Bellatrix Exploration (NYSE:BXE) is an interesting small-cap gas producer, but I have refrained from initiating a long position as the company's balance sheet contained a lot of debt. As I was expecting, the banks would reduce the borrowing base of BXE's credit line (well, the entire market was expecting this), I didn't dare to go long in case the company would be faced with a cash call.
Updating the funding sources ahead of the reduced credit facility
It would have been absolutely horrible if Bellatrix would have had to raise cash when it was forced with its back against the wall. The company had a credit facility in excess of half a billion Canadian Dollar, before voluntarily reducing the size of the credit line to C$460M ($345M) earlier in June. Despite having monetized an asset right after the end of the first quarter, and despite the fact the strip price for Canadian natural gas was improving, a further reduction of the size of the credit facility seemed to be unavoidable as banks were (and still are) pulling capital out of the energy sector.
Source: Company presentation
BXE's fear was confirmed and after several deadline extensions, its lenders told the company the borrowing base would be reduced to just C$210M ($160M) before the end of the fourth quarter, a decrease in excess of 50%. Fortunately, Bellatrix had been taking measures to reduce its (gross and net) debt. It didn't just sell an asset for C$75M ($55M), it also entered into an agreement to sell a 35% stake in its Alder Flats gas plant to its joint venture partner, Keyera. The total consideration for this sale is C$112.5M $85M), but as this sale hasn't been completed yet, the lenders have allowed Bellatrix a C$155M non-revolving facility, maturing on November 11, 2016. This should provide Bellatrix with sufficient amount of time to complete the sale of the stake in Alder Flats to Keyera, and use those proceeds to reduce its net debt.
On Tuesday, the company announced it had entered into an agreement to raise C$80M ($60M) on a bought-deal basis, consisting of C$30M ($22.5M) in equity (to be raised at C$1.20 per share ($0.90)) and C$50M ($37.5M) of unsecured convertible debt.
The asset sales will help to reduce the net debt
The first step is obviously to calculate the total net debt of Bellatrix. This will have to happen on a pro forma basis as a lot has changed since the company reported the financial results of the first quarter of this year.
According to those financial statements, the total net debt of Bellatrix was C$670M ($500M) which was way higher than my comfort level. The total amount drawn down from the credit facility was almost C$360M ($270M), and after taking the C$185M ($140M) in proceeds from asset sales into consideration, Bellatrix should have no problem to see the total amount drawn down on its credit facility to drop below the C$200M mark ($150M), and below the C$210M maximum level.
Source: Financial statements
That being said, even after these sales, BXE's net debt will still be approximately C$500M, and the C$30M the company is currently raising in equity will very likely immediately be spent on capital expenditures, rather than hitting the balance sheet, so I will be using a pro forma net debt of C$500M after the current string of deals. The majority of this debt would be related to the company's senior debt maturing in 2020, so if the banks don't cut its 'allowance' again, the company has just bought itself 4 years to wait for higher gas prices.
Why do I want the convertible debt but not the equity?
With an anticipated net debt position of C$500M ($375M), I definitely wouldn't touch the common shares of Bellatrix Exploration. At first, I also wasn't convinced about the convertible debt offering, considering this consisted of a 5-year term (maturing in 2021), which means the convertible debt will be maturing after the senior debt in 2020. That's pretty normal, otherwise, this unsecured convertible debt offering would have been senior to the senior unsecured notes due to the 'seniority by maturity' situation that would have occurred.
Source: Company presentation
So, my first thought was that a 6.75% coupon wasn't sufficient to make the risk/reward ratio appealing, considering the senior debt has an 8.5% coupon attached to the notes. But then I started to run some calculations based on the company's reserve statement.
According to BXE's most recent reserve statement, the total PV10 of the company's proved and probable reserves was C$1.34B ($1.03B) (excluding undeveloped lands and the recent acquisition). If I would now become even stricter and just use the present value (at a 10% discount rate and on a pre-tax basis) of the developed and producing wells, the value of C$518M ($390M) would cover the entire net debt position (as of right now). Should you also add the developed non-producing and the undeveloped proved reserves, the PV10 increases to C$820M ($615M), which does provide a certain margin of safety considering it's substantially higher than the value of the net debt.
So by purchasing the convertible debt, I will be able to participate in the gains from a substantial increase in the company's share price (the debt can be converted into common stock at a ratio of 617.284 shares per C$1000 lot, which basically means the conversion price is C$1.62/share ($1.22), 35% above the share price of the placement). So should the company's share price reach C$3 by the maturity date of the convertible bond, I won't just have received almost 35% of the original investment in interest payments, I would also end up with a 100% return as a 'balloon' payment at the end of the debenture's 'life span'.
Bellatrix didn't wait to see the outcome of the credit review and started to sell assets before its lenders announced the decision to cut the borrowing base by in excess of C$300M. Fortunately, Bellatrix seems to have a good relationship with the banks, as they gave the company some time to finish another asset sale which will further reduce the net debt.
Right now, I'm not touching the common shares, but I have allocated some of the company's convertible (unsecured and subordinated) debt. The interest rate is just 6.75%, but based on the values of the reserves (according to Sproule) and the price curve of the AECO-based gas price, I think there's a very decent margin of safety here. On top of that, even if the company's share price will sharply increase, I will very likely be able to benefit from this considering the conversion rate of the bonds has been set at C$1.62 per share (35% above the current share price). Whilst waiting for this to (hopefully) occur, I collect my 6.75% per year and won't have to worry for the first few years. And as I was allocated less than 40% of my desired amount, it does look like the bought deal will be very successful and potentially upsized.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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: I have no position in Bellatrix, but have been assigned an allocation of its newly issued unsecured subordinated convertible debentures.
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