EXCO Resources (NYSE:XCO) announced July 27, 2016 the commencement of a cash tender offer for outstanding 7.5% Senior Notes due 2018 and outstanding 8.5% Senior Notes due 2022. The combined amount of 2018 Notes and 2022 Notes tendered is subject to a cap of $40 million (the "Tender Cap" - ex. accrued interest and a special, one-time Consent Payment associated with the tender offer).
In conjunction with the tender offer, EXCO is soliciting consents from holders of the 2022 Notes to amend "certain terms" of the indenture governing the 2022 Notes. This transaction is hugely meaningful in terms of the overall EXCO narrative and this transaction speaks to the ultimate outcome scenarios for the stressed enterprise. I'll explain.
The Tender Offer…
First, what is this tender offer and what does it comprise? EXCO is essentially making three offers and the offers are in a specific, meaningful order of execution priority: To tender (or purchase at a specific time and price) its 2022 Notes, to allow 2022 noteholders to consent to the amending of "certain terms" within the Indenture Agreement associated with the 2022 Notes [i.e. EXCO is asking 2022 noteholders to allow it to change a specific, legally agreed to term of the contract that is the 2022 Notes; all bonds are essentially just contracts to be repaid a debt owed (with interest)], and to tender (or purchase at a specific time and price) its 2018 Notes.
The order of priority is as listed with specific mention being made that any acceptance of tender by 2022 noteholders is also an acceptance of the solicitation to alter legal terms within the 2022 Notes Indenture Agreement (again, the governing body of the 2022 Notes themselves).
Now that we know what EXCO is offering - why is it offering this (especially now) and what exactly is it wanting to alter within the legal document governing the 2022 Notes? This is where we "get into the weeds" a bit from a capital structure analysis standpoint. But, this is also where the narrative of EXCO shifts - so this is important (albeit somewhat sophisticated and somewhat dry).
Why and Why Now?...
EXCO is doing three things by making this tender offer and they range the spectrum of stress management: preparing for a worst-case scenario, preparing for a best-case scenario, and trying to add de-stressing optionality. These, unlike the offers being made, aren't in any particular order however, and these all work hand-in-hand. If EXCO secures one, it secures the others.
Preparing for a Worst Case Scenario:
EXCO noted within its tender offer solicitation that it's looking to open up potential stress management optionality to prepare for the possibility that its semi-annual borrowing base redetermination is not "as expected"; the expectation is that its borrowing base goes unchanged. If its borrowing base is cut, however, EXCO's liquidity would be materially affected and not in a good way. So EXCO, in asking for 2022 noteholders to allow for a more expansive, more open architecture definition of what is defined as allowable additional indebtedness (currently this is limited to issuing secured Credit Facility debt), is looking to have in-hand all potential destressing levers heading into this redetermination.
Frankly, given the level of execution that EXCO has evidenced so far, given the lengths that EXCO management/Board of Directors/insiders have gone to keep the enterprise a going concern, given the overall architecture and composition of the cap structure as is, etc., I don't believe the threat of a borrowing base redetermination is "credible" (in Game Theory terms). I believe that EXCO would do itself well to secure another destressing lever, in preparation for the unknown, but I don't believe this is the primary motivation behind 1) the tender offer itself and 2) noting this as a risk within the tender offer solicitation.
I think, as I've professed dating back 18 months, that EXCO wants to remove the junior bond tranche in an effort to take the company private - where restructuring can take place in near-complete open architecture as well as quicker, cheaper, and with less regulatory burden. I think that using the borrowing base redetermination "fear" as a motivation point is a great tactic to drive tender offer pricing lower and/or consent solicitation higher.
That said, I still think 2022 noteholders should consent to this asking (to alter the definition of acceptable additional indebtedness) regardless of taking the actual tender offer itself. 2022 noteholders need to realize they are essentially "the equity class" at this point (as are 2018 noteholders) - there is nothing of recovery value waiting for you if EXCO "goes to zero" (i.e. has to restructure in bankruptcy court). Yes, if EXCO issues additional, non-First Lien (or via its Credit Facility) debt in front of the 2018/2022 Notes, this will hurt the Notes from a pricing standpoint (also known as "priming"). But again, the ultimate goal is not to "go to zero" and consenting to a more open architecture will help with that.
Preparing for a Best Case Scenario:
The flip side to the Worst-Case Scenario is, of course, the Best-Case Scenario. As alluded to above - I think ultimately EXCO (being a mess from a cap structure standpoint) would prefer to execute a go-private transaction (given the composition of the cap structure this makes sense as well) where it can restructure (and potentially come public in 12-18 months) rather than to continue on in a "simple survival case." Frankly, I'm not sure the "simple survival case" makes sense past 2017 anyways [the point of intercept where this no longer makes sense during 2017 is variable (based on a handful of factors outside the scope of this note, but not outside of continuing coverage provided)]. I think ultimately the go-private is how this story ends.
EXCO absolutely must remove the junior tranche bondholders to make the cost/benefit analysis of a go-private transaction make sense. As they exist currently, both junior bond issues have "premium to par" payments in any "change of control." This would mean that both junior bond issues would be purchased at huge, huge premiums to market value if EXCO could go-private today. Why does this matter? Well, this (the "change of control" and "premium to par" issues) drives up the total takeout cost of course.
