Energy XXI Amended Reorganization Plan - How Does It Impact Investors?

| About: Energy XXI (EXXIQ)

Summary

An amended reorganization plan was filed on Nov.14.

Equity holders are still not getting any recovery, but the official equity committee is still fighting.

Confirmation hearing is set for Dec.13.

Unsecured note holders are getting a higher recovery, and 2lien and convertible note holders are getting less.

EXXIQ is expected to exit bankruptcy before the end of January.

There were major changes made in the reorganization plan (docket 1638) filed by Energy EXXI (Bermuda) Ltd. (OTCPK: OTCPK:EXXIQ) on Nov.14. Some creditors benefited under the amended plan and other creditors are getting less recovery, but equity holders are still getting nothing. The official equity committee is still fighting an impossible battle to get some token recovery.

Bankruptcy Judge David Jones gave conditional approval of the amended disclosure statement (docket 1644) for the reorganization plan during a hearing on Nov.14. The confirmation hearing, which has been postponed a number of times from the original date of Sept.21, is now set for Dec.13. The only party expected to object to the amended plan at that hearing is the official equity committee. Creditors and the company would like to exit Ch.11 before the end of January 2017.

Reorganization Plan

Even after a mediator, Judge Leif Clark, was appointed in September, the various parties could not agree to new plan. After numerous meetings, a reorganization plan and amended disclosure statement was finally agreed to on Nov.14. All parties, except the official equity committee, have agreed to the amended plan. Both EPL and EGC note holders are getting a higher recovery while 2lien and convertible note holders are getting less.

Second liens

New plan

84% new equity (diluted by equity issued under the management incentive plan and warrants issued to other claim classes). Estimated recovery of 19.0%-27.5%. Total claim of $1.874 billion.

Old plan

99% new equity (diluted by equity issued under the management incentive plan and warrants issued to other claim classes). Estimated recovery of 24.5%-36.2%.

EGC unsecured notes

New plan

12% of new equity plus warrants of 3.6% of new equity. The warrants are for five years with a strike price of $1.45 billion divided by the number of shares issued on the plan's effective date. Estimated recovery 6.9%-10.7%. Total claim of $754.5 million. (Does not include $471 million notes held by EGC that are not getting recovery.)

Old plan

0.9% of new equity plus out-of- the-money warrants of 8.75% of new equity. Estimated recovery 1.2%-5.4%.

EPL unsecured notes

New plan

4% of new equity plus warrants of 2.4% of new equity. The warrants are for five years with a strike price of $1.45 billion divided by the number of shares issued on the plan's effective date. Estimated recovery 8.1%-13.4%. Total claim $217 million. (Does not include $267 million notes held by EGC that are not getting recovery.)

Old plan

Warrants for 0.5% of new equity. Estimated recovery 0.2-0.9%

EXXI convertible notes

New plan

$2 million cash. Estimated recovery 0.5%. Total claim $366.6 million.

Old plan

0.1% of new equity plus warrants for 0.75% of new stock. Estimated recovery 0.2-1.0%

Equity

Preferred and common shareholders get no recovery under new and old plans.

Claims

Not including 1lien claims, there is $2.764 billion in debt. In addition, there are $122.8 in other priority claims, administrative priority claims associated with the bankruptcy case that are still increasing,$36.9 million trade claims, and $19.6 million general unsecured claims.

*the 8.25% note is the EPL note

Official Equity Committee

The lawyers for the official equity committee are following the typical approach to get a token recovery for equity holders. They are using delaying tactics and running up legal bills of creditors. I call this the "punishing" approach-if you don't give us something it will cost you more in legal fees and cost you more for delays in getting recovery (time value of money). The DIP lenders agreed to extending the milestone for confirmation of the plan until Dec.31, but they claimed in court that an extension beyond that date could be problem. The official equity committee wants the confirmation hearing delayed until Jan. 2017 -claiming that they need time to have depositions, file motions/objections, and to observe the holidays.

The official equity committee is also going to challenge the valuation of EXXIQ conducted by PJT Partners. Besides the 1lien claims, there are about $3 billion in claims that have priority over equity so that even using PJT Partner's $1.3 billion enterprise value, which was given to the board Feb.26, there would not be sufficient value to justify recovery for equity. The valuations used in the July disclosure statement (docket 805 exhibit G) estimated an even lower enterprise value of only $550 -$800 million. Sept. 23, PJT report estimated a new enterprise valuation of $500 million-$700 million.

It seems that based on statements by lawyers for the official equity committee at the Nov.14 hearing, their final strategy is to assert that current management, which filed the plan, is being "paid-off" under the plan's new compensation incentive agreement. The new compensation proposal has not been filed yet. It is expected to filed by Nov.23.

Basically, the official equity committee is trying to get "gifting" from higher priority class. While it is rare, it does happen. Under the reorganization plan for Halcon Resources Corp. (NYSE: HK) shareholders received 4% of the new company. The convertible note holders, a priority class, would most likely litigate if there was any "gifting" to equity holders, especially if it was more than their small $2 million total recovery against their claim of $366.6 million.

Just because an official equity committee is appointed that does not mean there will be some recovery for shareholders. This is a reality that shareholders of other energy companies that had official equity committees appointed, such as Breitburn Energy Partners LP (OTCPK: OTCPK:BBEPQ), also need to understand.

Estimated Recovery and Valuation

These estimated amounts of recovery are not my estimates, they are estimates included in the disclosure plan, which are often overly conservative. The equity capitalization on the effective date was estimated to be $425 million-$625 million by PJT in their Sept. 23 report. The table below shows the wide range in valuations by the different interested parties from a disclosure statement (docket 1416) filed on Sept. 25 (the UCC is unsecured creditors committee):

Still using the estimated equity capitalization range of $425 million to $625 million, the warrants would be way out of the money since the strike price is determined by dividing $1.45 billion by the number of shares issued on the effective date. The stock price would have to almost triple within the five year life of the warrants for the warrants to be exercised. PJT values the total warrant package at $5.7 million. If you double the estimated equity capitalization amount, the value of the warrants would more than doubles because you get closer to the strike price. Therefore, the total estimated recovery by unsecured note holders would more than double.

When the new EXXIQ starts trading, investors will determine the value of the shares-not PTJ Partners. Various creditor's expert analysis clearly indicates that they would value the equity capitalization at more than 3x PJT's estimate. After factoring an even much higher valuation for the warrants, it would indicate that the estimates by PJT significantly under estimates the potential recovery by unsecured note holders.

The note prices have risen about 30% since my Aug.29 article on EXXIQ because of the favorable trend in the negotiations attempting to amend the reorganization plan. The notes are now selling at about twice the low recovery estimate given in the disclosure statement.

Conclusion

After a highly contested creditor fight, an acceptable reorganization plan was negotiated, which does completely follow absolute priority. In introduction business classes it is taught that those with higher priority ranking get paid in full before a lower priority class gets paid, but this is not happening with EXXIQ. Second lien creditors, that have a higher priority class, are accepting less than full recovery so that lower priority classes get recovery.

Even with an official equity committee that is trying to be obstructionists in an effort get a token recovery, I do not expect them to get anything. I recommend selling preferred and common Energy XXI equity. I also recommend selling the convertible notes that are trading at over twice their cash recovery as holders hope that if equity holders get recovery then their recovery would be increased. The unsecured notes warrant consideration by investors willing to assume extreme risks associated with bankruptcy securities.

Disclosure: I am/we are long EXXI BONDS.

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.

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