Halcon Resources (NYSE:HK) appears to be making progress in its restructuring efforts, as it has now entered into a restructuring support agreement with lenders, with the intent of filing for voluntary relief under Chapter 11 by August 2 at the latest. Halcon does need to get additional support from affected stakeholders before it will definitively proceed with the filing, although it appears that the support percentages are already close to what is needed.
Halcon's common equity has rallied in recent days, but now appears distinctly overvalued compared to the unsecured bonds. An investment in Halcon's unsecured bonds will essentially result in twice the post-restructuring equity as the same net cash investment in Halcon's common stock. As well, Halcon's common stock is now implying a post-restructuring equity value well above my calculations as well as what is indicated by Halcon's restructuring warrant strike price.
Valuing the Unsecured Notes Versus The Common Equity
Halcon's $650 million in unsecured notes are scheduled to get 15.5% of the new equity, along with $37.6 million in cash, unpaid interest through May 15 and some warrants. The unsecured notes can be purchased for around 24 cents on the dollar right now, so if you attribute no value to the warrants and subtract the $37.6 million in settlement cash from the cost of the notes, you can get 1% of the new equity for approximately $7.64 million.
Halcon has around 122.7 million common shares outstanding, which means that at $0.50 per share, the total market capitalization is approximately $61.4 million. The common shares are scheduled to receive 4% of Halcon's new equity, meaning that if you buy the shares, you can get 1% of the new equity for approximately $15.34 million.
Thus, by purchasing common shares instead of the unsecured bonds, one is paying 101% more for the new equity. Looking at it the other way, purchasing the unsecured bonds would reduce the cost of the new equity by 50% compared to purchasing the common shares.
If you factor in the warrants, the disparity is even greater. Unsecured bondholders are going to receive warrants for 4% of the new equity at a $1.33 billion equity strike price. If the new equity is valued at $764 million (the rough valuation implied by the unsecured bond pricing), the value of the warrants for the unsecured bondholders is estimated at roughly $12 million. If the new equity is valued at $1.534 billion (the valuation implied by the current common equity pricing), the warrants for the unsecured bondholders are worth approximately $34 million.
Current Common Equity Is A Poor Long-Term Proposition
There doesn't appear to be a good reason to own Halcon's common shares instead of its unsecured bonds if one wants to own Halcon long term (post restructuring). Purchasing unsecured bonds will result in 101% more post-restructuring equity per dollar of investment (net of restructuring settlement cash) compared to purchasing the current common shares. If you add in the value of the warrants, the value of the unsecured notes increases by a few more percent.
In the event this restructuring agreement fails, Halcon is extremely likely to end up restructuring one way or another due to its very large debt burden. The result of that could potentially be worse for the unsecured bonds than the recovery seen in the current restructuring agreement. However, the unsecured bonds are still quite likely to do much better than the current common shares. The downside risk for the common equity is higher than the downside risk for the unsecured bonds if the restructuring agreement fails.
Thus, if the restructuring agreement goes through, the unsecured bonds offer roughly double the value of the common shares based on their current prices. If the restructuring agreement fails, the common shares are quite probably worth zero, while the unsecured bonds may still receive a modest recovery. There is more reward and less risk for the unsecured bonds compared to the common shares right now.
Halcon's current common shares are only good for shorter-term trades with the intent of selling before any restructuring agreement is completed or fails. The common shares do have better liquidity and smaller bid/ask spreads than the unsecured bonds. However, the intrinsic value of the common shares is also significantly less than its current price in my opinion, making it risky to own in the short term as well. Another indication of this is that at $0.50, Halcon's common shares are indicating a post-restructuring equity value of $1.534 billion, which is 15% higher than the $1.333 billion equity value strike price for the restructuring plan warrants. These warrants were assumed to be designed to be out of the money initially.
I think Halcon's unsecured bonds may be slightly undervalued based on my past calculations, but the common equity should be trading more in the $0.25 per share to $0.35 per share range. While one can argue about that Halcon's common equity is conclusively overvalued compared to its unsecured bonds, based on the restructuring proposal, one can get the new equity through the unsecured bonds for half the price of getting it through the current common equity. If the restructuring agreement fails, the common equity will likely be worth zero in the end due to Halcon's high debt load and the fact that the common equity is junior to three levels of secured debt, the unsecured debt, convertible notes and preferred shares.
I own a small amount of Halcon's unsecured bonds and have contemplated doing a long bond, short common equity pair trade. However, I haven't done so yet due to the relatively high cost to short (around 26% per year) and the amount of margin requirement that it would tie up. If the common equity becomes even more overpriced, I may pull the trigger, though.
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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in HK over the next 72 hours.
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.
Additional disclosure: Long Halcon's unsecured bonds
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