Removing the junior bond issues at a discount prior to the go-private transaction, regardless of reasoning (SEE: convincing noteholders to tender Notes based on redetermination fears), would be a coup; one that I believe has to take place before the final domino topples. If EXCO can prepare for a "worst-case scenario" it also, in yet another superb example of execution, can prepare itself for a "best-case scenario." That's generally called a strictly dominating strategy (for EXCO at least) - one that you take when it presents itself.
Adding Destressing Optionality
In short, because this has been semi-addressed above, if EXCO wins its proposed expansion of allowable additional indebtedness, it also wins an additional destressing lever. In addition to this, EXCO will also have delevered (assuming some noteholders take the tender offer and surrender their bonds), to a point, at deep discounts to face value. That means it will have a slightly reduced interest expense, which helps cash flows, which helps liquidity management, etc. This is fairly self-explanatory so I won't elaborate further.
Thoughts from an Energy Consultant…
Given that this note has a screencast associated with it (that I'm hoping readers will watch), I'll wrap up this note with my summary thoughts on the tender offer, what I think each bond issue should do, and what I think this means for the equity class.
First, I'll reiterate that I think 2022 holders should consent to the expanded definition of additional indebtedness. Help yourself out, allow the company to keep the music going (in a worst-case scenario but also in all other scenarios), and worry first about "going to zero" rather than about the "priming risk" associated with giving consent. If EXCO is forced to issue additional junior-tranche debt, it's likely issuing this as a survival method of last resort. Again, NOT going to zero is the primary priority for 2022 noteholders (as well as 2018 noteholders and the equity class). Give up a few points of pricing (in theory) for the security captured with allowing the change of terms. Just do it.
I think that depending on the cost basis, your positional requirements (if you're a small fund, you likely are close to "by prospectus" being forced to dump these notes anyways), and your ability to reallocate capital that taking the offer here makes a lot of sense. It certainly isn't the "worst-case scenario." I think you take the deal unless you have substantial belief that 1) a better offer comes later or 2) EXCO would still execute a go-private even with a small portion of your class on the board (this is "iffy").
Whether or not the 2018 Notes can participate in this tender offer is dependent on how much participation is engaged by the 2022 Notes. So, all of this might be a wasted effort in explanation. That said, here are my thoughts anyways.
I would reiterate all of my thoughts from the 2022 Notes section BUT alter them to include the following: I don't think 2018 holders should be as quick to participate in this offer in that I think EXCO, once it has the expanded capacity presumably to be granted by the 2022 class, will be able to make something of a better offer to 2018 noteholders in the immediate term.
Yes, this would presume that EXCO is "OK" with paying a higher cost to retrieve the 2018 Notes - but I don't think EXCO (especially being as sophisticated a management team/Board of Directors as they are) thinks that ultimately it's going to be able to take out the entirety of the 2018 issue at a blended rate of ~$45. I think that between voluntary retirements (EXCO reported a fairly significant drawdown to outstanding principal for both issues within its tender offer notice) and any financial maneuvering EXCO can manage once capped on voluntary retirements that EXCO will have pared-down the 2018 issue to levels where it can negotiate in legitimate good faith (from a compensation standpoint).
Put another way, I think that as long as EXCO can continue to make progress in overall destressing that the last remaining members of the 2018 issue will be much more handsomely rewarded than the first members to take an exit offer.
Again, I think EXCO absolutely must take out the junior tranches to get to its preferred go-private outcome. And we know that EXCO is going to have to come to the junior tranches with at least one follow-on tender offer (or ultimate offer) because this particular tender is tender capped. My guess is the follow-on offer is either 1) front run (meaning that speculators bid up the price of the remaining issues via exchange mechanisms), 2) at a higher compensation from EXCO (maybe partially as a result of being front-run), and/or 3) both of the preceding. All of these scenarios are an improvement over "trickle down" participation being offered under the terms of the current tender offer.
But 2018 noteholders be aware, as I told one client this morning - you're in the driver's seat right now but you won't be forever. At some point, again the point is variable based on the moving dynamic, you're going to be in a high stakes game of "chicken." One that you better be willing to credibly take to completion - because there are plenty of ways this game reaches "completion" that isn't a go-private transaction. Still, reiterating, right now, you're in the driver's seat. Maximize the value of that position.
I think that this offer has to be good for the equity class. Not only does this tender offer reduce net dilution risk (I'm not sure that real dilution risk was all that high to begin with - what debtholders, outside of those looking for immediate liquidity are swapping for equity anyways?) it also gives insight into the hand that EXCO is trying to play. As detailed above, I think that the ultimate outcome here is one that should see the equity class being compensated in some fashion. With the equity recently pricing just over $1.00, that's not implying much recovery value (there is going to be zero recovery value for equity in any bankruptcy filing BUT there would be recovery value in a go-private transaction) or monetization potential.
Realistically, I think that EXCO's equity could be worth as high as $2.00 depending on the final makeup of the cap structure. EXCO's equity traded near $2.00 only months ago - prior to an ill-timed, allegedly mistaken press release being issued (which detailed that EXCO was considering "in-court" restructuring, something the company has stated that it is NOT).
While $2.00 might not seem that much higher than market pricing, it's still a nice return on an equity that I think we now realize isn't at any immediate-term risk of going to zero. Still, don't get carried away with capital allocation (this would be my suggestion) as EXCO does still have considerable execution risk in front of it. Be careful here, but for speculators, this might be an equity worth taking a serious look.
Good luck, everybody.
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.