When I came up with the idea for the title to this article, my concept was that although stocks in my Bottom of the Barrel Club ("BOTB") have had serious price declines over the past one-, three-, five- and 10-year periods on an overall basis, there is still an open question as to whether they are "low enough" yet. I would suggest that readers review my recent article, "E&P Mid-Year 2019 Recap: A Terrible, Horrible, No Good, Very Bad Anniversary", to revisit stock price performance of the BOTB, as well as the rest of the E&P sector, and to familiarize themselves with company financials and guidance for 2019 capex and production (the most important of the indicators that determine many other critical metrics).
To me, "limbo" is a dance similar to the one the guy in the photo below is performing. The idea is to keep upright (i.e., feet planted) while simultaneously maneuvering below some obstacle - in this case a flaming apparatus of some sort, which is moved down with each successive, successful trip below it. The dancer or dancers who can maneuver the lowest "win", if they survive the flames above that is!
[Note to theologians and religious scholar readers: No, I am not referring to "Limbo" as the space that is neither heaven nor hell.]
[Note 2: I am also not referring to "limbo" as some reference books define it, i.e., "a place or state of oblivion to which persons or things are regarded as being relegated when cast aside, forgotten, past, or out of date."]
OK, now that I see the above notes printed out, maybe there is a bit of a double meaning going on here, but it's the markets' fault, not mine!
This particular article, as well as the other articles on the Middle of the Road Club ("MOTR") and the Top Producers Club ("TOP"), will focus primarily on events or activities within the relevant group of companies, not operational figures or specific numbers. Those are being reported beginning this week and will be subject to post-mortem articles (sorry for the deathly reference again) after the end of earnings season in mid-August.
My article highlighted above can serve as a reference point to compare actual six-month results with original guidance issued by companies earlier in the year, and company presentations and/or articles by other authors on individual companies may contain more detailed information. This article is intended to reflect high-level activities at individual companies with the primary purpose of seeing whether or how they might impact the sector as a whole, or other group of companies that are similar in some respect.
Petroquest Energy. PQ actually declared bankruptcy on Nov. 6, 2018, with debt totaling roughly $375 million and proved reserves with an SEC10 value at year-end 2018 of $124 million. It is not too hard to see why they filed for bankruptcy (even though they were nearly "Free Cash Flow" during 2018! - a subject I will briefly address later).
In their restructuring, a pre-pack filing, all of the former equity interests (both common stock and preferred stock) were cancelled, and all of the creditors save the DIP provider (Wells Fargo? (NYSE:WFC)) received their pro rata share of (1) $80 million in 10% Senior Secured PIK Notes due 2024, and (2) 8.9 million shares of Common Stock (out of 9.2 million total, with 0.3 million shares going to the backstop parties for their Exit Facility). The Exit Facility of $50 million was provided by certain former note holders who are clients of MacKay, Shields and Corre Partners; as a result, Petroquest still has $130 million in debt after emergence, against $124 million in 2018 SEC10 value, with plans to drill to enhance value.
Major shareholders are MacKay, Shields (44%), Corre Partners (28%), and Hotchkis & Wiley (10%). Up to 2 million shares (20%!) may be issued under MIPs. Petroquest emerged from bankruptcy on Feb. 8, 2019. I have not found a current quote and assume there will be essentially no trading. No, I will not be following it again in the future - ever!
Gastar. Gastar actually declared bankruptcy on Oct. 31, 2018 with debt of roughly $380 million and preferred stock with a liquidation preference of $150 million, and reserves estimated at $286 million at Dec. 31, 2017... Upon emergence on Jan. 22, 2019, all common and preferred equity shares were cancelled for nominal consideration. New money loans of $100 million were provided, and a new $200 million credit agreement was used to repay previous debt. Funds managed by private equity (PE) firm Ares Capital Mgt., the holders of all of the previous debt, have converted that debt to equity and own 100% of the new equity, which is not expected to trade publicly. Gastar also had free cash flow, at least as some scholars define it.
On June 19, 2019, Gastar announced that it would be merging with Chisholm Oil & Gas, another STACK company, to create an operator with 20,000 boepd of production and 165,000 net acres, primarily in Kingfisher County, OK. Chisholm is a portfolio company of funds managed by PE firm Apollo Capital Mgt. No terms were disclosed.
