Whiting Petroleum - Valuation Range Narrows To $8.25-$11.50

| About: Whiting Petroleum (WLL)

Summary

Whiting continues to reduce its debt by converting it into equity. The latest exchange may convert $1.065 billion in debt into 91.3 million shares (based on a $11 price).

Exact amount of shares will vary depending on Whiting's price until late July.

This reduces both Whiting's upside and downside as its debt burden becomes more manageable at the cost of many additional shares.

Impact on debt to EBITDA is nearly 1x based on $55 oil. Effect on breakeven point is modest due to the low interest rate on much of the converted debt.

Whiting Petroleum (NYSE:WLL) continues its efforts to reduce its debt and deleverage itself by exchanging $1.065 billion in existing notes for new mandatory convertible notes. This may add 91.3 million shares if the average conversion price is $11, bringing Whiting's share count up to approximately 337.5 million, while reducing its debt to $4.108 billion. This is a positive for the company's ability to manage its debt, and both reduces its upside and downside potential. The effect on Whiting's interest costs are a bit less than one would expect though, as the majority of the debt reduction involves Whiting's 1.25% Senior Convertible Notes due 2020. Thus the average interest rate on the involved debt is only 2.9%.

Conversion Effect

The new mandatory convertible notes will be converted into shares at 4% per day for the 25 day trading period starting on June 23, as long as the daily volume weighted average price (Daily VWAP) is above $8.75 on that day. The conversion price varies slightly depending on the note. If the Daily VWAP is $11, then the conversion price would range from $11 for the new 2018 notes to $11.88 for the new 2020 notes.

I've outlined below what would happen if the notes were converted with an average Daily VWAP of $11 during the 25 day trading period. The $1.065 billion in debt would be converted into approximately 91.3 million shares.

Notes

Principal ($ Million)

Shares (Million)

6.5% Senior Subordinated Notes due 2018

$23.60

2.15

5.0% Senior Notes due 2019

$22.68

2.05

1.25% Senior Convertible Notes due 2020

$687.93

57.91

5.75% Senior Notes due 2021

$172.73

15.32

6.25% Senior Notes due 2023

$157.97

13.88

Total

$1,064.90

91.30

Click to enlarge

If the average Daily VWAP was $12 instead, the notes would convert into 83.69 million shares. If the average Daily VWAP was $10, the notes would convert into 100.43 million shares.

Effect On Interest Costs

Although Whiting should be able to reduce its debt by a substantial amount by this exchange, the impact on Whiting's interest cost is less. This is because around 65% of the notes involved are the low interest 1.25% Senior Convertible Notes due 2020. Whiting is expected to reduce its interest cost by $31.07 million per year.

Notes

Principal ($ Million)

Interest Savings ($ Million)

6.5% Senior Subordinated Notes due 2018

$23.60

$1.53

5.0% Senior Notes due 2019

$22.68

$1.13

1.25% Senior Convertible Notes due 2020

$687.93

$8.60

5.75% Senior Notes due 2021

$172.73

$9.93

6.25% Senior Notes due 2023

$157.97

$9.87

Total

$1,064.90

$31.07

Click to enlarge

This brings Whiting's estimated annual cash interest costs down to approximately $189 million and reduces its estimated 2017 breakeven oil price by around $1 to $56 WTI oil.

New Valuation

Whiting will now have approximately 337.5 million shares outstanding (based on an average conversion price of $11) and $4.108 billion in long-term debt. Whiting's expected debt to EBITDA ratio is becoming more reasonable (around 3.5x at $55 long-term oil), which improves the status of its bonds and also reduces the potential downside for its stock. The conversion of debt to equity at a conversion price of approximately $11 also reduces the potential upside of its stock though due to the additional shares (over 130 million shares are expected to be added from conversion of notes during the last few months).

I previously estimated that Whiting's valuation range should be around $7 to $12. Whiting's updated valuation range is estimated at around $8.25 to $11.50 now. If the long-term price of oil was at $70, Whiting would be worth around $17.50 now, compared to around $22.50 before the two sets of new convertible notes. The additional shares (from the May to July conversions) reduces Whiting's potential upside as a $1 billion increase in enterprise value would only increase its share price by around $3 now instead of $5.

Conclusion

Whiting continues to improve its balance sheet by converting debt into equity. There is some uncertainty about the exact number of new shares that will be added due to Whiting's changing stock price. It is a bit unfortunate that the conversion price is affected by the surprise Brexit decision, but the overall effect of the conversions should be to narrow Whiting's valuation range to around $8.25 to $11.50. This is a move that both reduces the upside and downside for Whiting's shares. It also reduces Whiting's debt-to-EBITDA ratio by nearly 1x (based on $55 oil), but only has a modest effect ($1) on Whiting's breakeven point.

I am playing Whiting via sell strangles since its implied volatility has increased (the combined effects of the new convertible notes and Brexit) while its actual valuation range should theoretically narrow due to the conversion of debt into equity and the additional shares.

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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in WLL 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: My position is generally neutral through sell strangles, but may tilt more long if Whiting falls to the lower end of my valuation range.