Energy XXI (NASDAQ:EXXI) announced that the company intended to delay an interest payment and use the thirty day grace period. The company stated that it has the funds to make the payment, but that it would be in the best long term interests of the shareholders to try for a more aggressive restructuring of the company's balance sheet. The company did list $391 million in liquidity and noted its progress in repurchasing debt. The company reported purchasing debt of $738 million face value for $19 million including accrued interest in January and February (to date). A remarkable accomplishment that shows how little faith the market has in the company's ability to survive in its current form and it may also have another meaning that market has not yet valued.
Clearly, the fat lady is now in her dressing room humming few bars to warm up her voice. When she sings that last song, the curtain will fall on a company that pursued a risky financial strategy. So now its time to look realistically at what the future looks like for shareholders. Can management send the fat lady home before she sings?
Source: Energy XXI Investor Presentation 2 used at the Capital One Financial Corp. Energy Broker Conference in December, 2015.
This slide from the conference shows the costs that the company began the year with. Clearly these costs won't do in an environment like the present where oil prices are a little more than half of these costs.
Management has already stated that the debt repurchases have cut the cash interest costs $6.50 to a new amount of $12.50. Total costs per barrel are now down to $45.50, and it would be no surprise if the company is repurchasing more debt. As discussed in previous articles, it is not a bad negotiating tactic especially when dealing with the large institutional holders of debt. Debt holders usually like to negotiate as much of a cash payment as possible, so spending the available cash probably raises the anxiety of the lenders. Some large institutional holders approached the company about trading their unsecured debt for secured debt a while back, but with debt prices falling, the company never felt a need to come to an agreement. Now with debt prices probably as low as they are going to get, it probably time to negotiate.
The reasons why debt holders negotiate rather than force bankruptcy are many. First, in bankruptcy management always get the first try at reorganizing the company. If the company can make a realistic case that it needs debtor-in-possession financing, that financing could wipe out all claims as it is superior to all claims and management is free to reorganize any way it can. Second, expenses tend to "come out of the woodwork" in a bankruptcy which is any creditor's nightmare. Third, the bankruptcy can drag on until the assets are gone and there is nothing left to recover (sometimes all the lawyer fees cannot be paid from the bankrupt estate). So for these and many other reasons, creditors do not normally want a bankruptcy.
Wesley Kress, in the comments section of Windenberger's latest article, has stated that the bonds have covenants that allow for a coercive conversion below par (he cites some very knowledgeable references too). While executing that coercive conversion may be difficult and the lawyers may get rich over that set of clauses, the possibility a covenant such as that holds will keep many parties at the negotiating table rather than risking the consequences. That large repurchase at the start of this year is probably an big bond holder giving up after the lawyers looked at this clause. It is just one more sign that management is not going the bankruptcy route unless forced. Plus this may have weighed in on the decision by some large holders to sell for such a low price in the first place, as well as possible lack of security. As a result of the clauses, substantial more purchases may be on the horizon at greatly reduced pricing.
Management raised the ante some more when they knocked off a big chunk of reserves by stating that the company no longer had the funds to drill and produce those reserves.
"Due to the depressed commodity prices and our lack of capital resources to develop our properties, the Company believes that all of its proved undeveloped oil and gas reserves no longer qualify as being proved as of the period ended December 31, 2015. We have thus removed all of our proved undeveloped oil and gas reserves from the proved category as of December 31, 2015. Almost all of the proved undeveloped reserves that were removed from the proved category as of December 31, 2015 are still economic at current prices, but were reclassified to the probable category because they are no longer expected to be drilled within five years of initial booking due to current constraints on ability to fund development drilling. In addition, as of December 31, 2015, we identified certain of our unevaluated properties totaling to $336.5 million as being uneconomical and have transferred such amounts to the full cost pool, subject to amortization."
That quote is "brass knuckle" negotiations at its best. While everything that goes on follows accepted rules and practices, the investor can bet that management is going to do everything it can to fan the lender fears of no recovery. That means extremely conservative accounting and reporting. This helps keep the lenders at the negotiating table. Remember, no one wants to force bankruptcy if they cannot be paid for doing it. With this disclosure, management is telling the secured lenders that their security may not be worth much and that is important.
Interestingly, management disclosed that it was in compliance with its bank loan as of the end of the second quarter. However it anticipated not being in compliance at the end of the third quarter. While management still had the ability to access the remainder of the credit line, management would first have to prove that the reserves backing up the credit line were still there. Management stated that it believed there was no longer sufficient reserve value to allow access to the remaining unused credit balance. That statement should definitely jar the second lien-holders awake, as they were just notified there was no security left for them (or definitely an insufficient amount). For all intents and purposes, the credit line may be frozen, but there is still plenty of cash in the bank that can be used for various purposes, including more debt buy backs.
