Investors in Patriot Coal (PCX) have had quite a wake up call over the last month to say the least. Often times, the thrust of an investment thesis is based on future growth potential. The balance sheet gets pushed aside, and the all important statement of cash flow is virtually ignored. I will attempt to answer some relevant credit related questions surrounding PCX and the predicament the company has found itself in.
Q. PCX does not have any debt due until the 5/31/13 maturity of the convertible debentures, so why all the fuss?
A. The bank credit facility has an acceleration clause that says it matures 90 days prior to the convertible preferred if the convertible issue is not taken out by that date. Therefore the bank facility is 'current' as we stand today, with a maturity date of 3/1/13, not the 12/31/13 final as advertised.
Q. Since the convertible debenture can be converted to shares, isn't the only concern share dilution?
A. The convertible debenture will not become equity, it needs to be paid off at par or they will default.
Q. Dealing with all the bank issues is still almost a year away, so shouldn't the company have plenty of time?
A. PCX received an amendment to the bank facility in late January which reset the covenants. Based on that, I expect PCX to blow the September 2012 covenant of 3.75x maximum leverage.
Q. The bank's committed to a new facility and the company says that process is still being worked on. Isn't a commitment a form of binding obligation on the banks?
A. Commitments such as this typically contain a MAC clause (material adverse change). Indeed, the commitment from the banks does contain a MAC. The customer default would have certainly triggered the MAC. As such, the obligation of the commitment has likely been nullified.
Q. Even if the MAC is triggered, shouldn't other market participants be willing to lend to PCX?
A. With the unsecured bonds trading in the 40s currently, the capital markets are not open to PCX, even if they tried to come with a secured bond deal.
Q. PCX makes lots of money, don't they?
A. Please look at the statement of cash flow for PCX. They have burned cash since day one.
Q. Why would the creditors not work toward a new agreement instead of forcing PCX into a bankruptcy filing?
A. The new facility was to come from Citigroup (C), Barclays (BCS) and Natixis (NTXFF.PK). They are not the lenders under the current facility. The current credit facility was executed in 2007 at the time of the spin from Peabody Energy (BTU). The lenders under the 2007 facility are Bank of America (BAC), which acts as administration agent, L/C issuer and swing line lender, Fifth Third (FITB), Sovereign Bank (STD) and US Bank (USB). Bank of America, along with the other lenders under the facility, are not involved with the new commitment and as far as they are concerned their agreement terminates 3/1/13. I will note that Citigroup and Lehman were the underwriters that brought the 3.25% convertible debentures to partly fund the Magnum deal back in 2008. Thus, you see the historical tie in with Citigroup and Barclays/Lehman; Natixis is a new bit player. We can only speculate that PCX went to Bank of America in hopes of renewing the facility. Perhaps Bank of America, tired with the stream of amendment requests, rejected the idea of a renewal. Thus, PCX was forced to turn to their other banking buddies from the past, namely Citigroup and Barclays. Food for thought; the new facility was to be brought by what were historically investment banks (Salomon and Lehman) while the expiring facility is all commercial banks. Do you think a mainstream commercial bank would touch this situation?
Q. Isn't the new commitment just a standard bank loan situation and this is all being blown out of proportion?
A. The new deal was to be a $375mm revolver, which would be almost exclusively used for L/Cs. As of 3/31/12, PCX had $329mm in L/Cs outstanding on the Bank of America facility and this backstops AROs, workers comp and mine reclamation and closure costs. The other component of the deal was a new $250mm secured term loan (which I'll refer to as TL). The new TL was to price in the 9-10% range. A 9-10% price on a TL in today's market is extremely high. Such loans are typically priced at a spread over LIBOR, say +475 for a single-B rated secured issue, which is around 5.5% all in. All this was before the customer default news and then further rating agency downgrades. The new TL would have fully refinanced the convertible issue, paid transaction fees, and perhaps put a small bit of cash on the balance sheet. The most interesting thing about the TL is that it, like most TLs of this nature today, would have not been retained by the underwriters, but resold to investors. What that means is that Citigroup, Barclays and Natixis would not have held onto that piece of debt, but would have instead sold it to institutional loan investors. Those include loan mutual funds, CLOs, and large institutional separate accounts such as state pension funds and endowments. Large loan investors do their own credit work so you must ask if it is rational to expect them to take down a 9+% loan on a CCC-rated entity with a bloated balance sheet, negative FCF and poor industry dynamics.
Q. The coal industry is not dead forever and buying them time is a more prudent way of handling the situation, so why not wait for better coal prices?
A. Correct, the coal industry is not dead. That does not preclude the company from needing to be restructured. As the facility is 'current', time is of the essence. Banks unfortunately do not have patience. They do not lend on hope, since hope is not a strategy. The banks will not lose money at the secured level if there is a Ch. 11 filing. They recognize the company has been FCF negative since day one and their prospects have recently become even more speculative. Institutional lenders watch the stock price too, and the bond prices for that matter.
Q. Assuming PCX files for bankruptcy protection, shouldn't the competition benefit since PCX will cease operations?
A. That is absolutely incorrect. A bankruptcy filing will allow the company to restructure. The word restructure is key. Perhaps some PCX mines will shut, and maybe some out of the money contracts will be eliminated. However, on the whole, once the bankruptcy filing occurs, PCX will be afforded protection from creditors and will run their mines without pressing concern for bank covenants, interest payments and profit expectations. The company will be restructured as a going concern. Once legacy liabilities are eliminated, PCX should have a strong financial profile and be a leader in the markets in which they compete. To get to that stage will require compromise by the many constituents in the PCX capital structure. In short, once the company works through the pain, there is light at the end of the tunnel.
In summary, PCX has tremendous legacy liabilities they simply cannot pay. They cannot raise capital, and they will run out of cash. There is a strong chance that PCX will not pay the 5/31/12 convertible coupon, which will likely trigger a 30-day grace period allowing the company to file for Ch. 11 in orderly fashion sometime during June.