Picture of Mullet. Source: coorongwildseafood.com.au
Weatherford (NYSE:WFT) has been on a capital raising spree over the past few months. In March the company raised $630 million in equity which helped pay off part of its revolving debt and alleviate some of its liquidity strain. Earlier this month it announced a $1 billion debt offering; the convertible notes due 2020 are expected to repay senior notes due from 2017 to 2019. Then last week the company priced an additional $1.5 billion offering consisting of notes due 2021 and 2023.
I believe investors in the new bond offerings are providing mullet money or dumb money for the following reasons:
Weatherford's Q2 Results Will Likely Be Disastrous
Prior to Q1 results management intimated it would generate 2016 free cash flow ("FCF") of $500 - $600 million. In March it perfected a surprise $630 million equity offering designed to shore up its liquidity. In Q1 the company experienced free cash flow of negative $212 million. The surprise equity offering make a lot more sense then. The company knew Q1 would be disastrous and it would be hard pressed to make a $350 million principal payment due in February. Management also lost a lot of credibility after Q1 free cash flow was nowhere near what the company had projected.
The fact that Weatherford has now attempted to raise $2.5 billion in new debt is almost a de facto admission that [i] Q2 free cash flow will be awful and [ii] the company will be hard pressed to make a $600 million principal payment due in Q2 2017 with more outside capital. While Citigroup (NYSE:C) believes the debt offering relieves concerns over debt maturities, in my opinion, the company's ability to service debt has not gotten any better. Until Weatherford can generate consistent positive free cash flow -- which I do not foresee anytime soon -- the company's debt will likely represent a poor investment.
Debt Covenants Could Be In Jeopardy
Certain of Weatherford's debt is subject to covenants, including its revolving credit facility and a $500 million term loan. According to UBS the company had [i] $1.0 billion in specified debt and [ii] $600 million in letters of credit subject to covenants of debt/EBITDA at 4.0x.
In Q4 UBS projects the company's trailing 12 months EBITDA of approximately $399 million. That could potentially breach its debt covenants. Weatherford's Q1 EBITDA was $100 million. Q1 revenue fell Q/Q by 21% and 57%, respectively. Oil prices now hover around $50, but that has not translated into a rise in E&P. Until the North American rig count rise or global E&P picks up, Weatherford's revenue and EBITDA will likely fall further.
That is a long-winded way of saying the company's trailing 12 months revenue through Q4 2016 could easily miss the approximate $400 million required to meet its debt covenants. If Weatherford's $1 billion convertible note offering alleviated liquidity strain from near term principal payments, what was the additional $1.5 debt offering for? I believe management knows its debt covenants are in jeopardy. Its $1.5 billion notes have no covenants; the company could use these proceeds to repay debt subject to covenants.
Bondholders are lending money to a company with debt at over 10x run-rate EBITDA, while EBITDA and free cash flow are in decline. Secondly, these bonds are not subject to debt covenants, so lenders cannot force the bonds to be repaid if Weatherford's financial results fall short of expectations. They are putting themselves in a worse position than current lenders who have demanded covenants. Given Weatherford's precarious financial condition, I do not believe new bondholders are being paid for the risks involved. Instead of paring its debt load Weatherford is simply kicking the can down the road.
Disclosure: I am/we are short WFT.
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.