Pacific Drilling: New Important Information On Restructuring Revealed

About: Pacific Drilling S.A. (PACDQ), Includes: SDRL
by: Vladimir Zernov

Pacific Drilling shares information on the ongoing negotiations with creditors.

The positions of the negotiating parties are very far away.

Creditors have actually decreased the stake they offer to common shareholders.

It's been quite some time since we last heard news on Pacific Drilling's (OTCPK: OTCPK:PACDQ) restructuring. However, now the time has come as the company has released very important information regarding the ongoing negotiations with its creditors.

Here's what the company revealed. Currently, negotiations between Pacific Drilling and its lenders continue. The company submitted a new proposal to creditors on Jan. 16, which was met with a counterproposal from creditors on Jan. 30. We will now look at both proposals and see that Pacific Drilling and its creditors are still very far from common ground.

Here's what Pacific Drilling offered to the creditors:

  1. Extend the maturity of the revolving credit facility ($475 million) from 2018 to 2023.
  2. Extend the maturity of the senior secured credit facility ($660.8 million) from 2019 to 2024.
  3. Equitize all the Indebtedness: $719.1 million of Term Loan B, $750 million of 2020 senior secured notes and $438.9 million of 2017 senior secured notes. Holders of this debt will get pro-rata share 61% of equity, subject to dilution from MIP (management incentive plan, as I understand this abbreviation) and will get the right to invest up to $100 million in the equity rights offering on a pro-rata basis.
  4. Current equity holders will get pro-rata share of 6% of equity, subject to dilution from the equity rights offering, management incentive plan, warrants and contingent value rights. Existing shareholders will have the right to invest up to $100 million in the equity rights offering on a pro-rata basis. They will also get seven-year warrants for 15% of fully diluted equity. The contingent value rights are based on the successful arbitration/settlement of the Zonda dispute (Zonda was a drillship ordered by Pacific Drilling. The company cancelled construction due to shipyard's failure to timely deliver the vessel and is seeking to get $202.5 million, which is described as "other receivable" on the most recent balance sheet published in the monthly report (docket 187)).
  5. New capital providers under the equity rights offering will provide $200 million and receive a pro-rata portion of 31% of equity, subject to dilution from MIP, warrants and contingent value rights. The equity rights offering will be fully backstopped by Quantum Pacific, Pacific Drilling's main shareholder. Quantum Pacific will receive a backstop fee of 2% of equity, a consulting fee of 1% of equity, and a structuring fee of 1% of equity.

The offer is clearly a trick from Hemen/Centerbridge playbook used in Seadrill (SDRL) restructuring (read the latest news on Seadrill's restructuring here). Quantum Pacific's position in Pacific Drilling is worth almost nothing now, so it wants to reinstate the position by providing new capital at rock-bottom prices. Effectively, Quantum Pacific's offer values post-restructuring Pacific Drilling equity at $645 million. However, I should note that the capital provider always wants to acquire equity at a significant discount. The offer is putting Quantum Pacific way ahead of the company's creditors. That is quite the opposite from the absolute priority rule used in bankruptcy, which dictates that company's shareholders get any compensation only after the creditors' claims have been fulfilled. I cannot imagine creditors agreeing to such an offer.

Here is the creditors counter-proposal:

  1. Extend the maturity of the revolving credit facility ($475 million) from 2018 to 2023.
  2. Extend the maturity of the senior secured credit facility ($660.8 million) from 2019 to 2024.
  3. Equitization of 2017 senior secured notes, Term Loan B and 2020 senior secured notes.
  4. Existing shareholders get 2.5% of post-restructuring equity subject to dilution from warrants and MIP. They also get warrants for a 10% ownership in the reorganized company on a fully diluted basis. The warrants' strike price reflects recovery of ad hoc group of creditors of par plus accrued unpaid interest. The warrants will have no change of control protection (this detail hints that creditors may be willing to sell Pacific Drilling to the highest bidder as soon as practically possible).

The creditors' group proposal is more straightforward. In essence, they want to own the company, leaving a 2.5% stake for current shareholders as a small gesture for coming to common terms without the help of the bankruptcy judge. The proposal does not call for raising new capital, and there's a good reason for this: With the extension of credit facility maturities and the equitization of other debt, Pacific Drilling does not need new money.

Also, if the company is right in reflecting a $202.5 million claim on Zonda on its balance sheet, the actual amount of cash at its disposal will increase to roughly $500 million. It is obvious that Quantum Pacific's desire to raise money via an equity offer is purely dictated by its attempt to mitigate the damage to its stake in the company, rather than by any business needs.

This will be a very lengthy battle. The positions of creditors and Quantum Pacific are very far away from each other. In my earlier article on the topic, I estimated that an agreement between Quantum Pacific could lead to a 3%-5% recovery to the common equity. It looks as if creditors are set to offer just 2.5%. In fact, they have actually decreased their proposal from the 2.75% offered back on Oct. 16. As it turns out, Quantum Pacific's stubborn position does not lead to actual improvements during the negotiations. Also, a real risk exists that negotiations will fail completely and shareholders get nothing due to the absolute priority bankruptcy rule, as there's no way creditors will be compensated in full in the current market conditions. From a practical point of view, Pacific Drilling shares are not worth the gamble at the current levels.

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