Similar to Petroquest, no public trading is expected, and I will not be covering it anymore.
Jones Energy. Do not blink on this one! On April 14, 2019, Jones filed for bankruptcy, citing debt of approximately $1 billion and $100 million in preferred stock, and a proved SEC10 value of $570 million at Dec. 31, 2018. Jones reported a net loss for 2018 of $1.3 billion, impairing roughly $1 billion of undeveloped acreage and dropping its shareholders’ equity significantly negative. Jones kept its capex spending up right until the time it went over the cliff.
Jones effectively “primed” the rest of its capital structure by issuing $450 million in 1L Notes in Feb., 2018, using the proceeds to pay off its bank line and to fund 2018 capex. In the pre-pack bankruptcy, holders of the 1L received common stock equal to 96% of the total, and the remaining creditors received 4%. All other securities, both debt and equity, were cancelled, although a MIP of 5% is authorized.
Jones emerged on May 17, only 33 days after filing, and based on a $357 million plan value and $20 million in debt. It will also not trade publicly, and I will cease coverage of it.
Legacy Reserves, Inc. The (very) short version. Legacy filed bankruptcy on June 20, 2019, with roughly $1.35 billion in debt and proved reserves with a pre-tax PV10 value of roughly the same amount. Unlike the above companies, Legacy was in default on its debt at the time of filing, specifically with respect to payments due at maturity of its bank debt, which then triggered defaults on its 2L debt as well. The filing triggered the acceleration of all debt.
Although expected to be implemented as a pre-pack plan, Legacy has said it would likely not file a plan until Aug. 1 or thereabouts, subject to change. Under terms of the preliminary filings, common equity would be cancelled, and unsecured note holders would receive new common stock amounting to roughly $70 million pursuant to a rights offering (with their initial notes worth < 5% of their face amount). GSO Partners, the holders of Legacy’s 2L, would convert their position into the vast majority of the new common stock, as well as inject new money into the company to reduce the bank debt.
Legacy has not indicated if it plans to trade publicly after bankruptcy, but I would doubt it. There are really only a few major creditors, and they will likely run it privately until a better M&A market allows them to liquidate, sell or merge the company, IMO
Grizzly Energy. Grizzly Energy, formerly Vanguard Natural Resources, filed bankruptcy (for a second time) on Mar. 31, 2019, with debt of roughly $1 billion and an SEC10 value of roughly the same amount. The Grizzly deal is a fairly unusual restructuring in the E&P sector to date, in that the bank holders of the secured 1L/2L debt will end up with virtually of the reorganized company’s equity, something that I and others pointed out as a risk when it emerged from its first bankruptcy. It was simply too highly leveraged from the start (or restart), in large part because Fir Tree, a PE firm, wanted the leverage that the banks provided and would not agree to put in enough new equity to truly satisfy the banks’ needs.
This time around, the banks owning the 1L debt will end up with their pro rata share of a new Term Loan for $285 million + 86% of a new preferred stock class + 75% of the common stock. The holders of the 2L/Term Loan will receive the remaining preferred stock + 10% of the common stock, and the holders of senior unsecured notes will receive the remaining 15% of the common stock.
It appears to me as if the company will not be spending much in capex after fairly disastrous results the past couple of years, and will instead focus on paying down debt and/or liquidating. There will be no public trading, and also will be no further coverage here.
Elk Petroleum. Elk filed bankruptcy on May 23, 2019, with debts in the $200 million range. The only reason it is included here is that one of its subsidiaries, Resolute Aneth, was the company that purchased the Aneth Field in Utah from Resolute Energy and helped Resolute avoid its own financial distress - before selling out to Cimarex. A close shave for Resolute.
Arsenal Resources. Arsenal, an operator in West Virginia, filed for bankruptcy on Feb. 5, 2019, and emerged 10 days later. In the process, it equitized almost $900 million in debt owned by PE firm First Reserve, Stanford University and others into equity. This brief summary is included to show how quickly the bankruptcy courts can move cases along, as well as how quickly debt can be converted into equity, which then frees up the reorganized company to continue its business and possibly even expand capex, not simply wither and die as some readers might think.
