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On April 16, I wrote about James River Coal (JRCC) and assessed their chances of going bankrupt. The conclusion was that their survival into 2015 was dependent on the metallurgical coal market making at least a modest recovery by that point. However, if the metallurgical coal market made a recovery and they survived, then they could be worth $5 to $10 per share depending on the extent of the recovery.

Since writing that article, James River Coal's share price is up 99% and a major development took place where James River Coal exchanged $243.4 million of convertible bonds for $123.3 million in new notes that are due in 2018. We are going to look into how that note exchange effects their future prospects and valuation.

The Note Exchange and Effect On Interest Payments

James River Coal exchanged $90 million in 4.5% Senior Convertible Notes that were due in December 2015 and $153.4 million in 3.125% Senior Convertible Notes due in March 2018 for $123.3 million in 10.0% Senior Convertible Notes due in June 2018. Despite the principal amount being reduced by nearly 50%, the increase in interest rates changes the annual interest from $8.844 million to $12.33 million per year for the notes involved in the exchange. This is an increase of $3.486 million per year.

Note Type

Principal Amount

Interest Rate

Annual Interest

Existing 4.5% Notes Due 2015

$90 Million

4.5%

$4.05 Million

Existing 3.125% Notes Due 2018

$153.4 Million

3.125%

$4.794 Million

Total Existing Notes

$243.4 Million

3.633%

$8.844 Million

New 10.0% Notes Due 2018

$123.3 Million

10.0%

$12.33 Million

The additional interest expense is likely to have minimal impact on James River Coal's near-term risk of bankruptcy. That risk is still primarily affected by metallurgical coal pricing, as the $3.486 million in extra interest expense can be offset by a $1 per ton increase in metallurgical coal pricing. The possible range of outcomes for metallurgical coal prices is much higher than that, with a strong recovery in the market potentially increasing average 2013 metallurgical coal prices by as much as $20 per ton.

Effect on James River Coal's Chances Of Bankruptcy

On the other hand, the note exchange has made a substantial difference to James River Coal's prospects in 2015 and beyond, as the value of the notes maturing in 2015 have been reduced from $141.2 million to $51.2 million. As well, the 2018 maturities have been reduced from $205 million to $174.9 million. The 2019 maturities remain at $270 million. This removes much of the uncertainty around refinancing in 2015 as well as reduces the overall debt levels by $120.1 million.

Valuing James River Coal

Aside from reducing the debt levels, the note exchange also reduced the conversion price to $5.00 per share on the new notes, with an option for James River Coal to convert the notes into common shares at their option if the stock price maintained at least a $7.50 daily volume weighted average price for 20 trading days in a 30 trading day period. We are now going to look at how the reduced debt levels plus lower conversion prices may affect James River Coal's valuations in certain scenarios.

In a strong recovery scenario (mentioned in the previous article as James River Coal's metallurgical coal pricing averaging $140 per ton in 2014 along with CAPP thermal coal reaching $90 per ton and Midwest thermal coal reaching $47 per ton), James River Coal could make $170 million in EBITDA in 2014. Valuing James River Coal at 6x EBITDA would lead to a value of $15.88 per share prior to the note exchange. The new 2018 notes would convert under this scenario, adding an extra 24.6 million shares. However, much of this dilution would be counterbalanced by the reduced debt levels (the reduction of $120.1 million from the initial exchange plus $123.3 million from the conversion of the new 2018 notes into equity). Therefore despite the additional shares, the valuation in the new scenario would still be $13.31 per share.

 

Old Strong Recovery Scenario

New Strong Recovery Scenario

2014 EBITDA

$170 Million

$170 Million

Estimated Net Debt

$450 Million

$215 Million

Enterprise Value @ 6x EBITDA

$1.02 Billion

$1.02 Billion

Market Capitalization

$570 Million

$805 Million

Shares Outstanding

35.9 Million

60.5 Million

Target Price Per Share

$15.88

$13.31

In a moderate recovery scenario (mentioned in the previous article as James River Coal's metallurgical coal pricing averaging $125 per ton in 2014 along with CAPP thermal coal reaching $90 per ton and Midwest thermal coal reaching $47 per ton), James River Coal could make $115 million in EBITDA in 2014. Valuing James River Coal at 6x EBITDA would lead to a value of $4.32 per share prior to the note exchange. With the note exchange though, debt is significantly reduced. It is uncertain whether the price would reach the levels needed for James River Coal to exercise their conversion option in this scenario, but with or without conversion the shares should be worth roughly around $7.

 

Old Moderate Recovery Scenario

New Moderate Recovery Scenario (with conversion)

New Moderate Recovery Scenario (w/o conversion)

2014 EBITDA

$115 Million

$115 Million

$115 Million

Estimated Net Debt

$535 Million

$300 Million

$425 Million

Enterprise Value @ 6x EBITDA

$690 Million

$690 Million

$690 Million

Market Capitalization

$155 Million

$390 Million

$265 Million

Shares Outstanding

35.9 Million

60.5 Million

35.9 Million

Target Price Per Share

$4.32

$6.45

$7.38

In a scenario without a meaningful recovery in metallurgical coal, James River Coal will face liquidity problems in 2014. This is unchanged from before they completed the note exchange since the note exchange primarily affects long term valuation and debt levels.

Conclusion

James River Coal has continued to make impressive strides to improve their balance sheet, reducing their long term debt load by around $180 million over the last year due to these note exchanges plus additional repurchases. The current note exchanges somewhat limits the maximum upside due to dilution, but also makes James River Coal more valuable in a moderate recovery scenario due to the reduced debt loads. However, their situation is unchanged if the metallurgical coal market fails to make a meaningful recovery. In such a scenario bankruptcy remains a serious possibility in 2014, although management has proven to be resourceful in managing financing. James River Coal remains a high risk and a high reward stock, although with slightly reduced reward now, and reduced long-term risk if they can weather the next year or so.

Source: James River Coal: How Its Debt Swap Affects Valuation And Bankruptcy Risk