Whiting Petroleum's Bankruptcy: Shares Are Trading At Over 10x The Value Implied By The Unsecured Notes

Summary

• Whiting filed for bankruptcy, with the unsecured notes expected to get 97% of the new equity, compared to 3% for common shareholders.
• One could buy 1% of the new equity for $2.44 million via the unsecured notes.
• At $1 per share, it would cost $30.6 million to buy 1% of the new equity via the common shares.
• Past experience suggests that the unsecured note prices are much better at predicting the value of the new equity.
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Whiting Petroleum (WLL) has filed for restructuring, and announced a plan where its unsecured notes would be converted into 97% of the new equity, while its common shareholders would receive 3% of the new equity. Whiting's unsecured notes are now valuing its new equity at close to $250 million, while its common stock (at $1) is valuing its new equity at over $3 billion. Past experience suggests that the unsecured note prices are much closer to reality based on current market conditions.

Restructuring Plan

Under the terms of the proposed plan, the unsecured notes will be exchanged for 97% of the new equity in Whiting (subject to dilution from the management incentive plan and warrants). Existing equity holders will receive 3% of the new equity in Whiting (also subject to dilution from the MIP and warrants).

Existing equity holders also will receive four-year warrants to purchase 10% of the new equity at an exercise price equal to an implied 110% recovery for the unsecured notes and five-year warrants to purchase 10% of the new equity at an exercise price equal to an implied 125% recovery for the unsecured notes. The warrants are subject to dilution from the MIP only). Another 8% of the equity is reserved for the MIP.

This would result in Whiting's new share distribution looking like the following table, assuming 100 million new shares.

	Shares Excluding Warrants	% Ownership
New Shares Issued To Current Whiting Shareholders	2,760,000	2.76%
New Shares Issued To Unsecured Holders	89,240,000	89.24%
New Shares Issued Under MIP	8,000,000	8.00%
Total	100,000,000	100.00%

Click to enlarge

Whiting's New Equity And Bond Prices

At last report Whiting had 91.8 million shares outstanding. It also had $2.371 billion in unsecured notes outstanding. The unsecured notes are currently trading for approximately 10 cents on the dollar. This would imply that one could purchase 1% of Whiting's new equity (before dilution from warrants and the management incentive plan) via the unsecured bonds for $2.44 million.

Whiting's common shares most recently traded at $1.00 per share. This means that one could purchase 1% of Whiting's new equity (also before dilution from the warrants and MIP) for $30.6 million.

Thus one could buy Whiting's new equity via the unsecured bonds for around 8% of the price one would pay to get its new equity via the common shares at this point in time.

If the unsecured bond prices are accurately reflecting Whiting's actual new equity value, then its current common stock should trade for around 9 to 10 cents. This would be based on 8 cents for the value of the new shares plus 1 to 2 cents for the value of the warrants.

Historical Comparisons

There are some questions about whether Whiting's stock is overpriced now or whether its bonds are underpriced. I'd lean towards the bonds being fairly close to representing Whiting's value, at least based on current market conditions.

Back in June 2016, Halcon Resources went through its first bankruptcy. At the time, I noted that one could purchase 1% of its new equity for $7.64 million based on the price of the unsecured bonds. One could also purchase 1% of its new equity for $15.34 million based on the price of its old common stock. This translated into a price of $8.49 per share for Halcon's new equity based on the price of the unsecured bonds, and $17.04 per share based on the price of its old common stock.

Fast forward to its emergence from bankruptcy in September 2016, and Halcon's new equity ended up trading at around $8.56 per share, suggesting that the prices of the unsecured bonds were fairly accurate for predicting what the new equity would trade at.

Oil Price Volatility

That being said, spot oil prices were a couple dollars lower when Halcon emerged from bankruptcy compared to when it filed for bankruptcy. Thus it could be said that the price of Halcon's unsecured bonds in June 2016 may have slightly undervalued Halcon's new equity value in an environment where commodity prices did not deteriorate slightly.

Whiting's bond prices should reasonably accurately reflect the current oil pricing environment, which involves mid-$20s WTI oil for the second half of 2020 and low-$30s WTI oil for 2021 based on current strip prices. In that sort of environment, Whiting's post-restructuring market capitalization would probably be around $250 million.

Upside for the bonds from their current price of 10 cents on the dollar would depend on oil futures shifting upwards from their current curve.

Conclusion

Whiting's restructuring has resulted in a large discrepancy between what its bond prices say about the value of its new equity and what its common share price says about the value of its new equity. With the bonds trading at 10 cents on the dollar, Whiting's current common shares would need to be trading at around 9 or 10 cents to value its new equity equivalently.

This is a situation that I've encountered before, and in the end the bond prices ended up being much more predictive of the new equity value. I have now purchased a small amount of puts in Whiting. This is a bit of a challenging trade though, as the market already expects Whiting's shares to go down in price significantly. For example, with Whiting's shares trading at around $1, its June $1 puts are trading at close to 2.5x the price of the June $1 calls.

Disclosure: I am/we are short WLL. 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.