In addition to the bankruptcy activity discussed above, the BOTB Club continues to see various restructuring actions attempted to deal with ongoing financial distress (often without much success). The “playbook” I have published before, most recently in my article, "E&P Bottom Of The Barrel Club Q4 Review: You Picked A Fine Time To Beat Me, Lucille," illustrates most or all of the actions that distressed companies typically have taken over the years - actions that are still appropriate today. The stock market deals with equity valuations pretty effectively, and often very cruelly, but debt valuations and maturities are much more difficult since they involve legal contract rights that entitle their owners to their money before equity receives anything. The major actions and the companies involved are discussed below:
Approach Resources. Approach (NASDAQ:AREX) is now in the grace period for its unsecured debt, which totals “only” $85 million, but which sits below another $325 million in secured bank debt. Cash flow in the first quarter was anemic, essentially $0, and while the company still sports an SEC10 value of $660 million on total reserves of 180 million boe, almost two-thirds of its reserves are undeveloped and will require another $1 billion in capex to convert to PDP. Its discount for timing of cash flows is almost 75% of future net cash flows, showing that not only are reserves undeveloped, but they would come online many years in the future and are very marginal to begin with. DeGolyer & McNaughton do their reserves, a very reputable firm, but I am curious how AREX could show $1 billion in capital being financed in the next five years (the SEC standard for including PUD reserves) with $0 cash flow and no availability under its credit instruments. I therefore expect a significant impairment sometime soon.
In the meantime, AREX has violated its bank debt covenants as of the first quarter, but has obtained waivers to negotiate some sort of arrangement with its stakeholders or others, with the waiver now scheduled to expire Aug. 21, 2019. Of its non-bank debt, roughly 70% is held by Wilks Bros., who also own roughly 50% of AREX’s common stock. I therefore expect a restructuring to likely involve them converting their debt to additional equity, at a minimum, although it may take a pre-pack bankruptcy filing to force other debt holders to also convert. Even then, the bank debt may still be too high, so it would also not be surprising to see new money needing to be injected into the company.
All of AREX’s senior management save the CFO have now been terminated, which will save the company substantial G&A, but not enough to materially impact cash flow available to pay debt. Like many of the other companies who negotiated waivers with their lenders and then negotiated extensions, as AREX has, I expect that the time delay is to facilitate a pre-pack filing, not some other out of court solution. Certainly, prices are not moving in favor of AREX right now, but even if they were, their debt is simply too high, and its equity market cap is only $26 million.
Chesapeake Energy. Chesapeake (NYSE:CHK) completed a debt swap of roughly $900 million in 8% senior notes due 2026 for various issues that were set to mature in 2021-2022, increasing the interest rate in return for the extension of the maturity date and payment at a slight premium to face value. While this is not a distressed debt exchange, because no new money was raised, I am including the swap in this Restructuring section, as in a restructuring of the debt side of their balance sheet. The swap extended roughly 60% of the face amount of the issues swapped ($1.6 billion), so reduced Chesapeake’s cash outlays in 2020-2021 by the $900 million, to roughly $700 million, by my reading. Chesapeake has been very active in managing its debt maturities, and by swapping at or above par, they remain in good graces with their creditors even with a total of $10.8 billion in long-term debt + working capital deficit to deal with going forward after the merger with WildHorse Resource Development (see below under the Mergers and Acquisitions section).
Contango Oil & Gas. Contango (NYSEMKT:MCF) is a small E&P company, made smaller by a rapid decline and impairment in its offshore Gulf of Mexico assets. It has been attempting to transition to the Delaware Basin, but has an $85 million debt facility that matures October 1, 2019, rendering it a current liability. Its first-quarter cash flow was essentially $0. Its banks have given no indication that they will extend the maturity, although they have indicated they are still negotiating with the company. Contango’s next borrowing base redetermination date is Aug. 1, 2019.
John Goff, a prominent real estate and energy investor, owns 20% of Contango’s common stock, and FMR (Fidelity) owns another 10%.
