Obsidian Energy: In A Precarious State

Summary

• Obsidian is attempting to get the revolving period of its credit facility extended, which requires a couple conditions to be met first.
• It was not able to achieve those conditions by the first deadline and was granted an extension until March 13.
• A further extension seems unlikely due to the reluctance of the credit facility lenders to take on the March 16 senior note maturity.
• If negotiations fail, Obsidian will not be able to draw further on its credit facility and the balance will become due in April 2021.
• Obsidian's common shares have questionable value in the current market environment due to low commodity prices and the credit facility issues.
• This idea was discussed in more depth with members of my private investing community, Distressed Value Investing. Get started today »

Obsidian Energy (NYSE:OBE) is attempting to get the revolving period of its credit facility extended, but is facing significant challenges in doing so. The credit facility lenders are willing to extend the revolving period, but only if Obsidian gets a rent reduction and the credit facility doesn't take on the additional risk from Obsidian's near-term senior note maturities.

Negotiations are ongoing to extend the senior note maturities, although the first deadline already passed and the March 16 note maturity means another extension beyond that date is unlikely.

If the credit facility revolving period extension falls through, Obsidian may not need to restructure immediately, but will face an April 2021 repayment deadline for its large credit facility balance and won't be able to draw further on its credit facility in the meantime.

Obsidian's common shares are of questionable value in the current market environment, as shown by its considerable credit facility issues.

Credit Facility Situation

Obsidian's credit facility revolving period was previously set to expire on February 28, but it announced on February 27 that it reached an agreement to extend the revolving period to May 2021 and the term period to November 2021 if certain conditions are met.

These conditions include Obsidian reducing the net rent payable for its office lease to $10 million CAD per year and getting the maturity dates of its March 16, May 29 and December 2, 2020 Senior Notes extended until at least November 30, 2021. If those conditions aren't met, then the revolving period was scheduled to end on March 4, but it got an extension until March 13 now.

The rent reduction appears to be the easier of the conditions to meet. With downtown Calgary office vacancy rates still above 20%, it would make sense for the landlord to have a tenant paying a reduced rate rather than have it sit empty for a while.

The extension of the senior note maturities until November 2021 appears to be a more challenging discussion given that the original deadline has passed with no agreement. If no agreement is reached by March 13, there probably won't be any further extension granted by the credit facility lenders given that there is a $10 million USD senior note maturity on March 16. The credit facility lenders don't appear to be willing to let Obsidian pay for the senior notes with the credit facility.

If no agreement is reached in time, Obsidian's credit facility revolving period will expire on March 13 and it won't be able to draw further on the facility. This won't necessarily mean that Obsidian will restructure immediately. The credit facility balance doesn't become due until April 2021 and Obsidian can probably manage the 2020 senior note maturities through working capital and positive cash flow. It may halt second half 2020 development activities in order to generate enough cash flow for the maturities though.

2020 Outlook With No Second Half Development

If Obsidian halts development in 2H 2020, it may average around 25,000 BOEPD for the full year.

At current strip prices (including roughly $43 USD Edmonton Mixed Sweet oil), Obsidian would be expected to generate around $238 million USD in revenues after hedges.

Obsidian has a decent amount of oil hedges for Q1 2020, but its hedges start tailing off after that.

Source: Obsidian Energy

Type	Units	$ USD/Unit	$ Million USD
Light Oil And NGLs [BBLS]	4,653,750	$38.00	$177
Heavy Oil [BBLS]	1,423,500	$19.00	$27
Natural Gas [MCF]	18,286,500	$1.40	$26
Hedge Value			$8
Total Revenue			$238

Click to enlarge

Obsidian would then be expected to generate around $85 million USD EBITDAX after hedges. This would probably allow it to deliver close to $30 million USD in positive cash flow assuming that there is no second half development activity. This would cover its $27 million USD in senior note maturities and keep its credit facility borrowings constant.

	$ Million USD
Revenue	$238
Less: Operating Expense	$99
Less: Transportation	$20
Less: Royalties	$19
Less: Cash G&A	$15
EBITDAX	$85

Click to enlarge

Valuation

The current market environment is not promising for the value of Obsidian's common shares. The credit facility lenders are not interested in having the senior notes be repaid via the credit facility. The outcome of the negotiations to extend the senior note maturities is uncertain. Whatever price Obsidian could get for its properties now is likely less than it was a few months ago, given that commodity prices have fallen and its credit facility situation looks tenous.

