BXE – Divestor

Mid-tier Canadian oil on the ropes

A couple pieces of evidence to indicate the malaise in the Canadian oil sector.

First one was Pengrowth (TSX: PGF), who announced:

The Company’s $330 million Credit Facility (all amounts in Canadian dollars) is provided by a broad syndicate of domestic and international banks and had a scheduled maturity of September 30, 2019. The lenders have agreed to provide the Company with a 31 day extension of the maturity date under the Credit Facility to October 31, 2019 with a maximum facility draw of $180 million under the Credit Facility and a $5 million Excess Cash provision.

Holders of the Secured Notes have agreed to the extension of the Credit Facility and to a 31 day extension of the maturity date under the October Notes to November 18, 2019.

The Company will continue to operate its free cash flow positive business as usual. This short-term extension will allow the Company to continue to advance discussions with its lenders and noteholders with the objective of completing a long-term extension transaction. The mutual goal of Pengrowth and its senior debtholders is to negotiate a three year extension that allows the Company the flexibility to reduce its outstanding debt with the benefit of additional time and improved market conditions.

The Company believes it has made significant progress with its lenders and noteholders on a number of key areas in respect of the potential extension transaction, but there remain ongoing detailed discussions which require additional time. A transaction may result in dilution of the outstanding common shares of the Company (with an associated impact on the value of such shares) as part of any consideration provided to affected lenders and noteholders. There can be no assurance or guarantee that a long-term extension transaction will be agreed to or on what terms.

Pengrowth has CAD$57 million (denominated in foreign currency) in secured debt that is due on October 18, 2019 which has been extended a month as a result of the above release. They also have significant debt in 2020 and 2022, and also a line of credit which was set to expire on September 30, 2019. Current debt outstanding is $362 million, and non-current portion is $340 million.

The only way the company could pay the upcoming bond maturity is by the extension of its term facility, which of course the banks are unlikely to give without security, but the security has already been pledged to the noteholders. So this is a very sticky situation where both secured entities (noteholders and credit facility) have an incentive to pulling the pin to getting instant payment. Pengrowth also has covenants relating to the secured notes that they are likely to break imminently (even though they were relaxed in the past).

This is not likely to end very well for Pengrowth shareholders. The only wild card here is whether Seymour Schulich (who owns 159,400,000 shares of PGF or about 28.5% of the company) will be asked to put up a bunch more money to salvage his investment, which, needless to say, is seriously under water at the moment.

Second item: Bellatrix Exploration (TSX: BXE) went into CCAA today. Shareholders will probably get little out of it. While an energy company going into CCAA may not necessarily be unexpected news, the surprise here was that it took place after a recent capitalization (June 4, 2019). However, it is pretty clear in retrospect that the replacement of 4 of the 7 directors resulted in them changing gears and instead are representing the debtholders with this action.

Bellatrix Exploration recapitalization

The carnage in the small-to-mid cap Canadian oil and gas sector continues.

Today’s interesting news is the recapitalization proposal of Bellatrix Exploration (TSX: BXE).

In this process, I’ll walk through the financial statements and this will give you a snapshot of how I go through these things. Indeed, this is not exhaustive, but a small part of the thought process.

Readers with exceptionally good long-term memory will know that I had an investment in their debt a very long time ago. Indeed, you can read about a minor exit trading error I made on the investment.

I haven’t touched Bellatrix since (9 years ago!), but still keep track of things. You never know when future opportunity may strike.

Bellatrix, just like most smaller Canadian oil and gas companies, has been really struggling.

From the cash flow statement:

The key 2018 figures include CAD$52 million in EBITDA (not including impact of hedging), but the “I” is $41 million (cash cost is $35) and the “DA” is about $70 million of capital expenditures. People that are untrained at reading financial statements of oil and gas companies will be swayed by the syren’s voice of operating cash flows without due regard in consideration to how much capital expenditure it actually takes to sustain those barrels of oil (equivalent) per day.

In other words, the entity bled about $54 million cash in 2018. Without a change in oil price, the company is going nowhere financially.

On the balance sheet, we note that the company has no cash on hand (cash is provided by a credit facility) and is capitalized by debt financing. This next picture is a gong-show illustration, so forgive me:

This is a company that is in very bad shape on its balance sheet. People that look strictly at financial metrics will see a $672 million book value (shareholder’s equity) and they will say “Hey! That’s over $8/share in value, and with the stock trading at 50 cents that’s a bargain!” but in economic reality, most of that equity value consists of already spent money that takes place in the form of Property, Plant and Equipment – exploration expenses that are capitalized and not expensed. Whether these assets have any recovery value or not depends on economic assumptions of the price of fossil fuels.