Denbury Resources. What a difference a few months makes! Last fall, Denbury (NYSE:DNR) was set to merge with Penn Virginia, a lower-leveraged company than it, and its stock was in the $4/share range. After oil prices fell and shareholder opposition to the deal arose, it was terminated early this year, and Denbury’s stock price dropped to $1.08 (while Penn Virginia’s stock price dropped from $85 to $33 today.
Denbury has $2.8 billion in long term debt + working capital deficit on its balance sheet (although its debt is overstated due to the accounting treatment of a prior distressed debt swap), and its proved reserves pre-tax PV10 value were $4.0 billion, with a significant portion of its production receiving Louisiana Sweet pricing that tracks closer to Brent than to WTI. Adjusted EBITDA in the first quarter was $138 million, or $550 million annualized; total debt/adj. EBITDA was therefore roughly 5:1, a measure that puts it in the distressed category.
Denbury recently completed another debt swap. Per the first-quarter 10-Q:
In the Exchange Offers, the Company accepted exchanges of a total of approximately $152.2 million aggregate principal amount of its 6⅜% Senior Subordinated Notes due 2021, $219.9 million aggregate principal amount of its 5½% Senior Subordinated Notes due 2022, $96.3 million aggregate principal amount of its 4⅝% Senior Subordinated Notes due 2023 and $425.4 million aggregate principal amount of its 7½% Senior Secured Second Lien Notes due 2024 (the “Old Second Lien Notes”) in exchange for a total of approximately $120.0 million of cash, $528.0 million aggregate principal amount of new 7¾% Senior Secured Second Lien Notes due 2024 (the “New Second Lien Notes”) and $245.5 million aggregate principal amount of new 6⅜% Convertible Senior Notes due 2024 (the “New Convertible Senior Notes”).
By my count that is roughly $900 million in debt due in 2021-2024 for a total of roughly the same amount in cash and new debt that is now a Senior Secured 2L Note due 2024. So, Denbury’s exchange gave existing creditors some cash now, in return for an extension of maturities for some creditors and secured debt status for all. I assume the swap will be discussed in more detail on their earnings call.
EP Energy. EP (OTCPK:EPEG) is a failed IPO that arose after certain PE firms took it private in a major acquisition involving its former parent, El Paso. EP currently has around $4.6 billion in debt and working capital deficit, with assets less than that. It has $182 million in debt that matures in May 2020, and is facing potential going-concern issues that could arise beginning with its year-end 2019 financial statements. Cash flow from operations for the first quarter, annualized, would total $288 million, woefully inadequate for a company with $4.6 billion in debt (16X cash flow). Like many of the other distressed companies, they indicate that management will be evaluating alternatives to address its debt prior to that maturity. EP shares were also delisted from the NYSE and trade on the Pink Sheets with an equity market cap of $45 million.
Halcon Resources. Halcon (OTCPK:HKRS) is another company that has declared bankruptcy once before. After selling its Bakken properties and seeking to become a Delaware Basin player by buying acreage there, it has accumulated $800 million in debt and working capital deficits, and in the process it has tripped several financial covenants in its bank debt that have been waived to this point. Its banks recently reduced Halcon’s borrowing base from $275 million to $225 million, and gave the company until Aug. 1 to come up with a restructuring plan or some sort. Halcon has hired advisors to assist them in evaluating strategic alternatives, usually legal code for a bankruptcy restructuring, but those advisors will also be considering asset sales and other measures to avoid another bankruptcy filing. The state of the markets now, particularly for leveraged companies with large undeveloped acreage positions, is currently very poor.
If no restructuring proposal is forthcoming that can satisfy creditors, HK will likely have no option but to file bankruptcy for a second time. Its common stock has been delisted by the NYSE and trades in the Pink Sheets with an equity market cap of $26 million. After pressure from stakeholders including Fir Tree and Ares, both PE firms, management changes have been made at HK, but the magnitude of the current debt augurs for a pre-pack bankruptcy filing shortly after the conclusion of their “strategic alternatives” process sometime in the third quarter.
