Questar Market Resources: Change of Control Triggered?

| About: Questar Corporation (STR)
On the tape yesterday came some news regarding Questar Corp (NYSE:STR):

Questar Corp said it’s considering spinning off its exploration and production business, a unit which accounted for about 34 percent of the company’s net income in 2009. The new company would also include Questar’s gas-management and energy-trading subsidiaries, in addition to the exploration and production unit.

For those not familiar with Questar Corp, here is a brief description from the website:

Questar Corporation is a natural gas-focused energy company with five major lines of business - gas and oil exploration and production, midstream field services, energy marketing, interstate gas transportation, and retail gas distribution - which are conducted through its three principal subsidiaries:

  • Questar Market Resources, Inc. (Market Resources or “QMR”) is a subholding company that operates through four principal subsidiaries. Questar Exploration and Production Company (Questar E&P) acquires, explores for, develops and produces natural gas, oil and NGL. Wexpro Company (Wexpro) manages, develops and produces cost-of-service reserves for gas utility affiliate Questar Gas. Questar Gas Management Company (Gas Management) provides midstream field services including natural gas-gathering and processing services for affiliates and third parties.
  • Questar Energy Trading Company (Energy Trading) markets equity and third-party natural gas and oil, provides risk-management services and owns and operates an underground gas-storage reservoir.
  • Questar Pipeline Company (Questar Pipeline) provides interstate natural gas transportation and storage and other energy services.
  • Questar Gas Company (Questar Gas) provides retail natural gas distribution services in Utah, Wyoming and Idaho.
What makes this interesting is a provision in Questar Market Resources' senior notes, which is called a change of control redemption ("COC"). Having once owned their debt, I was curious as to whether this news could trigger the COC provision, which would require them to repurchase their debt at $101.
What does this affect? Here is the company's debt structure (as of YE '09):
Let's focus on the Questar Market Resources issuer (Baa3/BBB+).
It is important to realize that the issuer is an intermediate holding company whose subsidiaries are listed above.
From the prospectus (the STR 6.8% 03/01/20 issued 8/24/09), although all QMR debt has the provision (emphasis mine):

If we experience a Change of Control and the notes are downgraded below investment grade by Standard & Poor’s Rating Service or Moody’s Investors Service, Inc., we will offer to repurchase all of the notes at a price equal to 101% of the principal amount plus accrued and unpaid interest to the repurchase date.

Change of Control

If a Change of Control occurs and is accompanied by a Rating Decline (together, a “Change of Control Triggering Event”), each registered holder of the notes will have the right to require us to offer to repurchase all or any part (equal to $2,000 or an integral multiple of $1,000 in excess thereof) of such holder’s notes at a purchase price in cash equal to 101% of the principal amount of such notes plus accrued and unpaid interest, if any, to the date of purchase.

For purposes of the Change of Control offer provisions of the notes, the following terms will be applicable:

“Change of Control” means the occurrence of any of the following:

(1) Questar or any of its affiliates ceases to own, directly or indirectly, beneficially or of record or otherwise, collectively more than 50% of the aggregate voting power of our voting stock (or our successor by merger, consolidation or purchase of all or substantially all of our assets);
(2) the sale, lease, transfer, conveyance or other disposition (other than by way of merger or consolidation), in one or a series of related transactions, of all or substantially all of our and our subsidiaries’ assets, taken as a whole, to any person or group (as such term is used in Sections 13(d) and 14(d) of the Exchange Act) other than to Questar or any of its affiliates;
(3) the first day on which the majority of the members of our board of directors cease to be Continuing Directors; or
(4) the adoption by our stockholders of a plan or proposal for our liquidation or dissolution.

“Rating Date” means the earlier of the date of public notice of (i) the occurrence of a Change of Control or (ii) our intention to effect a Change of Control.

“Rating Decline” shall be deemed to have occurred if, no later than 90 days after the Rating Date (which period shall be extended so long as the rating of the notes is under publicly announced consideration for possible downgrade by either of the Rating Agencies), either of the Rating Agencies assigns a rating to the notes that is lower than an investment grade rating. An investment grade rating with respect to Moody’s shall mean a rating of “Baa3” or higher and an investment grade rating with respect to S&P shall mean a rating of “BBB-” or higher.

Okay, lets review: if there is a sale/transfer/disposition of all or substantially all of the assets of the company, this can qualify as a change of control. If, due to the sale/transfer/disposition of all or substantially all of the assets, the debt is downgraded by EITHER agency within 90 days, the company will have to redeem the debt at a price of $101.

Lets work backwards now and start with the agencies:
Moodys (4/22/10): Moody's Investors Service placed the Baa3 senior unsecured ratings of Questar Market Resources, Inc. (QMR) under review for possible downgrade.

QMR's ownership of Wexpro and its association with Questar's regulated subsidiaries has always been an important support for QMR's Baa3 rating," commented Pete Speer, Moody's Vice President. "Following the proposed transaction QMR will have reserves and production scale more comparable to a Ba rated exploration and production company.

S&P (4/22/10):

Salt-Lake City-based Questar Corp. announced it is considering a possible tax-free spin-off of the company's natural gas and oil exploration and production (E&P) business. We believe that should QMR be spun-off from Questar, it would not have a business risk profile that would support the existing ratings, given the inherent volatility and uncertainty of its E&P business which would comprise the majority of its operations. QMR's current business risk profile benefits from support from Questar's regulated businesses as we have treated the Questar rating on a consolidated basis.

Okay, if QMR is rated Baa3 and they might be downgraded (high probability), the next stop is non-investment grade. The non-investment grade rating satisfies the "Rating Decline" component.
Now the biggie: "the sale, lease, transfer, conveyance or other disposition (other than by way of merger or consolidation), in one or a series of related transactions, of all or substantially all of our and our subsidiaries’ assets, taken as a whole" condition. Why is this the "biggie"? Well, I have been down this road before with issuers doing spin-offs, split-ups and sales and this is a beast of a provision. Every time I have been down this road, the legal team always emphasizes that there is no "bright line" for what constitutes "all or substantially all" of anything. The company tells you as much in the prospectus:

The definition of “Change of Control” includes a phrase relating to the sale, lease, transfer, conveyance or other disposition of “all or substantially all” of our assets and those of our subsidiaries taken as a whole. Although there is limited body of case law interpreting the phrase “all or substantially all,” there is no precise established definition of the phrase under applicable law. Accordingly, the ability of a holder of notes to require us to repurchase the notes as a result of a sale, lease, transfer, conveyance or other disposition of less than all of our assets and those of our subsidiaries taken as a whole to another “person” (as that term is used in Section 13(d)(3) of the Exchange Act) may be uncertain.

See what I mean?
Well let's look at the breakdown of the company's subsidiaries using a couple of metrics:
(Click to enlarge)
As you can see, by all the metrics used here (PP&E is gross by the way), the disposition of Wexpro (it is staying with Questar, so we will consider it the disposed asset) is about 12-17% of the companies assets or operating income. Is this all or substantially all? I really don't think so.
Okay, so why bother with this exercise? If QMR gets downgraded, the bonds are obviously trading down (the '20s traced at $106 or +214/10yr) - gap them out to +300/10yr and they are trading at $100.25. If you think that your downside is $101 (the redemption price), I think you might be wrong - and you should have sold them anyhow.
Bottom line: I don't think the COC is triggered by the proposed spin-out, I would be a better seller of QMR debt (although liquidity is an issue).
Disclosure: No positions