Obsidian's debt in the above scenario would end 2020 at around 3.7x hedged EBITDAX or 4.0x unhedged EBITDAX at current strip prices, which is a level at which there may not be any value left over for Obsidian's common shares.

Obsidian's credit facility lenders aren't interested in taking on more risk (by taking on the senior notes), but they also aren't interested in forcing a liquidation in the current market environment (hence the April 2021 repayment extension even if the revolving period is not extended). Thus Obsidian's common shares could benefit if the oil pricing environment improves by next year.

Conclusion

Obsidian is a company that largely serves its creditors now, with its credit facility revolving period extension dependent on negotiations with other creditors. It may not end up restructuring in 2020, but will be a debt zombie even if it gets a revolving period extension until next year.

This situation is a negative for Obsidian's common shares, as the challenges in getting its revolving period extended points to Obsidian's precarious situation. The hope for the common shares is that Obsidian can linger around for a while and then have oil prices rebound before its debt matures in 2021.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.

Analyst’s Disclosure: I am/we are short OBE. 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.

Comments

[lovetolearn]

So Elephant what say you about this?

www.obsidianenergy.com/...

[Effen]

MAR 15, 2020
Obsidian Energy Announces New Senior Note Maturity Dates, Amendments to our Financial Covenants and Agreement with Landlord on Renewed Lease Terms

[Empirical Wonder]

Seems to me, liquidity will get them through the next year, and a year could easily see an end to the price war and renewal of demand. However, it OBE will need both. Should provide lots of volatility meantime.

[Joe689]

They did it

[Hendrick3]

Great news and in true OBE style, this announcement comes out on a very negative day for oil and the markets. They are priced for bankruptcy right now at a$25 million market cap and yet have the terms they need to be quite viable in the future. This was clearly a vote of confidence from their creditors.

[mikego_34]

Sounds like verbal agreements thus far; still need contracts signed.

[hector.padillamejia]

Are these mf at least going to announce a release of last qr. earnings or something ?

[divconsulting]

Alberta government should give temporary relief to producers on decomissioning liability. E&Ps are not going to survive at this price.

[john18]

Hope this is temporary.

[Hendrick3]

Obe may get support from the banks for up to $540m if they can meet the conditions and $450million is already committed until April 1, 2021. Yet shareholder support is at about $30m Canadian which is the current market cap. It just seems that the banks are more comfortable getting their money than the shareholders whose value is 1/15th to 1/18th as large. I wonder if the banks would have called the debt if they were reviewing it today.

[Elephant Analytics]

The $450 million is technically not already committed until April 2021. If they don't meet the conditions, OBE won't be able to draw on the facility anymore, so it would essentially become $399 million in borrowings (at last report) due in April 2021.

The banks are in a priority position ahead of the shareholders, so the relatively small market cap isn't that relevant.

For example, if the banks thought that OBE was worth $475 million in total, that would be enough to cover the secured debt and the banks would be okay. That would not be enough to cover the secured debt plus OBE's working capital deficit, so if its assets were all sold for that amount, shareholders would get zero.

[Hendrick3]

Yes I know how bankruptcy works but a couple of problems with your thesis. They have spent money on a capital plan so I doubt they are at $399, probably higher. Secondly the environmental liability takes precedence for old wells which means the banks are behind the government and the government doesn’t take the liability at the end of life value, they take the wells times the reclamation cost per well off the top.

I worked on a number of bankruptcies in the mid 80’s and I can assure you the banks are already on the hook for the existing debt and they have no interest in running this company. They will be working very hard with the company to find a way through this. Secondly the landlord is probably going to do the deal because they lose everything in a receivership. The note holders are probably the wild card but again they are on the hook for the existing debt. Why put the government at the top of the receiver’s list when flexibility can be provided for the short term until the insanity stops. There would be no winners in receivership. Keep in mind this is only the third day of below $40 oil prices.

[divconsulting]

Hendrick, I think you are right over there. Environmental liabilities take priority in Bankruptcy. So, anyways banks are not going realize their money for another 1-1.5 years if they don't extend the debt.