Sanchez Energy. Sanchez (OTCPK:SNEC) has debt of roughly $2.6 billion, mezzanine equity of another $472 million and preferred stock with a relatively nominal value after conversion of most of it to common in the first quarter. Like Jones, Sanchez “primed” the capital structure by issuing $500 million in 2L debt in 2018. As of July 15, Sanchez entered a grace period with respect to one of its debt issues, and disclosed that it was negotiating with stakeholders on a comprehensive restructuring.
In the first quarter, annualized, Sanchez generated $220 million in cash flow per its financials. However, its financials are complicated by the consolidation of a JV with Blackstone/GSO that is not a Sanchez debt guarantor, so those assets are effectively outside of Sanchez and likely of little value as well. Sanchez’s interest only comes into effect in liquidation if GSO has earned a 14% IRR, which it has not done and will likely not do. Separating out reserves that are owned by Sanchez and are part of its collateral value vs. reserves that are effectively owned by GSO will make the discussions fairly complicated. And to add to the drama, GSO is suing Sanchez to remove it as operator of the JV.
Sanchez has been delisted by the NYSE and trades on the Pink Sheets with a market cap of $6 million, clearly an indication that creditors will end up owning a substantial position in Sanchez equity after a likely pre-pack bankruptcy filing.
Ultra Petroleum. Add Ultra (UPL) to the list of formerly bankrupt companies that exited their first bankruptcy with too much debt and are again in significant financial distress. Its most recent restructuring attempt, after getting its banks to agree to a Term Loan structure late last year in exchange for higher interest and a prepayment requirement, was a proposed debt swap of new 9% cash + 2.5% PIK Senior Secured Third Lien Notes due 2024 for up to $90 million of its existing 7.125% Senior Notes due 2025. There is $225 million in principal amount of the notes, and the exchange offer priced them at 47.5% of their face amount - a significant discount. That offer failed to attract enough participation and was terminated.
Ultra currently has $2.3 billion in long-term debt and working capital deficit, with an SEC10 value at year-end 2018 of roughly the same amount. Its primary debt maturities are not until 2024, but it has pretty steep interest rates similar to what was recently proposed (i.e. 9% cash + 2% PIK) that reduce cash available for reinvestment and/or debt repayment. The Term Loan requires quarterly principal payments of 0.25% of principal (1.0% per year, or roughly $10 million per year), plus mandatory prepayments if Ultra’s NAV coverage ratio falls below 2:1.
Ultra’s previous debt exchanges in 2018 resulted in a GAAP gain currently, improving shareholders’ equity, but then effectively reversing that gain as payments are made with the higher interest rates. This most recent exchange would likely have had the same result if it had not failed.
Ultra reported adjusted EBITDA in the first quarter of $115 million, or $460 million annualized, putting total debt/adj. EBITDA at 5:1 - very high in today’s price environment. It recently dropped a rig in its drilling program as well, so future guidance should be analyzed closely when the company reports. Some potentially good news arrived for Ultra in the form of a judgment in its former bankruptcy that may allow Ultra to recover approximately $400 million in “Make-Whole Premiums” paid in their bankruptcy. Of course, with its unsecured debt trading at roughly $10 and its 2L debt trading at $28, the market clearly thinks that creditors should be the primary beneficiaries of such a payment, if the decision is upheld on appeal.
Ultra’s equity market cap has fallen to $40 million, so with debt of $2.3 billion that equates to a debt/enterprise value of almost 60X, clearly unsustainable in the long term.
The capital markets have changed a great deal year to date in 2019, after a somewhat hopeful fourth quarter of 2018 that saw relative improvement. However, traditional capital markets remain largely closed to E&P companies, and the BOTB Club is certainly no exception. However, a few deals have been done so far this year.
California Resources. California Resources (NYSE:CRC) recently announced a JV with Colony Capital to develop locations in its Elk Hills Field core area, with Colony agreeing to invest $320 million to drill 275 wells ($1.16 million/well) over three years. Colony will put up all capital, in return for 90% of net cash flow prior to an undisclosed IRR (often 14%), with its interest reduced to 17.5% after such hurdle rate is reached. California Resources will receive 10% of net cash before the IRR hurdle rate is reached, and 82.5% thereafter. Colony also received warrants to purchase California Resources common shares at $40/share, a premium of 170% over today’s price.
