Halcon's Chapter 11 Restructuring Proposal

| About: Halcon Resources (HK)

Summary

Halcon has proposed a debt restructuring agreement that has gained the support of the key noteholders.

This plan would reduce Halcon's debt by over 65%, making it a viable company going forward.

Currently, Halcon needs around $90 oil to survive in the long-run.

Common equity is to get a small stake in the new company, but will do worse than other stakeholders.

Bonds have typically performed much better than common equity in restructurings of heavily indebted companies. Halcon's proposal is another example of this.

Halcon Resources (NYSE:HK) is an example of a company that was clearly uncompetitive in the current oil price environment due to its massive debt load. I previously estimated that it needed $90 oil to survive in the long-run with its debt load, and that it need to reduce debt by at least 50% to be viable. A restructuring appeared inevitable at some point, although Halcon could have delayed a restructuring into at least 2017 if negotiations with debtholders did not go well.

Halcon has negotiated a restructuring agreement that will reduce its debt load by over 65% if approved. That would make it a competitive company going forward. The common equity will receive a small stake in the new company, but did much worse than other elements of the capital structure. This reinforces the notion that the common equity is not where one should invest in a heavily indebted E&P company. Shorting the common equity of heavily indebted E&P companies has generally been quite a winning strategy, although in this case I hadn't shorted Halcon recently due to some uncertainty of when it would actually restructure.

Recovery Rates

I've included Halcon's proposed restructuring plan results below.

Stakeholder

Treatment

Senior Secured Revolver

- New or amended reserve based facility to be provided by existing lenders

2L Notes

- Unaffected and reinstated

3L Notes

- Fully equitized into 76.5% of the pro forma equity
- Receive $50.0 MM in cash plus accrued and unpaid interest through March 31, 2016

Unsecured Notes

- Receive 15.5% of the pro forma equity
- Receive warrants for 4.0% of the pro forma equity (4 year term, $1.33 BN equity strike)
- Receive $37.6 MM in cash plus accrued and unpaid interest through May 15, 2016

Convertible Note

- Receive 4.0% of the pro forma equity
- Receive $15.0 MM in cash
- Receive warrants for 1.0% of the pro forma equity (4 year term, $1.33 BN equity strike)

Preferred Equity

- Receive $11.1 MM cash

Existing Common Equity

- Receive 4.0% of the pro forma equity

Click to enlarge

With 122.7 million shares outstanding, the after hours price of $0.30 per share translates into the existing common equity being worth $36.8 million. The existing common equity is scheduled to receive 4% of the new equity with this plan, which would indicate a new equity market cap of $920 million. We can use that number to calculate recoveries for the debt.

Halcon's first-lien and second-lien debt are not impaired. Halcon has $1.018 billion in third-lien debt, which is going to translate into 76.5% of the new equity (value of $704 million) and $50 million in cash plus accrued and unpaid interest through March 2016. This results in an estimated 74% recovery for the third-lien notes.

Halcon has $650 million in unsecured notes, which gain 15.5% of the new equity (value of $142.6 million) plus $37.6 million in cash plus accrued and unpaid interest through May 15, 2016. This results in an estimated 28% recovery. The unsecured notes also gain warrants, which probably add around 2% to 3% to the recovery, although I've left those out from the table below.

There is also $290 million in convertible notes, which will translate into 4% of the new equity (value of $37 million) and $15 million in cash. The recovery for the convertible notes is approximately 18% before any warrant value and approximately 19% including the estimated warrant value.

Halcon's preferred equity is receiving $11.1 million in cash, which is a 5% recovery on the $222.5 million par value.

Original Amount ($ Million)

Implied New Value ($ Million)

Recovery

Third-Lien Notes

$1,018

$754

74%

Unsecured Notes

$650

$180

28%

Convertible Note

$290

$52

18%

Preferred Equity

$222

$11

5%

Click to enlarge

This is consistent with typical recovery curves where a 70% to 80% recovery for one level of debt translates into a recovery of below 40% for the next level down the capital structure.

Outcomes For Various Capital Elements

The after hours price for Halcon's common stock indicated a 69% decline versus its closing price. This is another piece of evidence that the common stock is not where you want to be in a heavily indebted company that is at serious risk of bankruptcy. In this case, common shareholders are seeing some recovery, which is a better outcome than many other cases such as Linn Energy. The common shares are probably seeing some recovery because Halcon is modestly less leveraged (albeit still very leveraged) than Linn. As well, Halcon's debt structure is a bit more favorable than Linn's, as Linn had a large amount of first-lien debt that is averse to taking a haircut. This allows Halcon to offer the common equity a small recovery to defuse opposition to the plan, with a possible threat of no recovery if the plan doesn't go through.

That being said, the proposed outcome for Halcon's common stock is still quite poor despite it not being completely wiped out. The after hours price is still 29% below Halcon's previous low closing price. On the other hand, the very lightly-traded preferred shares (HKRCP) stand to receive more than double their closing price on May 18 in cash, although still only 5% of par.

The unsecured notes appear to be receiving a slight premium (15% to 30%) above their last trading prices, and around four times the 7 cents on the dollar that the unsecureds were trading at in February.

Moving up the capital structure helped the third-lien bondholders, as their effective recovery is 48% of their original unsecured bond value, compared to 28% for current unsecured bondholders. The effective recovery is 39% of original bond value for the unsecured bondholders who swapped into second-lien bonds in December. This is also an improvement over what they would have received if they had remained unsecured.

Conclusion

I will examine the proposed new Halcon some more over the next few days. My initial calculations indicate that a $0.30 to $0.40 price for the current common equity is reasonable based on an expectation for long-term oil prices of $55 to $60.

Once again, the bonds are proving to be a better place to be than the common equity. I find that the bonds are often ignored by investors, but someone who invested in the unsecured bonds at their February lows would have done quite well (a potential 4x return), while the common equity may lose 29% versus February lows. This represents a relatively good outcome for the common equity as well, which has often been wiped out in recent restructurings.

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