That cash will also reassure suppliers that they will be paid, as unpaid suppliers are usually the first to file a bankruptcy request or file a lien which leads to all sorts of unpleasant circumstances.
Management also has delayed and will probably skip altogether an interest payment on one of the bond issues. Nothing gets lenders attention like not paying them the interest on schedule. With management busy limiting the options of the lenders, this action will lead to some very heated negotiations. More covenant violations are sure to follow, but those extra violations won't change the situation materially.
The latest 10-Q also discloses that lease operating expenses decreased about 10% from the budget. The lease operating expenses are part of the lifting cost shown above. So let us assume that management dropped those lifting costs about $1.50 per barrel. That brings the total costs down to $44 per barrel doing some very rough figuring. Without the remaining financing costs, the total cost per barrel would be roughly $31.50. Management thinks that they can drop the costs even more.
It is important to look at the latest total costs before financing costs because that is a strong clue about whether or not there is a company to save. In this case, without the remaining cash interest costs, this company has some very low costs and as a result it has a realistic chance to survive the current downturn. Plus with the hedging the company had a combined selling price of $36.83 in the second quarter. So with a little more cost cutting, this company probably can get by even with the current low commodity prices (before the interest costs).
The company reported negative cash flow, but in the latest 10-Q there was payments of $120 million of (mostly) liabilities while accounts receivable rose $71 million. So out of the negative cash flow from operations of about $90 million, nearly $50 million of that amount came from working capital. Normally companies that plan on a bankruptcy do not pay down their liabilities and prepaid expenses. Plus this action did have the effect of making the cash flow from operations look about $50 million worse. Similar to the discussion above, it is in management's best bargaining interest to make the statements look as conservative or as low as possible. If management has a plan to present the most grim picture possible as a negotiating tool, then every little bit helps. Lowering the recovery ambitions of the debt-holders will leave more of the company for the common shareholders.
Then management declared a shareholder rights plan. That is not an action usually taken by distressed companies about to go bankrupt. Normally the way leveraged distressed companies are acquired is by the acquiring company purchasing a significant amount of the debt (usually the secured debt) at a discount and then making an irresistible, possibly threatening (bankruptcy but with a plan to control the proceedings) offer for the common stock. In this case, a fair amount of debt is in institutional hands and divided, and the company, through its open market purchases is preventing the consolidation of that debt any further into fewer hands so far. So it is just possible that the next leverage a lender would have is to purchase large amounts of common stock and threaten to evict the management. The new rights plan appears to prevent that.
James, LaChance, Chairman of the board of directors, has considerable experience in distressed securities. His experience was discussed in several articles previous to this one and in the corresponding comments section as well. He is going to make a very tough opponent (and a very valuable and knowledgeable ally of shareholders) at the negotiating table. So it makes sense to try and protect him as well as the rest of the management bargaining team during negotiations with the bondholders and lenders.
Clearly this company management is not going the route of declaring bankruptcy, reorganizing the company, and then re-establishing their equity position through options after the bankruptcy. Instead management appears to be ready to fight for shareholders to the very end, which is commendable. Even though management appears to be running out of options, it appears to be making the most of the few options it has left. This is definitely a very speculative situation, and there are no guarantees that management will prevail. Plus there is a very real chance this will not work and the company will end up bankrupt. However, should management succeed, then debt will decline materially from the current levels which have already decreased substantially.
An investor at this point could lose his entire investment, but if management does succeed (and it looks like they have a few things extra going for them), the potential returns on the bonds (possibly, but read and really know the covenants first) from negotiation, the preferred stock, and maybe the common stock could be huge from current pricing levels. Some investors love excitement, adventure, immense complications, and lots of risk (as well as long odds). This situation is strictly for those people with a very strong stomach and the ability to research some very complex issues. Plus the investor needs faith that management can beat some considerable odds to pull off negotiations that leave the common shareholders with at least part of the company.
Should management successfully reorganize the company without using bankruptcy, the common stock and more likely, the preferred stock could soar. It all depends upon how successful the negotiations and any potential court actions are.
Disclaimer: I am not a registered investment advisor and this article represents my personal views. It is not an investment recommendation and readers are advised to evaluate their own risk profiles and determine whether or not this investment fits their own risk profiles. The reader is also advised to read the government filings of the companies mentioned for further information (they include but are not limited to 10-K, 10-Q and as well as the press release filings). There is no substitute for doing your own due diligence as due to the financial leverage of the company, these securities would be considered to be speculative.
Disclosure: I am/we are long EXIXF.
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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