Comstock Resources. Comstock (NYSE:CRK) registered its $850 million in 9.75% Senior Notes due 2026 that were privately issued in 2018. In addition, in connection with its acquisition of Covey Park (see below in the Mergers and Acquisitions section), Comstock issued 50 million shares of common stock and $175 million of new convertible preferred stock to Jerry Jones, its majority owner and control shareholder, for a total of $475 million. Comstock also assumed Covey Park’s $625 million in 7.5% senior notes and issued preferred equity for $210 million, plus cash and common stock as set forth below. Comstock’s new preferred stock is convertible at $4/share on or after July 16, 2020 and bears dividends at 10% per annum.
Midstates Petroleum. Midstates (MPO) conducted a tender offer for shares of its common stock, offering to pay $10/share for up to 5 million shares, when the stock was trading at approximately $8/share (i.e. a 25% premium). Almost 19 million shares (almost 75% of the total outstanding) were tendered, but only the 5 million were actually purchased, for a total of $50 million. I am not generally a fan of stock buybacks, especially for small E&Ps, but MPO was simply distributing cash proceeds from prior sales to its shareholders as a return of capital, in effect continuing a liquidation process it has been pursuing since it emerged from bankruptcy. See below for a discussion of Midstates’ current merger plan.
Riviera Resources. Like Midstates (which has an overlapping significant shareholder in PE firm Fir Tree), Riviera (OTCQX:RVRA) recently completed a tender offer for its shares, buying back 2.67 million shares at $15/share, for a total of $40 million. Over 60 million shares were tendered, almost 90% of those outstanding. The price of $15/share represented a premium of 20% to the price on the day it was announced. Also, like Midstates, Riviera was using proceeds from asset sales to fund returns of capital to shareholders (the former creditors of Linn Energy).
Riviera also entered into a Volumetric Production Payment (VPP), something that has not been used very much in the E&P sector since Chesapeake used them extensively in the 2000. With a VPP, Riviera effectively transferred a certain volume of reserves to back up the payment, rather than a set dollar figure. The amount of the VPP was $82 million, and transferred 23% of its helium reserves at an effective discount rate of 5.2%. The helium reserves (from the company’s Hugoton Basin assets) were given no collateral value by Riviera’s banks so are incremental cash to Riviera.
Roan Resources. Roan (NYSE:ROAN) entered into a $100 million term loan with certain of its existing stakeholders (again largely former creditors of Linn Energy) to tide them over pending a review of strategic alternatives, expressed as indications of interest in buying the company. That review is ongoing, and progress should be discussed in the upcoming earnings release and/or conference call. Roan has $750 million in long-term debt and working capital deficit, and an equity market cap of $176 million.
Mergers and Acquisitions
California Resources. California Resources sold $200 million, including $165 million in cash plus a drilling carried interest valued at $35 million, of interests in its Lost Hills Field. Proceeds were used to pay down its revolver.
Chesapeake Energy. Chesapeake made a big splash by agreeing to merge with WildHorse Resource Development, a company with operations in the Eagle Ford, Texas trend. Chesapeake agreed to pay either $3 in cash plus 5.336 shares or 5.989 Chesapeake shares for each WildHorse share. Total consideration was estimated at roughly $4 B, including assumption of debt and issuance of 717 million shares of stock at $3.72/share. By the time of closing, the stock price of Chesapeake had dropped to $2.84/share, so the total consideration became $2.4 billion. At today’s price of $1.65/share, the price received by WildHorse shareholders who have continued to own their shares throughout has therefore dropped by approximately 56%. The second quarter will be the first full quarter for the combined company.
Comstock Resources. Comstock has agreed to buy Covey Park Energy, a private portfolio company of PE firm Denham Capital, for $2.2 billion in cash and stock. The deal will make Comstock the largest operator in the Haynesville and Bossier shale plays in Louisiana and Texas, with almost 300,000 net acres there.
