Just like baseball cards, scarcity helps to underpin the value of stocks. Whiting's recent decision to increase shares outstanding from 204M shares to 360M shares in the span of 2 months certainly doesn't help burnish an aura of exclusivity amongst its shareholders. The company's shareholders can now expect a downtrodden stock price and increased volatility as the market digests the new share issuances.
Let's revisit what's transpired in the last few months and parse out why Whiting may have been forced to undertake the equity issuance:
Shares for Everyone
- On March 23, 2016, Whiting announced it exchanged $477M of certain senior and senior subordinated notes for new convertible notes, which the company subsequently converted into 41.8M shares of common stock on May 10.
- On May 17, 2016, shareholders approved the proposal to increase the number of authorized shares from 300M to 600M of common stock.
- On June 23, 2016, Whiting then announced a plan to exchange certain nonconvertible and convertible notes for new mandatory convertible notes. The ultimate shares to be issued under this plan will be determined using a VWAP based computation with a built-in floor. Unfortunately, in the hours after it was announced, Brexit happened. Although the market has recovered, Whiting's stock price hasn't. Given Whiting's recent trading price, we anticipate that the total maximum shares to be issued will be very close to the maximum 114.8M (as we assume arbitrageurs would continue to buy/own the bonds and short the stock).
With these two share issuances, total principal on debt will have declined from $5.650B to $4.173B, a decrease of $1.065B or 26%. Shares outstanding will increase from 204M to 360M, an increase of over 77%.
Why So Much?
Whiting has been beset by many challenges of late, most of which are self-inflicted, and a few (e.g., Brexit) were just poor timing. Almost half of its debt came from the company's acquisition of Kodiak in December 2014. While the company paid for this acquisition in part by exchanging shares of Whiting, it also assumed Kodiak's $2.5B in debt.
The Kodiak acquisition increased Whiting's drilling inventory, but the purchase effectively doubled the company's total long-term debt from $2.7B to $5.6B at just the moment oil began its steep descent.
As Whiting entered 2016, the large debt load jeopardized its credit line, and for a heavily indebted "cash light" company, the credit line is the key life line. Given the weakness in strip prices, we believe Whiting's forecasted EBITDAX placed it at risk for violating certain bank covenants by year end. Whiting's amended credit line contains 3 covenants to be met as of the last day of any quarter:
- consolidated current assets to consolidated current liabilities ratio (which includes an add back of the available borrowing capacity under the credit agreement) of not less than 1:1,
- total senior secured debt (i.e., credit line) to the last four quarters' EBITDAX ratio of less than 3:1, and
- ratio of the last four quarters' EBITDAX to consolidated interest charges of not less than 2.25:1.
It was likely the third covenant (i.e., the 2.25:1 EBITDAX to interest charges ratio) that caused Whiting to issue shares to strengthen its balance sheets. We forecast Whiting's 2016 EBITDAX to total $635M** based on today's strip (and including Whiting's hedges). Given that Whiting was averaging $62M in cash interest expense per quarter (as of Q1 2016), annualized cash interest expense would have totaled approximately $250M. While this would appear to produce a 2.54:1 ratio, we're using today's strip, which is higher than even a few months ago.
Even if Whiting were comfortable being aggressive with its covenant, having a ratio so close to the required 2.25:1 floor hampers its ability to borrow significantly more under the credit line. We anticipate that Whiting will have a cash shortfall of $124M for 2016, and would need to continue using its credit line as a buffer. Thus, the share issuance was prudent if not unpalatable. Moreover, there's no guarantee that oil prices will continue to stay within this range, or that the banks will not further reduce Whiting's borrowing base. Banks are really good about giving you an umbrella on sunny days, and then taking it away when it starts raining. As such, deleveraging the balance sheet gives Whiting further financial flexibility, and improves its financial metrics to mitigate any potentially negative redeterminations or a minor decline in oil prices.
Post-dilution, Whiting's interest expense for 2016 should total $216M, assuming the same $635M of EBITDAX, the interest coverage ratio will be 2.93. Although any additional borrowings would again increase interest expense, the increased ratio coverage gives Whiting additional "cushion" to tap the credit line.
** Note that in calculating our EBITDAX we're using LOE of $9.20, a differential of $8.00 and interest on the credit line of 4%.
What About the Assets?
Looking further out, we think future funds can come from asset sales instead of share issuances. We anticipate Whiting will monetize its existing natural gas processing plants in the Bakken. The creditors have already carved these assets out in the Third Amendment to the Sixth Amended and Restated Credit Agreement ("Credit Agreement") (i.e., the latest amendment to the credit line). In the amendment there's a defined term "Midstream Asset Dispositions", the sale of which would not give rise to a redetermination of the credit line. Schedule I of the Credit Agreement defines Midstream Asset Disposition as a sale of the 50% ownership interest in two gas processing plants located in the Williston Basin of North Dakota: (i) the Robinson Lake plant located in the Sanish field, and (ii) the Belfield plant located near the Pronghorn field.
The delay in selling the plants, intentional or unintentional, may come down to pricing.
At the J.P. Morgan Energy and Equity Investor Conference (June 2016), Jim Volker, Whiting CEO, shared that many midstream natural gas plant operators have converted their contracts from percentage of proceeds ("POP") to fee-based (i.e., typically 20-25% POP to $1.65 - $1.75 per mcf plus fees for fractionalizatioin), and as the contracts become amended, natural gas plants have become increasingly more valuable. He stated "a number of folks out there like us, who if they are considering selling their plants they are wanting to make sure that they get solid value that reflects that increase in revenue caused by the change in contracts."
In addition, as third-parties complete their inventories of drilled uncompleted wells, there's a possibility of increasing throughput in the Robinson Lake Plant from 120 mcf/d to potentially 155 mcf/d. Jim Volker further stated "I actually think the opportunities to increase the value of these plants is very real while it may take a little more time to sell them it may take the form of better offers."
If we assume some conservative figures, we think the 50% working interest in Whiting's Robinson Lake plant and Belfield plant could be worth $300M and $100M, respectively. The sales proceeds could then be used to further pay down debt or fund 2017 capital expenditures. While any midstream sale could increase operating expenses, any such increase will be partially offset by the interest expense reduction from debt repayment or not having to access the credit line.
Lastly, the company could sell its North Ward Estes property, which produced 8,900 boe/d in the first quarter. This CO2 enhanced recovery project with its high capital costs would likely garner a depressed price at today's strip. Whiting may wait for a higher price environment before selling.
So while we believe Whiting's share issuance was necessary to reduce pressure on its over-levered balance sheet, the dilution has to be weighed against the risk of illiquidity and default. Going forward Whiting has additional midstream and noncore assets it could sell to fund 2017 capital expenditures and/or continue accessing its credit line. Should the strip stabilize and even increase, the likelihood of another share issuance decreases.
As always higher oil prices solve many problems, so the goal at this stage is survive the deluge, keep your head above water and wait for sunnier days.
Disclosure: I am/we are long WLL.
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.