Paragon Announces Restructuring - Fundamentals Matter Again

| About: Paragon Offshore (PGNPQ)

Summary

The company will use Chapter 11 to execute what is essentially a debt repurchase.

$984 million of senior unsecured notes will be exchanged for $345 million and 35% of Paragon shares.

Existing shareholders will own 65% of Paragon.

It has been a long time since I have written about Paragon Offshore (NYSE:PGN) (OTCQX:PGNPF). After having written about the company for months, I stopped covering the company in September, after the news that they had announced the hiring of bankruptcy advisors to restructure the debt.

The move made little sense to me at the time. Why pursue bankruptcy with so much cash still available? Why not use that cash to repurchase debt at a significant discount?

I stopped writing because I felt that I no longer understood what was going on with the company and, frankly, I didn't have any useful perspective on what a bankruptcy would look like since I didn't even understand the rationale behind it.

Today's restructuring announcement answered a lot of questions. The unknowns around the restructuring have been removed and I feel we can finally talk factually about this company again. To summarize the two main elements of the plan:

1) The unsecured bondholders will swap $984 million in face value for a cash payment of $345 million plus roughly 46 million shares which will mean that current shareholders will own 65% of the company and the bondholders will own 35%.

2) The revolver will be partially paid down and the $630 million left will be converted into a term loan at LIBOR + 4.5% which will now be due in 2021, extended from 2019.

Many are professing surprise at the fact that the shareholders were able to retain 65% of the company in what is technically a Chapter 11 bankruptcy. But I always found it to be absurdly premature to talk about bankruptcy for a company that had over $700 million in cash and is still cash flowing quite well.

In my view, the more useful way to look at this transaction is as a debt repurchase with a little bit of equity thrown in to sweeten the pot. Indeed the terms of the restructuring actually look a lot like the type of debt repurchase that I had initially hoped for back when the debt was at 40% and the equity was at $1.00.

It has been a harrowing journey for Paragon shareholders. It sure would have been nice if we could have managed a transaction like this without the drama of the last four months … but I suppose it gave us an opportunity to average down.

So what now?

The restructured company should have 132 million shares outstanding, for a market cap of $45 million, and my best estimate of net debt would be around $1025 million by the end of Q1. So we are looking at an EV of $1070 million at the current price.

My best estimate of FCF is $300 million for 2015, however that will come down in 2016 as big contracts roll off. MSS2 will roll off in April 2016. DPDS3 and Prospector 1 will roll off by October 2016.

All told, I am looking for FCF in 2016 of $175 million in the current contracting environment and maybe $40 million in 2017 without significant improvement in the contracting environment.

Much of the company's profitability is in the North Sea and much will depend on whether they are able to keep their rigs working there (especially the Prospector rigs).

However, I don't expect to see oil stay at $30 for next two years and I would hope to see the contracting environment improve. The significant option value in Paragon will be unlocked if we see a meaningful recovery in oil to perhaps the $50 level. So what this news really means is that we now have some runway, around two years I'd say.

I do remain optimistic (anyone can look at the FCF of the company and then the market cap and see dollar signs) but it does bear repeating that without a recovery in oil and in shallow water drilling, Paragon shares will not have value.

Disclosure: I am/we are long PGNPF.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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