Some Interesting Issues Facing Current Bankruptcy Cases

Summary

• Fight over the value of the new equity to be received by debt holders of EXCO Resources.
• Westmoreland Coal shares are still trading despite having the reorganization plan confirmed by the court weeks ago.
• Vanguard Natural Resources files for bankruptcy a second time.
• Babcock & Wilcox is trying to raise cash via a rights offering to avoid bankruptcy.

There are many Ch.11 bankruptcy cases of publicly-traded companies that are not followed by the media, including Seeking Alpha. Often court rulings and issues from these cases have an indirect impact on other bankruptcy cases and traders need to be aware of this information in making investments in bankrupt companies. This article gives a brief overview of a few issues in some current or potential bankruptcy cases.

EXCO Resources - Fight Over Equity Valuation

EXCO Resources (OTCPK:XCOOQ), which has been in bankruptcy since January 2018, was hoping to exit bankruptcy last December, but because of lower energy prices, they were only able to get about an 80% commitment for exit financing and decided to wait until 2019. Since then, there has been a lot of litigation involving various insiders and hedge funds. The major current problem is the valuation of equity being paid to 1.5 lien and 1.75 lien claim holders under the reorganization plan. (Use docket 1907 for the red-lined filing).

Oaktree Capital Management, which owns 13% of the 1.5 lien notes, is asserting (docket 1883) that Fairfax and Bluescape Resources have established a too high of value for the new equity in order to give fewer new shares to Oaktree and other minor holders of 1.5 lien notes under the reorganization plan and thus are able to give more new shares to the lower priority class of 1.75 lien term loans. Collectively, Fairfax and Bluescape own about 75% of 1.5 lien notes and more than 75% of 1.75 lien term loan. While Fairfax and Bluescape will get few shares for their 1.5 lien claim, they will more than make up for this lower amount by the greater amount they will receive for their 1.75 lien claim. The court has ruled that this issue can be contested at the confirmation hearing that is currently set for June 10.

This is a rather unusual case. Usually, a lower priority class asserts that a higher class is undervaluing the new shares so that the higher class gets more shares to satisfy their claim.

Some investors trading the XCOOQ shares may have been confused by a "Secured Lender Settlement" approved by the court on April 23 because the shares soared to $0.48. Earlier this year, the shares were under $0.02. Under the plan, the shares are in class 11 and according to the plan:

On the Effective Date, existing Interests in EXCO shall be deemed canceled, discharged, released, and extinguished, and there shall be no distribution to Holders of Interests in EXCO on account of such Interests.

Westmoreland Coal-Two Interesting Events

The Ch.11 bankruptcy cases of Westmoreland Coal Company (OTCPK:WLBAQ) and Westmoreland Resource Partners (OTCPK:WMLPQ) are not being jointly administered and have had some very unusual developments. The effective date for Westmoreland Coal's reorganization plan (docket 1556) was March 15, but the stock still trades. Under their plan, the stock will stop trading and be cancelled on "Post-Closing Reconciliation Date", which will be after Westmoreland Resource Partners sells all their assets and has their plan declared effective. So, the stock is still trading as just a "shell" company with no assets - 1lien holders got all the assets using credit bidding. (Shareholders did not get any recovery.) It could, however, be a very long time before Westmoreland Resource Partners exits bankruptcy because it was recently announced the buyer of their Kemmerer coal mine has backed out of the deal due to some complex issues regarding getting proper bonding for mine reclamation liabilities.

In an unusual move earlier this year, WLBAQ and WMLPQ had a tender offer (SEC filing) to buy back WMLPQ units from investors at $0.01 per unit. This was done so investors who tendered their units would not get stuck with large cancellation of debt income-CODI. Westmoreland Resources Partners is a partnership which means "debt income" from cancellation of debt flows to holders of the units on plan's effective date. Many investors, however, did not participate in the offer and could end up with a very large tax liability. The K-1 form in box 20 next year will show their own specific CODI liability.

Vanguard Natural Resources Bankruptcy - A Case Study

Vanguard Natural Resources (OTCPK:VNRRQ) is back in Ch.11 bankruptcy again - just 20 months after exiting bankruptcy. The new Vanguard had too much debt, especially considering their assets are only medium quality and management is inept. The company had $936 million in debt and only $17 million in cash ($137 million total liquidity) upon emergence from Ch.11 on August 1, 2017. The new equity capitalization was only about $400 million.

In my opinion, whoever created their 2017 reorganization plan (docket 1096) was inept and incompetent. While the plan reduced debt by $820 million, it should have reduced debt even further. The $936 million in debt was about 71% of their estimated mid-point enterprise value. Vanguard is in a high-risk commodity business that depends upon prices and drilling/exploration success.

The plan equity value of $20 per share was unrealistic based in part on unrealistic annual projections for revenue, EBITDA, and interest expense. (The financial projections can be found in disclosure statement docket 892, Exhibit H, page 4). The 2018 revenue was projected to be $489 million ($460 million actual), EBITDA $253 million (actual $197 million), interest expense $48 million (actual $63 million), and EBITDA interest coverage 5.3x (actual 3.1x). (Note: the "adjusted EBITDA" in the recent 10-K was $137 million for 2018, but it was determined using a different method than used in the disclosure statement, which is the method I used.) While the 2018 results were below estimate, the current going forward expectations are for even wider divergence for future years.