Jerry Jones will remain the largest shareholder of Comstock with 75% common stock ownership and a total investment of $1.1 billion, including the $47 million investment in common and preferred stock cited above. Covey Park shareholders will receive $700 million in cash, $210 million of the preferred shares described above, $625 million in debt assumption, unspecified bank debt and preferred equity payments and 28.8 million common shares, a 16% ownership, for the $2.2 billion total consideration. The deal closed July 10 so will not be included in second-quarter numbers, but should undoubtedly be addressed in second-quarter disclosures. In connection with the merger, Comstock also obtained a $1.5 billion (elected commitment amount) bank credit agreement going forward.
Harvest Oil & Gas. Harvest (OTCQX:HRST) sold assets in the San Juan basin for $43 million and sold 4.2 million shares of Magnolia Oil & Gas it held, for another $52 million.
Midstates Petroleum. In May, Midstates and Amplify Energy, both former bankrupt companies, agreed to merge. Under terms of the deal, presented as a “merger of equals,” Amplify shareholders will receive 0.933 shares of Midstates for each of their Amplify shares. At the time, that would have given the combined company a total EV of $720 million and an equity market cap of $430 million, with pro forma EBITDA of $240 million based on the fourth quarter of 2018, for a leverage ratio of 1.2:1.
On May 3, the day before the merger announcement, Midstates was trading at $12/share and Amplify at $6.95/share, creating an apparent “premium” to Amplify of around 60%. However, both companies have relatively illiquid stocks, and with an overall selloff in E&P equities also beginning, their share prices have declined to $4.75 and $4.48, respectively, a ratio of almost the 0.933 factor with no premium left and an overall market cap of approximately $200 million.
Montage Resources. Montage (NYSE:MR), formerly Eclipse Resources, merged with Blue Ridge Mountain Resources (a former bankrupt company then known as Magnum Hunter). Under terms of the deal, Blue Ridge shareholders received 4.4259 shares of Eclipse, which then undertook a 1:15 reverse split, making the consideration 0.29506 shares of post-split Eclipse, which was then also re-named Montage Resources.
Longtime readers know that I have advised extreme caution in going long stocks undergoing a reverse split; my experience is nearly universal that such splits result in continued selling, often back to where the stock sold before the reverse split. Unfortunately, that has been the case with Montage, which has declined since the split from $16 to $3.32 today, somewhat mirroring the declines seen in many other Appalachian producers like Range Resources (NYSE:RRC), Southwestern Energy (NYSE:SWN), Antero Resources (NYSE:AR), etc. Low debt, $340 million in liquidity, excellent technical expertise and what appear to be very attractive reserve, production and cash flow metrics have been insufficient to stanch the bleeding.
Northern Oil & Gas. Northern (NYSEMKT:NOG) continued its acquisitive strategy, buying Williston Basin assets from a subsidiary of Flywheel Energy, a portfolio company of PE firm Kayne Anderson, for $165 million in cash, $130 million in the form of a three-year 6% senior unsecured note due 2022, and 5.6 million shares of common stock. (Northern had 382 million shares outstanding prior to the acquisition.) A press release this week announced the closing of the transaction and a company statement that production and cash flow on the deal are running ahead of projections. Given Northern’s rapid growth, after restructuring its debt last year and then embarking on an ambitious use of common stock to fund acquisitions, an update is needed. Based on my past experience, the caution I would express is not about whether current production or cash flows are running “high” or “ahead,” but how future production and cash flow will be impacted. Recent wells in the shale plays have fairly high depletion rates, so high levels of future capex are necessary to keep rates from falling, and the overall growth metrics can be misleading if the dilution from stock issuances is not taken into account.
Riviera Resources. Riviera sold assets in the Hugoton Basin for $31 million and assets in the Arkoma Basin for $65 million, continuing its program of asset sales designed to return capital to shareholders over time (via liquidation).
W&T Offshore. W&T (NYSE:WTI) acquired natural gas properties and related infrastructure in and near Mobile Bay from Exxon for $200 million.
Accounting. Two more companies switched from Full Cost (FC) to Successful Efforts (SE) accounting this year, Chesapeake Energy and Grizzly Energy (Vanguard). As readers should know, I have longtime skepticism about SE accounting, which is supposed to be the more conservative treatment, when it comes to impairments. FC companies are forced to take asset impairments quickly when prices decline, at least relative to their SE counterparts.