The company also has germane issues with its solvency – so we have to dig into the credit facility and debt financing:

We discover the company can borrow up to CAD$95 million and that this facility is first in line, and is up for redetermination at the end of May. This is not a good sign.

The next in line to maturity are the senior notes (which are third ranking, US$145.8 million par outstanding) and this matures in May 15, 2020 (not that far away). The first and second in line creditors will not allow a third-line creditor to jump them in maturity, so this has the makings of a classic credit crunch, which has to be solved. One scenario is that the credit facility provider will choose to extend the timeline another six months to facilitate a recapitalization, but in no way would they ever allow the senior notes to be repaid without huge assurances they would be paid first. Note the second-line noteholders do not have the ability to directly compel BXE to not pay the Senior Notes, but there are covenant issues regarding the loaning of money that is adverse to the interests of the second-line noteholders.

There are other issues regarding covenants which I will ignore for the purposes of this analysis (this adds a layer of complexity which in itself is interesting but I don’t wish to get into this post).

Now we get to the meat of the recapitalization proposal:

* an exchange of all of the Company’s outstanding 8.5% senior unsecured notes due 2020 (the “Senior Unsecured Notes”) for, in the aggregate and taking into account early consent consideration, a combination of US$50 million of new second lien notes due September 2023 (the “New Second Lien Notes”), US$50 million of new third lien notes due December 2023 (the “New Third Lien Notes”) and approximately 51% of the common shares of Bellatrix outstanding immediately following the implementation of the Recapitalization Transaction; and

* an exchange of all of the Company’s outstanding 6.75% convertible debentures due 2021 (the “Convertible Debentures”) for, in the aggregate and taking into account early consent consideration, approximately 32.5% of the common shares of Bellatrix outstanding immediately following the implementation of the Recapitalization Transaction.

…

* it is a condition to completion of the Recapitalization Transaction that the Company’s existing senior bank credit facility (the “Credit Facility”) (which currently matures on November 30, 2019) be extended for a one-year term on terms substantially similar to those currently in place;

The summary is that the company is asking their US$145.8 million senior noteholders to take a US$45.8 million haircut in exchange for 51% of the equity in Bellatrix, and also to become pari-passu (equal standing) to the second-ranking noteholders for US$50 million and effectively extend their own notes for another 3.5 years. The convertible debentures (CAD$50 million par, who are last in line on the pecking order) will receive 32.5% of the equity in Bellatrix.

Existing shareholders will keep 16.5% of the company, in exchange for offloading CAD$50 million plus US$45.8 million in debt, but the company will also receive a term extension on the primary part of its debt until 2023 (when everything becomes due).

The company obtained consent of 90% of the senior note holders (so passage becomes inevitable), but the question then becomes – what if the convertible debenture holders do not agree to this? They received consent from somebody owning 50% of the debentures, but with regards to the other 50%, they cannot be “force consented” unless if a sufficient number of them vote in a class to recapitalize (I am not sure what the threshold amount is).

The debenture holders, if they do not agree, can be told by the company that they will go into CCAA to force the matter (where they will receive nothing in return, instead of the 32.5% equity they are being offered today).

Hence it is interesting that the convertibles are trading up about 10 cents on the dollar today to 60 cents – valuing the remaining equity (plus the encumberance of the second-lien debt and credit facility) at CAD$92 million.

By no means does this recapitalization put Bellatrix on a good financial standing – certainly offloading CAD$111 million in debt will be good for the company, but the underlying operations still need an assist on the price of oil. If this recapitalization does go through, there are still considerable headwinds to be faced.

Bellatrix Exploration debentures trading lesson

I own (clarification: after today, this should be “owned”) some debentures of Bellatrix Exploration (formerly True North Energy Trust). They mature in June 2011, coupon of 7.5%. They also were a relatively safe pick to be redeemed at maturity.

Today the company announced they raised money for more debentures and announced their intention to redeem the existing debentures. The debentures have an early redemption term as follows:

Subject to closing of the Offering, Bellatrix intends to give notice on or following the closing date of the Offering of its intention to redeem its currently outstanding approximately $84.9 million 7.50% Convertible Unsecured Subordinated Debentures due June 30, 2011 (the “Existing Debentures”). The Existing Debentures are redeemable for an amount of $1,050 for each $1,000 principal amount of the Existing Debentures plus accrued unpaid interest if redeemed on or prior to June 30, 2010 or an amount of $1,025 for each $1,000 principal amount of the Existing Debentures plus accrued unpaid interest if redeemed after June 30, 2010. A determination as to the redemption date will be made prior to closing of the Offering. Proceeds from the Offering will be used by Bellatrix to partially fund the redemption of the Existing Debentures and the balance of the redemption amount is intended to be funded through bank indebtedness.

