Pay $22 For $25 Worth Of Bonds - As A Bonus, Get Warrants For Free

| About: Dynegy Inc. (DYN)

Summary

Struggling Dynegy subsidiary Illinois Power Holdings has been negotiating with bondholders and just filed a prepackaged bankruptcy.

$825M of bonds are impacted.

Subsidiary is ringfenced from the rest of the company.

Bondholders receive bonds tied directly to Dynegy, as well as cash and Dynegy warrants.

Value of cash and exchanged bonds is greater than current price of the existing bonds.

In 2013, Dynegy (NYSE: DYN) acquired Ameren's (NYSE: AEE) Illinois competitive generating assets (IPH). These power plants were struggling, and AEE essentially gave them to DYN on the condition that the $825M worth of debt associated with the plants came along as well. DYN took pains to ringfence these assets from the rest of the company so that if the struggles continued, Dynegy's other assets wouldn't be impacted.

The situation at these plants has not improved much in the three years since they were acquired, and in 2016, DYN entered negotiations with creditors to find a way to ease the debt load on these assets. In October, an agreement was reached. This proposed to give IPH bondholders cash, bonds, and warrants as shown in the table below:

EXHIBIT 1

(Source: page i of IPH Disclosure Statement)

Dynegy tried to complete the restructuring process with a less costly exchange offer, but they weren't able to get the required 97% participation level to complete the deal. Approximately, 20% of these bonds were held by retail investors, which likely led to an inadequate participation rate. After the exchange offer failed, Dynegy filed a prepackaged bankruptcy plan with identical terms for bondholders. (See more about the bankruptcy filing here.) The hurdle to complete the exchange offer was higher than the more expensive prepackaged bankruptcy, so the outlook for completing this deal is still very good.

Exchange details

The newly-issued bonds will mature in seven years and be equal in standing to the rest of Dynegy's existing debt. $210M of these bonds will be issued. The coupon of these new bonds will be based on the volume-weighted average yield (VWAY) of Dynegy's existing 2023 and 2024 bonds at the completion of the deal. Based on the way these bonds are currently trading, the new coupon should be close to 9%. Exhibit 2 shows the yield to maturity of these two bonds over the last year.

EXHIBIT 2

(Source: FactSet)

Since the coupon for the new bond will not be determined until the restructuring is complete, investors have some interest rate protection for the next few months against the risk that yields may continue to rise.

There is already $1.75B of debt outstanding between the two existing DYN bonds ($500M in 2023 and $1.25B in 2024). Adding $210M of new debt shouldn't over-saturate the market, so investors shouldn't be too worried about the debt crashing in price as soon as it is issued.

Based on current bond prices and the cash they will receive after the deal is completed, buyers of the bonds today are essentially being paid to take the new bonds as shown in Exhibit 3.

EXHIBIT 3

(Source: FactSet and company documents)

Exhibit 4 shows how these three IPH bonds have traded over the last year.

EXHIBIT 4

Of course, investors aren't just receiving new bonds and cash. Every $100 of bonds receives 1.21 warrants. The warrants will expire 7 years after issuance, and have an exercise price of $35/share. 10M warrants will be issued altogether.

As shown in Exhibit 5, Dynegy's stock price has been near or above $35 a number of times over the last three years. And even this past year, after a substantial drop, the stock went back over $21/share. So there is reason to hope that an improvement in power markets would get these warrants in the money.

EXHIBIT 5

(Source: FactSet)

Eligible and Non-Eligible Holders

One nuance about the deal is that only accredited investors and qualified institutional buyers will be allowed to own the new bonds and warrants. However, Non-Eligible holders can still take advantage of this situation. According to the plan, Non-Eligible holders will just be paid the cash value of the new securities. Dynegy has estimated that the value of the 10M warrants they plan to issue is $15M, or $1.50 for each warrant.

Conclusion

These bonds are looking extremely attractive right now. At current prices, buyers of the existing bonds are essentially being paid to receive the replacement bonds. In addition, you receive warrants that give you a free option on improvement in the power industry. For those wanting to dig into the details of this deal, I highly recommend reading the disclosure statement that came out with the plan. (See here.)

Disclosure: I am/we are long DYN AND THE IPH DEBT.

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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