Energy XXI: It's Just Business, Nothing Personal

| About: Energy XXI (EXXIQ)

Summary

Energy XXI has reached a pre-filing restructuring support agreement with 63%+ of the second lien note holders.

The agreement contemplates 100% equity in the restructured company to go to second lien noteholders.

Management would participate in equity via an incentive plan.

John Schiller would continue as the reorganized company CEO and board member.

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Important Note: This article is not an investment recommendation and should not to be relied upon when making investment decisions - investors should conduct their own comprehensive research. Please read the disclaimer at the end of this article.

As expected, Energy XXI (NASDAQ:EXXI) this morning filed for protection under Chapter 11. Prior to filing, the company's management had reached an agreement with holders of more than 63% of the company's secured second lien 11.0% notes on the material terms of a balance sheet restructuring plan ("the Restructuring Support Agreement" or "RSA"). The company stated:

We believe that entering into these agreements and implementing them through a court supervised process is the best course of action for Energy XXI and maximizes value for all of our stakeholders.

The RSA eliminates substantially all of the Company's prepetition funded indebtedness other than its first lien credit facility.

The RSA contemplates that secured second lien noteholders will receive 100% of the new stock in the reorganized company, subject to dilution from a management incentive plan which is also contemplated by the agreement.

The RSA also provides that John Schiller, the company's current CEO and a Board member, will continue as the reorganized company's CEO and a Board member.

The company is also continuing ongoing negotiations with a steering committee of lenders under the Company's first lien reserve based loan facility that is not party to the RSA at this time.

As of the time of this writing, Energy XXI has not made the filing with the SEC disclosing the RSA. I expect such filing to be made soon. However, the company's statements in conjunction with the filing for protection under Chapter 11 appear quite straightforward as it relates to the most likely outcome for stock holders, preferred holders and holders of unsecured debt if the reorganization plan envisioned by the RSA is approved by the court.

What To Expect? - Equity

According to Energy XXI, the RSA provides that no distribution is expected on account of Energy XXI's existing stock upon the Company's emergence from Chapter 11. The senior secured noteholders will receive 100% of the new stock in the reorganized Company, subject to dilution on account of a management incentive plan.

Any recovery to existing stockholders will be determined in connection with the Company's plan of reorganization upon emergence from Chapter 11; however, the Restructuring Support Agreement provides that no distribution is expected on account of the existing equity interests in Energy XXI. We expect that existing Energy XXI stockholders will receive no recovery at the end of the restructuring process.

The company will seek to limit the ability for certain stockholders to sell their shares during the Chapter 11 cases to protect the Company's valuable net operating losses.

What To Expect? - Preferred

According to Energy XXI, the RSA provides that no distribution is expected on account of Energy XXI's existing stock upon the Company's emergence from Chapter 11. All preferred stock will be cancelled.

Any recovery to existing holders of preferred stock will be determined in connection with the Company's plan of reorganization upon emergence from Chapter 11; however, the Restructuring Support Agreement provides that no distribution is expected on account of the existing equity interests in Energy XXI. · We expect that existing Energy XXI stockholders will receive no recovery at the end of the restructuring process.

What To Expect? - Unsecured and Secured Notes

The RSA contemplates that all the existing debt with the exception of senior secured debt will be wiped out.

This will significantly reduce Energy XXI's debt by more than $2.8 billion and provide Energy XXI with enhanced financial flexibility.

It is important to note that the company's comment with regard to the unsecured debt was qualified. Specifically, the company stated with regard to Energy XXI's, EGL's and EPL's unsecured bonds:

It is not possible to predict what value, if any, Energy XXI unsecured bonds may ultimately have.

We will not pay interest on the unsecured bonds or the secured second lien bonds, and interest will not accrue on the bonds during the financial restructuring process.

Reporting

The company will not issue earnings press releases or hold quarterly conference calls during the reorganization proceedings. However, the company plans to continue to file quarterly and annual reports with the SEC. As part of the reorganization process, the company will also be required to periodically disclose certain financial results.

Expected Emergence From Chapter 11

The company anticipates emerging from this financial restructuring process in September 2016.

What to Watch For

Two very important elements of the restructuring that still need to be resolved relate to DIP financing and executory contracts (specifically, the company's midstream contracts). Please see the debate in the comments thread to the previous article.

The DIP financing is one of the first items to be negotiated following the Chapter 11 filing and is likely to be resolved within the first week.

The company has 30 days to accept or reject executory contracts.

In Conclusion…

Let's make no mistake, the reorganization plan must be approved by the bankruptcy court following the proceedings. Given that the RSA is so far supported by only one group of stakeholders, court battles are certainly possible.

It is important to remember, however, that the company's management will have the exclusive right to file the initial reorganization plan. While objections to the plan from unsecured noteholders may be vigorous, the fact that under the contemplated reorganization plan the second lien noteholders are receiving common stock and no debt, the chances appear high that the plan will be approved by the court.

Energy XXI's announcement brings a logical resolution the debate with regard to the possible outcomes of the restructuring negotiation. The RSA appears to confirm the theses that the company's asset quality and cash flow generation potential, which ultimately define the value of the collateral and the financial logic of the restructuring, were not enough to support a more favorable outcome for equity holders.

As one can see from the comments thread in one of the previous note, the outcome was to a great degree predictable.

While every single Chapter 11 situation is different, Energy XXI's filing provides a highly relevant case study with regard to several other deep distress situations in the E&P sector, such as LINN Energy (NASDAQ:LINE), Ultra Petroleum (NYSE:UPL), SandRidge Energy (OTCPK:SDOC) and several others.

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

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