Under the 2017 plan, senior noteholders received 97% of the new stock, which was extremely diluted by various factors and were allowed to participate in a rights offering to purchase new shares at a 25% discount (for accredited investors only). Over $300 million of the approximately $400 million new equity valuation was via the rights offer that raised $225.7 million cash to pay down 1lien debt. Another $19.25 million was raised from 2lien holders who received almost $27 million in new equity for this cash. (2lien holders also received new notes.) Because of these and other dilution factors, senior noteholders were expected to only receive 12.5% recovery on their $443.7 million claim. General unsecured claim holders and preferred stockholders received very modest recoveries. Vanguard shareholders received 3 ½ year warrants to purchase new stock at $61.45 per share.

On multiple occasions, (June 2018) and (December 2017), holders of over 17 million shares of the new stock tried to sell, but they still held these soon to be worthless shares when Vanguard filed a second time for bankruptcy on March 31, 2019.

Despite selling a number of assets over the last year to pay down debt, Vanguard filed for bankruptcy on March 31, 2019. They entered Ch.11 with $929.5 million in debt compared to an estimated PV10 of only $884 million. (4/8/19 date of estimate) A reorganization plan (docket 230) and disclosure statement (docket 231) have already been filed. The disclosure statement did not include financial projections, but it will be interesting to see how realistic the figures are this time compared to the 2017 document when they file the amended statement prior to the disclosure statement hearing.

The revolving credit facility claim holders are getting a new term loan, convertible preferred stock, and 75-89% of the new equity. Term loan claim holders are getting 10% of the new equity and preferred stock. Senior claim holders are getting 15% of the new equity if the class votes accept the plan, but only 1% if they vote to reject the plan. Shareholders are getting nothing. So the investors who paid about $226 million for new stock in 2017 via the rights offer are getting $0.00 for those shares.

Releases are part of the plan. If a shareholder, who is not being paid for releases, does not file a formal objection with the court, the shareholder will be deemed to consent to those releases. This means if you do not file an objection you can't bring litigation against insiders in the future.

A number of lessons for investors from this Vanguard case: 1) Just because one can buy stock via a rights offer at a steep discount does not necessarily make it a prudent investment. 2) Question if financial projections are used to estimate enterprise values/plan equity values or are the financial projections "manipulated" to justify an already predetermined plan equity value. 3) Do not assume that if some high profile hedge funds participate in a rights offer that they must have done their due diligence thoroughly, which, therefore, makes participation a rational investment. 4) Investing in highly leveraged commodity companies is often a mistake.

(Note: there are two different dockets at Prime Clerk for the two different bankruptcy cases.)

Babcock & Wilcox Trying To Avoid Bankruptcy

Often investors wonder why companies don't try to raise new equity instead of filing for Ch.11 bankruptcy. There is a company that is trying that approach. Babcock & Wilcox Enterprises (BW) is trying to raise $50 million via a stock rights offer to purchase new shares at $0.30 per share and is also trying to equitize $37.1 million term loans via a 123.7 million shares for debt exchange offer. The $50 million is expected to be used to partially pay down $150 million Tranche A-3 debt that has an interest rate of 15.5%. (SEC filing)

Since the rights are non-transferable I would expect a large number of shares could be purchased under the backstop agreement with P. Riley, one of the current largest shareholders. This raise could cause a "change in control", which opens up the potential for a number of issues such as limitations on using NOLs.

Assuming events go as planned, the number of shares will increase from 168,867,532 to about 476 million, including shares from the backstop fee. They are also trying to get stockholder approval for a reverse stock split to maintain NYSE listing. The board will decide from a range of 1 to 5-50.

BW had a rights offer in March/April 2018. The terms were amended from the right to buy 1.4 shares at $3.00 for each share to 2.8 shares at $2.00. They raised $248.4 million and used the cash to payoff a 2lien line of credit. Those 124.3 million shares purchased at $2.00 are now trading at just $0.47.

On the surface, this is an interesting case about avoiding bankruptcy, but looking at their operations and finances, it may only be a delaying tactic for a bankruptcy filing in the future. Vince Martin wrote a Seeking Alpha article recently that presented a strong case for a bankruptcy filing. While the company is not in bankruptcy, I wanted to include them in this article on companies who are going through the Ch.11 process.

Here are some of problems facing investors trying to trade BW: 1) Watch out for the announcement of dates, such as the record date for rights and the date for shareholder meeting. (There are a number of issues related to this deal that require shareholder approval.) 2) The stock could drop if it is trading above the rights purchase price of $0.30 on the ex-date. The price could drop even more when those receiving the new shares try sell. (I did not see any statements of the new shares being "restricted".) 3) Investors holding shares at brokerage firms, be aware of the various deadline dates set by the broker-they are often different than those mentioned in various SEC filings. 4) The entire deal may fall apart and the company then would most likely file for bankruptcy.

Conclusion

Judges follow other bankruptcy cases in making their decisions and so should investors. Sometimes, however, investors overreact, such as when an official equity committee is appointed in another bankruptcy case and shares of other bankrupt companies soar on the news. Following and reading docket filings in other cases is a great way to keep informed, but also doing internet searches entering "Ch.11 bankruptcy news" and using short time periods, is an easy way to keep up with the news. Of course, reading news on Seeking Alpha is important as well.

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.