Earlier this year, Bellatrix debentures were trading very close to 102.5, which was my exit price. I was actually the asking price at one point in time, but nobody bought my asking price. I had assumed the company would wait until June 2010 to mature the debt and just left my open order at 102.5, assuming they would never consider an early redemption at 105.

I was apparently wrong – the debentures today traded from 102 to 104, settling around 103.5. The people buying above 102.5 obviously are speculating that management will be redeeming earlier than the June 30, 2010 date.

The math is pretty simple – the new convertible debenture deal closes on April 20, 2010. If the company redeems early, they will pay $2.125 million more in redemption premiums if they do it immediately after the deal closing than if they did so in June 30, 2010. If they wait the 2.3 months before redeeming, they are paying $1.22 million in interest payments, and this also does not include the company’s ability to utilize the $85 million in capital during that time period. Even if they redeem today, they will be paying $1.59M in interest expenses, much less than the $2.125 million they would save by delaying the redemption.

The calculation highly suggests the debentures will be redeemed on June 30, 2010, and anybody buying Bellatrix at 103.5 is insane. When the debentures are deemed, they will receive a -3.6% annualized return on their investment.

The trading lesson here, however, is that keeping open orders in this manner exposed myself to the risk of this happening and as a result, I am short a small amount, but an amount that certainly would have paid for quite a few ribeye steaks.

I also could have avoided this issue by actually waking up at 5:30am Pacific time and reading the press release to cancel my order, but Pacific coast investors automatically face the handicap of having the financial world set on the eastern time zone (even for an Alberta corporation) and I was obviously asleep at the time.

I am happy, however, that this trade was successful in the overall scheme of things.

Selling debentures above par value

The decision to sell debentures that are trading above par value is an interesting challenge of capital allocation and tax optimization. Assuming the premium is dictated by the underlying company’s likeliness to pay rather than a conversion premium, there are a few variables to consider. A real-life example is the best illustration.

The company formerly known as True Energy Trust (now Bellatrix Exploration) has an $86M issue of 7.5% debentures that are scheduled to mature on June 30, 2011, which is 1.4 years away. The underlying company is otherwise debt-free and has recently performed a successful equity offering to fund the next year of capital projects. Additionally, the company has a market capitalization that would suggest that even if it was not able to raise capital before the maturation of debt, that they would be able to equitize the debt upon the maturity date.

In other words, getting paid out is a very likely scenario and would only take extraordinary risks (fraud or an absolute collapse in oil prices, etc.) over the next 1.4 years to prevent debenture holders from getting paid.

The debentures have a call provision, where the company can purchase the debentures at 105 cents before June 30, 2010 and 102.5 cents after June 30, 2010. It is unlikely they will use this call provision before June 30, 2010, but there is a low probability chance they will use it just after June 30, 2010, which implies a 4.9% yield to maturity on June 30, 2010. The company will only exercise this option if they can raise cheap money – it doesn’t necessarily have to be at a lower coupon than 4.9%, but rather an extension of the maturity is the functional objective.

In terms of tax optimization, the debentures were purchased at a cost basis significantly lower than par value, which means there is a bottled up capital gain embedded within them if I choose to sell them in 2010. The other decision is to wait until January 1, 2011, which means capital gains taxes will be deferred to an April 2012 cheque to the CRA. I will also be receiving interest income as a reward for patiently waiting.

The debentures are trading at 101.5 cents between the bid and the ask, which means that I can sell today and receive a 1.5 cent capital premium in exchange for the interest I will forego between now and June 30, 2011. This does not match up to the 10.5 cents of interest income I would receive between now and the maturity date. In terms of the capital that I am locking up to receive this interest rate, it implies my current yield is 7.4% and my capital gain will be -1.3% annualized assuming I do not sell today.

In order for a sell decision to be worthwhile, I would need to be able to realize a total yield of greater than 6.3% on my subsequent investment, not factoring in the tax liability, which would increase my hurdle rate by requiring me to divide 6.3% by (1-t), where t is the marginal tax rate for selling.

Since there is nothing with this return for a comparable risk that is not already in my portfolio, it means I will be holding onto the debentures for the next little while and keep on accruing interest. 6.3% at present is about 5% better than what I can get at ING Direct for risk-free money, so taking a very slight risk for a 5% premium still is very worthwhile.