BreitBurn Energy Partners - Secured Debtholders Might Prefer A Near-Term Restructuring

| About: Breitburn Energy (BBEPQ)

Summary

BreitBurn is in discussions with secured debtholders now and both suspended its preferred distributions and elected to take the 30 day grace period for its bond interest payments.

First-lien lenders would prefer that BreitBurn restructures now. Converting second-lien and unsecured debt to equity would likely allow BreitBurn to pay down its credit facility to $700 million by 2018.

Common and preferred unitholders should hope that the secured debtholder discussions aren't fruitful. Any resolution would likely result in zero value for the units.

I had believed that a restructuring would be delayed due to the question of what to do about cancellation-of-debt income.

BreitBurn may have hired advisors to figure out a solution that allows them to restructure without passing on CODI.

BreitBurn Energy Partners (NASDAQ:BBEP) announced that it was suspending its preferred distributions and electing to take a 30 day grace period on its bond interest payments. It also is engaged in discussions with secured debtholders and has hired a number of advisors.

Any agreement reached with secured debtholders is likely to result in zero recovery for common and preferred unitholders. This is because BreitBurn needs to sharply reduce its interest costs to be competitive in a $60 oil environment, and that will only happen if the second-lien and unsecured debt is converted into equity. Preferred and common unitholders need to hope that the discussions with secured debtholders go nowhere and that BreitBurn ends up paying its April bond interest.

Perspectives From Various Stakeholders

I think that it is useful to attempt to look at the situation from the perspective of the various stakeholders. The first-lien credit facility lenders are at the top of the capital structure. The credit facility lenders are primarily concerned with getting their money back. They lend money at relatively low interest rates and the loans are secured by the oil and gas reserves. At $50 oil, the value of BreitBurn's reserves are essentially equal to the outstanding credit facility borrowings, which makes the situation an uncomfortable one for the credit facility lenders once the hedges run out. Credit facility lenders lend an average of 61% of proved developed producing reserves, so somewhere around $700 million to $750 million would be what the lenders would be comfortable with without hedges if there was an expectation for $50 oil.

With its current interest costs, BreitBurn can probably pay down its credit facility to around $1 billion by the time (at the end of 2017) that its hedges mostly expire. However, if the second-lien and unsecured debt were to be converted to equity now, the interest savings should allow BreitBurn to pay down its credit facility to $700 million by the end of 2017. Hence, the best result for the credit facility lenders would be for the second-lien and unsecured debt to be converted to equity now rather than later.

EIG (the second-lien debtholder) is currently in a position to control the majority of BreitBurn's post-restructuring equity. I think it is in EIG's interest to push for a debt restructuring now as well, since if oil is at $50 in 2018 and no restructuring has happened by then, the credit facility lenders would likely end up owning most of BreitBurn and EIG's would have a limited recovery. Right now, EIG should be able to get a strong and perhaps full recovery on its second-lien notes. The question that is probably being discussed is how much would be left for unsecured noteholders, and whether EIG would be interested in making a bid for the unsecured notes to gain full equity ownership (if the unsecured notes are left with any recovery).

The Energy XXI restructuring left unsecured noteholders with only OTM warrants, but I think there is a decent chance that BreitBurn's unsecured noteholders are left with a modest equity share. Energy XXI's unsecured bonds were trading at 3 cents on the dollar for a prolonged period of time before the restructuring agreement was announced. BreitBurn's unsecured bonds are a bit better at 8 cents on the dollar, indicating expectations for a modestly better return. The second-lien debt was a huge part of Energy XXI's capital structure (at $1.45 billion and around 50% of total debt), so the second-lien debt had great negotiating power. With BreitBurn the second-lien notes have $650 million in face value and represent around 22% of total debt, giving it somewhat less power.

The second-lien notes are still the key to the negotiations as they are likely to be the highest level on the capital structure that will be converted into equity. The preferred and common units are two and three rungs below the second-lien debt in BreitBurn's capital structure, which makes them an afterthought in terms of getting any recovery. Preferred and common unitholders should hope that no deal is reached with the secured debtholders, as a deal would likely result in the current units being cancelled.

The only path for a return for the preferred and common units is for the talks with the secured debtholders to go nowhere, for BreitBurn to then pay its bond interest and then for oil to go up very quickly before BreitBurn runs out of liquidity.

Linn Vs. BreitBurn

One not entirely accurate point that has a tendency to come up is the assertion that BreitBurn is much better off than Linn since it has significantly less debt. That is technically true. BreitBurn has around $3 billion in net debt and Linn has around $8.5 billion in net debt. However, Linn is also around 2.5x (based on reserves) to 2.7x (based on projected EBITDA) BreitBurn's size, so when adjusted for company size, there is only a modest difference. As well, BreitBurn has over $550 million in preferred units, so the likelihood of common unitholders seeing any return is lower for BreitBurn than it is for Linn.

The CODI Question

Any restructuring of BreitBurn's debt is potentially going to create a significant amount of cancellation-of-debt income [CODI] that is going to be passed on to unitholders. This could result in a large tax bill for unitholders. The CODI issue was a key reason that I believed there was a reasonable chance that BreitBurn would make its April interest payments and attempt to put off a restructuring for a while. BreitBurn's management owns a fair number of units and made some additional purchases a few months ago, so there is also personal incentive to avoid CODI being passed to unitholders.

However, if the advisory companies that BreitBurn has hired are able to figure out a solution that avoids CODI being passed to unitholders, then a near-term restructuring appears much more likely. To be clear, any restructuring is likely to result in zero return for unitholders as discussed above. There is a good chance that the restructuring will be done after a solution is implemented to address the CODI issue though. That changes the likely result from a greater than 100% loss for unitholders to just a 100% loss. Still, there remains a non-negligible chance that unitholders will get CODI passed onto them, either through BreitBurn proceeding with restructuring without a solution or the IRS challenging whatever solution BreitBurn comes up with.

Conclusion

I think that there is a strong chance that BreitBurn's preferred and common units end up being worth zero. For BreitBurn to compete in a $60 oil environment requires its non-credit facility debt to be converted into equity and that would result in the current equity being wiped out. That being said, I have closed my short position in BBEPP for now since there is likely going to be some volatility before a restructuring actually happens.

Common and preferred unitholders should not look upon the discussions with the secured debtholders as a positive. It is actually in the best interests of the credit facility lenders for BreitBurn to restructure its other debt while it still has substantial hedges. EIG is also in a position to end up with control of a company that is viable with $60 oil if restructuring happens now. If restructuring happens later on, much of the hedge value goes to paying unsecured bond interest. Common and preferred unitholders need to hope that the discussions do not result in anything and that an oil price recovery happens before BreitBurn restructures or gets its liquidity cut off by the credit facility lenders.

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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in BBEP over the next 72 hours.

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