Valaris - Short The Momentum Rally With Bankruptcy Likely Just Weeks Away
Summary
- A stunning jobs report and extended oil production cuts caused a major momentum rally in beaten down offshore drilling shares on Friday with Valaris recording an eye-catching 162% gain.
- Company skipped bond interest payments last week with the 30-day grace period expiring on July 1.
- Similar to peer Diamond Offshore Drilling in April, expect Valaris to file for bankruptcy within or at the very end of the current grace period.
- A short position should yield decent short-term returns but investors need to avoid getting trampled down by the current momentum stampede.
- Patiently wait for momentum to abate and trading volume to taper off over the next couple of sessions before initiating a position.
Note:
Valaris PLC (NYSE:NYSE:VAL) has been covered by me previously, so investors should view this as an update to my earlier articles on the company.
On Friday, a stunning jobs report and the OPEC+ decision to extend recent production cuts by another month, caused a massive rally in oil and oil service stocks with beaten down shares of offshore drillers outperforming the market by a wide margin:
Source: Yahoo Finance
The rally extended into the after hours session and momentum is very likely to carry over into pre-market trading on Monday, providing the potential setup for an epic short trade in ailing offshore driller Valaris as the company is likely to file for bankruptcy at or before July 1 after skipping bond interest payments last week:
At this time, the Company has elected not to make the approximately $15.1 million interest payment due and payable on June 1, 2020 with respect to its 2022 Notes and the approximately $10.8 million interest payment due and payable on June 1, 2020 with respect to its 2042 Notes. Under the indentures governing the Notes, the Company has a 30-day grace period to make the Interest Payments before such non-payment constitutes an “event of default” with respect to the Notes. The Company has elected to enter into the 30-day grace period, which expires on July 1, 2020. As of May 29, 2020, the Company had approximately $238 million in cash, in addition to available borrowing capacity under its revolving credit facility. The Company continues to have discussions with its lenders and bondholders regarding the terms of a potential comprehensive restructuring of its indebtedness.
With Valaris entirely dependent on its revolving credit facility, lenders agreed to provide a much needed waiver to avoid an uncontrolled meltdown of the company. In my opinion, there's a decent chance that amounts currently drawn under the credit facility will be rolled into a potential debtor-in-possession ("DIP") financing thus putting the banks first in line for repayment while pocketing juicy interest payments and fees.
Photo: Soon-to-be-scrapped 6th generation drillships Valaris DS-3 and Valaris DS-5 cold stacked at Santa Cruze de Tenerife, Canary Islands in October 2018 - Source: Shipspotting.com
But the waiver "will terminate if at any time the obligations under all or a portion of the Notes are accelerated in accordance with the terms of the Notes" which would likely be the case after the expiration of the current 30-day grace period on July 1.
Just like peer Diamond Offshore Drilling (OTCPK:DOFSQ) in April, Valaris will likely file for bankruptcy within or at the end of the grace period.
As discussed in my last article, simply equitizing the company's debt would not do the trick here as Valaris is burning large amounts of cash from operations each quarter. In my opinion, the company would likely require up to $1 billion of new capital for the bankruptcy court to confirm the plan of reorganization.
Depending on the amount ultimately drawn under the credit facility and size of the required liquidity injection to successfully emerge from bankruptcy, noteholders are apparently at risk of getting wiped out alongside equityholders as their claims are structurally junior to credit facility lenders.
With the company's bonds on average trading around 10% of face value, equityholders will almost certainly be wiped out in the upcoming restructuring.
Given the company's massive capital needs, it's difficult to imagine that Valaris would come to terms with noteholders on a potential pre-packaged bankruptcy ahead of the July 1 deadline.
With a bankruptcy filing likely close at hand, investors should use the recent momentum rally to establish a short position in Valaris' common shares. That said, betting against the momentum crowd could easily become a costly experience, so investors should rather wait for momentum to abate and trading volume to come down over the course of the next couple of sessions before initiating a short position. While borrowing fees might reach elevated levels, the short time frame until an expected bankruptcy filing should limit any potential impact.
To provide some perspective on the potential gain of this trade:
After Diamond Offshore Drilling filed for bankruptcy in late April, the stock took an approximately 70% hit when trading continued on the OTC the following day.
What are the risks here? The chances for securing additional waivers from noteholders after the end of the current grace period would be slim to say the very least and the company made no reference to this potential course of action in its recent regulatory filings. In addition, this wouldn't change the requirement to restructure the company's more than $6.5 billion in long-term debt.
Bottom Line:
Just like peer Diamond Offshore Drilling recently, Valaris is likely to file for bankruptcy within or at the end of the current grace period on July 1.
With the company likely requiring a material capital injection to successfully emerge from bankruptcy, even bondholders might end being wiped out alongside equityholders.
Given this issue, I do not expect Valaris to have a restructuring support agreement in place with creditors at the time of filing which usually results in drawn out bankruptcy proceedings.
Speculative investors should use the current momentum rally to establish a short position in the company's common shares with timing being the key for a successful trade here. Avoid shorting into a likely continuation of Friday's rally in early trading on Monday and patiently wait for momentum to abate and trading volume to taper off before building a position.
Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.
This article was written by
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in VAL over 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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PS - Btw, I enjoy your articles.
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