalued. They said the newly installed executive management team is incapable of delivering the $2.5 billion of cost synergies that were promised after the merger or leading a company that now produces more than 1 Tcf of natural gas annually.

The situation escalated this week after EQT CEO Robert McNally picked apart a plan the Rice brothers presented to the board to generate $1 billion of free cash flow annually and drastically improve operations. McNally instead advanced a different blueprint for 2019 and vigorously defended his vision for the company. The board joined McNally in panning the Rice presentation. The brothers shot back, saying they’d have shareholders vote at the next annual meeting to replace directors with those who would support Toby as CEO.

In a letter sent to the brothers, board members said the Rice plan is better suited to a “small-scale, early stage enterprise,” and not a business with the “size and complexity of EQT.” The letter took a shot at the company the Rice family sold to EQT in 2017 for $8 billion, less than four years after they took it public.

The board also wrote of Toby that “with respect to your demand to be appointed CEO and a director on the board of EQT, we have questions about your experience and suitability for those roles that we would like for you to separately address.”

The correspondence was not signed by another Rice brother who got a seat at EQT’s table after the acquisition closed and who has remained silent throughout the ordeal. Board member Daniel J. Rice, IV, who served as Rice Energy Inc. CEO, joined McNally in not signing the letter. McNally had already shared his views and said the Rice presentation was based on “flawed assumptions” and lacked detail.

“Historically, EQT for a decade or more has been very volume-driven,” McNally told analysts during a call Tuesday to discuss this year’s plans. “It was a different time in the marketplace, growth was what was at a premium. The fundamental change we’re making here is a move from being driven by volume targets to being driven by capital efficiency.”

A Transformational Deal

While McNally played an important role as CFO in the Rice acquisition, he did not oversee the milestone transaction. That task was undertaken by his predecessor, Steven Schlotterbeck, who took the helm in early 2017. Schlotterbeck continued pushing basin consolidation before he resigned after just a year following a dispute with the board about his compensation.

Schlotterbeck, who has since voiced his support for the Rice brothers, also faced opposition from other activist investors, one of which at the time the deal was announced pushed for it to be scrapped, arguing the synergies would be far outweighed by the purchase price.

“I’m a big proponent of more restrained growth, of capital efficiency and let’s not pump more gas into a market that’s already saturated,” McNally told NGI.

Between 2016 and the time McNally took over as chief last November, his predecessors had acquired nearly 500,000 acres in deals with Rice Energy, Trans Energy Inc., Stone Energy Corp. and Equinor ASA, among others. It was the Rice transaction that finally transformed the 130-year old company — once a natural gas utility — from being Appalachia’s largest gas producer to the nation’s largest.

Under McNally’s vision, one that no doubt heeds to a market now expecting capital discipline, the company could grow by single-digits in the coming years. He pitched a plan on Tuesday to generate $350 million of adjusted free cash flow this year, and at least $2.7 billion through 2023. The company also has taken actions to cut $100 million in administrative and well development costs and committed to cut capital costs by another 10% by next year.

“It’s time for the companies to start acting like grown-up companies, generating returns for shareholders and not just consuming capital, not growth just for growth’s sake,” McNally said during an interview shortly after the company released its capital budget. “I’m pleased with the direction we’re headed, and I think that many in the industry are following that same path.”

EQT forecast 2019 production volumes at 1.470-1.510 Tcfe, roughly flat with the 1.488 Tcfe it produced last year. The company has budgeted $1.9-2.0 billion for 2019, compared with $2.7 billion last year. The 2019 drilling program, meanwhile, anticipates a 5% increase in production volumes in 2020.

After Schlotterbeck left, the general counsel, chief investor relations officer and president of exploration and production, among others, left the company and were replaced. Given the personnel changes and a move to separate the midstream and upstream segments that was completed last year, McNally calls EQT a “new company.”

”Ready To Deliver’

“Today’s announcement makes it abundantly clear that EQT plans to continue with the same team that has openly admitted, based on their plan, that they cannot deliver on EQT’s 2017 merger promises,” the Rice brothers said Tuesday after the company released this year’s forecast, adding that they “stand ready to deliver.”