FC companies’ ceiling tests are determined on a country basis, with all capex costs capitalized but then subjected to the test, which takes the present value of proved reserves, based on trailing 12-month pricing and cost information, held constant and discounted at 10%, and compares that present value with the book value of proved properties within a company’s PP&E account. If the book value exceeds the present value so calculated, an impairment is booked to bring the book value down to the PV10. From that point forward, no upward adjustments are made, but if prices do recover, FC companies will make up the difference over time because their DD&A rate will be lower due to the impairment.
SE companies’ impairment standard is far laxer. Instead of using discounted present values for comparison to book values, SE companies use undiscounted future net cash flows, which effectively means that as long as reserves will be able to produce enough cash flow over time to recover their book value, there is no impairment. Impairments are usually measured on a field-by-field basis or a well-by-well basis. Then, if it is determined that an impairment should be considered, management can use its own future price deck, along with non-proved reserves like probable and possible reserves, as well as any other factors they are able to justify to their auditors, to determine whether an impairment has actually occurred. If it has, the treatment then becomes the same as for full cost; write the book value down to the PV10 value.
E&P companies have quite a history of converting from FC to SE to avoid either a current or future impairment, one that dates back to the 1980s. Once a company switches to SE, it cannot switch back. As a result of cyclical price declines, the number of FC companies has steadily declined, and 2019 will mark another reduction. While arguments can be made about what the “real” value of a company’s proved reserves are worth, my experience is that FC usually tracks FMV more closely than SE - and that using SE often presents great risk to readers who rely on such accounting concepts as shareholders’ equity, etc., as evidence of financial health.
The net results of Chesapeake’s switch will be to increase its shareholders’ equity by approximately $1.5 B. Grizzly/Vanguard’s impact is nil currently, because its assets were recently valued in bankruptcy and therefore should be relatively current. In addition to these two companies, switches over the past couple of years include Sanchez, Devon (NYSE:DVN) and Apache (NYSE:APA), with Anadarko (NYSE:APC) a bit further removed. Also, because of mergers, Carrizo (NASDAQ:CRZO), Newfield and Resolute have or will have disappeared as users of FC.
The chart below is a subset of the data that was published in my most recent article, and details information only about BOTB members (including those designated as X-11, or companies who have declared bankruptcy). As I said there, I have not updated the data since it was disclosed earlier this year, and will be using second-quarter reports to compare and contrast actual vs. estimated figures. I would not expect any material changes, but it will be interesting to note changes in capex and production guidance in particular.
Top-performing companies just within this group are designated by highlighting them in green, while those at the bottom are highlighted in red (10 for each). Companies with red type are Permian players.
[Note: The easiest way to view the Table is to right click on it, then click on 'Open Image in New Tab,' then zoom in to your desired magnification]
Attached is a picture of current bond pricing for members of the BOTB as well as a few other E&P companies. Obviously, with the financial distress discussed in this article, it is not surprising to see low prices for many companies’ bonds, and with “junk bonds” usually defined as those with YTM of 10% above applicable Treasuries, I would suggest looking at the companies with bond prices > 10% as those the market considers as the highest risk issues. Only the nearest maturity for each company is contained in the picture.
There are no specific recommendations made in this article, nor are there any particular conclusions I expect readers to make. The data is submitted prior to the release of second-quarter reports so that readers can draw their own conclusions and make their own comparisons between these companies, but there are many more companies for which data was presented in my most recent article, from which to draw items of interest for further research and analysis.
This quarter is setting up as another weak earnings season for E&P producers, and if results reported to date are any indication, continued selling may well occur after earnings releases and updated guidance. The key is to know what companies might be of interest in certain circumstances, and then be ready to act if/when those circumstances arise. For example, when stocks are this oversold, it is not uncommon to see sharp rallies in the short-term that attract traders; we have witnessed that several times since 2016. However, those rallies have been relatively short-lived, which continues to auger more for a trading approach than for a long-term investment approach.
Good luck to all, and may you maneuver beneath the fire and come out unscathed, just as our limbo dancer did at the beginning of this article!
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.
Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.