On the other hand, Obsidian can reduce $20MM capital allocated towards decommission expenditures out of $120MM total capital spending. Also, based on their presentation, the 2020 H2 capital spending is not yet decided. They would reduce it drastically.

[divconsulting]

Blood bath tomorrow. However, we are so much down. Nothing much left anyway.

[kaplanassetmgt]

The company could reduce CAPEX to fracked and no new wells. The extra cash flow should be used to reduce debt. A few million dollars can be used to buy back a lot of shares. Reduce the Board size and reduce the fees. The company should maybe reduce salaries by say 5% while oil prices are down here. Certain Board members thought our bloc was crazy when we screamed that some CAPEX funds should be used to reduce debt. Now it shows that our bloc was right. Debt reduction is #1. It always has been. Being short is nuts. There is but 41¢ on the down side and a heck of a lot more than 41¢ on the upside.

[batman10023]

lol, kaplan talking share buybacks as we are on our knees begging for extensions.

[vxmike]

With the outlook for oil almost all producers with debt outside the majors are at risk for insolvency. The question then becomes do the banks even take action? I’m guessing they don’t want to own the entire North American oil industry.

OBE ought to cut capex to ZERO in light of the virus and plummeting oil prices. Get the office lease fixed and use 100% of cash flow to pay down debt. Don’t drill until WTI is solidly over $55 again.

[Hendrick3]

No doubt low oil prices are not helping however the sudden drop in oil may incent the landlord to drop the lease rate. The landlord gets no future rent in financial distress conditions but can keep a viable rent stream if Obsidian keeps going. Obsidian is also worth a lot less in bankruptcy to the banks. They had cash flow of $150 million in 2019 and have some good hedges. The market cap is around $40 million so relative to others they are already at liquidation prices. Keep in mind the banks have extended the base debt which is $450 million. It’s the revolver that may be called which is about $100 million. If the banks wanted their money back they wouldn’t have made any of the extension.

Elephant is effectively short the stock so recognize he is painting as dismal a picture as possible.

[divconsulting]

Shale revolution is suffering. All the US energy companies are down big time.

[Elephant Analytics]

I would say that the reality is pretty dismal right now. OBE is hedged on close to 50% of its March oil production, but this drops to below 30% for April production.

Operating cash flow probably drops below $100 million CAD at strip for 2020, despite those hedges.

OBE's in a tough spot with near-term debt maturities, supply potentially increasing due to OPEC/Russia disagreements and demand dropping due to the Coronavirus.

Companies with less debt and no near-term debt maturities should be fine as the market eventually rebalances itself. The confluence of events is pretty close to being a worst case scenario for OBE though.

You were comfortable about their credit facility extension situation before, but now the lenders have given OBE an ultimatum that the secured notes need to be extended (plus the rent reduction), otherwise OBE won't be able to draw on its facility after next week.

[Hendrick3]

Here is a theory you may not have considered. The banks ultimatum was not to OBE but to the landlord and to the note holders. Essentially they were saying play ball and give OBE some flexibility or end up losing big time. The Calgary building market has a huge vacancy rate. The tower that OBE is in probably has a higher occupancy rate than most largely because of OBE. The market is 180 degrees different than it was when the lease started in 2015.

So the landlord can cut them a break and continue to stay reasonably well occupied or hold firm, bankrupt the company and have the whole building virtually empty, collect very little rent and pay all the heating and taxes on the empty floors. I presume that the banks are in fact helping OBE because they are drawing a clear line in the sand. With oil at $42, there is no one waiting to move in to the empty space. I am fairly sure they are going to agree evidenced by Morguard press releasing the impact to the trust holders as if it was pretty much done. Why tell the shareholders how much it will cost them if you don’t plan to do it?

Why would the debt holders agree to an extension if they wanted to take the company under? I believe the debt holders are working with OBE leadership to help them not as adversaries.

[mikego_34]

Coronavirus isn’t helping....

[divconsulting]

" It may not end up restructuring in 2020, but will be a debt zombie even if it gets a revolving period extension until next year." - Survival is the name of the game right now.

At current strip price, hardly anyone is making money.

[Empirical Wonder]

The shares could go to zero, but it's very plausible they could triple. A very risky short.