The presentation they shared said “we have executed this plan before and are ready, willing and able to execute it again.” Hedge fund D.E. Shaw & Co. LP, which owns 4.5% of EQT shares and has in the past agitated for change at EQT, has also thrown its support behind the Rice brothers, calling them “seasoned operators with a proven track record of delivering peer-leading results on the exact assets that EQT owns today.”

Toby, Derek and Daniel IV, all in their 30s, took Rice public in 2014. The company long enjoyed the backing of private equity and their father, Daniel J. Rice III, formerly a managing director at BlackRock Inc. with energy investing experience.

The company’s wells were often named after comic book characters, and the brothers quickly took on a reputation of up-and-comers that would further define Appalachia’s rebirth as an epicenter of gas production. The company was easily producing more than 1 Bcfe/d with core Appalachian assets in only three counties by the time EQT came knocking and took it over.

Toby and Derek believe they can prop up a company that has at times stumbled through the complexities of the acquisition and underperformed its peers. They said their plan would increase operational and logistical efficiency to lower well costs and reduce shut-ins and system constraints that have plagued EQT. One oilfield service worker told NGI that the company’s logistics last year were a “nightmare,” with crews waiting on materials and operations coming to a complete standstill at times as the supply chain became stretched by various well pads.

In the third quarter, management was open about how it had to cut guidance and increase spending after a frenzied stretch of drilling in the wake of the Rice acquisition put stress on supplies, logistics and pad operations.

McNally said, however, that the fourth quarter performance shows new strategies are paying off and many of last year’s woes have been resolved. The company also has a plan to resolve curtailments by the end of next year. The company produced 394 Bcfe in the fourth quarter, a 5% increase over 3Q2018, beating Wall Street expectations and exceeding internal guidance.

Notably, the Rice team said they would implement processes developed at their company before it was sold and shake up management with former Rice Energy personnel to boost EQT’s performance and better control its costs. They also contend that EQT could have executed its 2018 well development program at much lower costs and claimed wider well spacing at 1,000 feet, compared to the company’s current plans for 880-foot spacing, would increase estimated ultimate recoveries by 10%.

Playing Defense

McNally told analysts, however, that a thorough analysis of the assumptions, which included a detailed review of Rice Energy’s historical records acquired in the merger, turned up different results versus those presented by the brothers.

“Obviously EQT’s 2019 operating plan should not be predicated on Rice Energy’s well costs for wells turned in line during the first half of 2017, especially considering that those wells were turned in line in a small geographic area and utilized 100% pipeline-delivered freshwater,” McNally told analysts. “This is not repeatable given EQT’s geographic footprint, infrastructure and water dynamics.”

He noted that an internal analysis showed that 1,000-foot spacing with smaller fractures (fracks) “would actually result in a negative production impact versus our 2019 wells with 880-foot spacing and larger fracks.” McNally said the company is targeting wider spacing, but would do so slowly in the coming years.

In its letter to the brothers, the board said they had failed to address how their plan would account for service cost inflation or how long it might actually take to achieve some of the goals they outlined, “except to change the management and all of the department heads of EQT and replace them with people from Rice Energy,” which the directors noted would be “quite disruptive.”

The brothers noted that they took 80% of the merger consideration in EQT stock. In announcing support for the Rice team this month, D.E. Shaw said if the company can’t find a solution to the concerns shareholders have raised, the matter should be put to a vote.

“Our sentiment appears to be widely held among shareholders; Tudor, Pickering, Holt & Co. (TPH) recently wrote that there was ”near unanimous support for the Rice proposal,’” the hedge fund said. TPH said this week after EQT unveiled its plans that they’re a “step in the right direction, as 2019 capital efficiency screens better versus expectations, and management demonstrates its commitment to optimizing the development cost structure.” The firm said EQT’s decision to hire a COO could further help boost confidence in operations.

The company is expected to make an announcement about the operating chief position by the end of March. When asked if Toby, who formerly served as Rice COO, is being considered for the position, McNally told NGI that “we would be happy to consider him, but he has indicated that he wants the CEO role, which is not what we’re hiring for.”

The board opened the door further in its letter noting it would consider Toby’s candidacy for the role and said the company is interested in meeting with the brothers again if they can better develop their plan. The brothers responded by saying their expectations for free cash flow generation are unchanged, but added that they too are open to reaching a negotiated resolution with the board,” despite their threat to take the matter before shareholders.