(Nearly) Distressed Debt

Anyone play with this stuff? I’m looking at some convertibles in the Canadian energy space trading at $0.20-0.30 on the dollar. The conversion feature is worthless (way way way OTM now), but we are talking a yield in the 25% range. If these firms really ate it, am I going to get just pennies on the dollar? This is senior debt, next in line only to the banks. One particular firm I’m looking at had, at Q3, $574M of assets (book), $121M bank lines and $100M debentures. If I’m paying $0.30 for these bonds, the assets would need to sell for less than half their book value for me to lose anything, assuming the bank is made whole first. The upside is a potential huge yield and the chance of being taken out at par in a refinance or a transaction. The firm looks to be solvent for the next year anyway even at these shit WTI prices. Am I looking at this right?

i’m assuming you’re talking about Argent?

in these situations, i’ve can’t remember seeing a deb that broke below $50, ever get paid back at $100.

that said, almost always, the debs will see a major relief rally, like seen in the cases of IBG and SPB debs over the years, though it may be different for a company that relies on a commodity price for its cash flow. for example, Ivanhoe debs have gone straight down with no relief rally.

my best guess as to what will happen to the Argent debt is that it will be converted. at what price is anyone’s guess but it most likely will not be at $30. more likely to be $5-$15.

when a company has multiple layers of debt and the bottom layer has a YTM of 50%, the market has decided that the company will die. refinancing the debt would require a yield of about 50% and the bank lines would have to be refinanced at ~20-30%, which won’t happen. the bank lines will likely be pulled and the company will go down.

best case scenario in a $60 oil scenario is a refinancing at $15. unless you think oil will jump back up to $80 by June, these debs will likely lose you money.

if you can’t tell, i hate argent. assets are too spread out to reach any meaningful scale and too small that there won’t be many buyers willing to pay a fair price, especially in this environment.

I’m not a fan of Argent either, but just pondering this play and perhaps some others. You’re right the above example was Argent, but there are others too. Arcan, Anderson, Long Run, Shoreline… Argent affirmed its dividend ($0.01) and production level based on ~$65 WTI for 2015. Your right the banks will get skittish but you can fight that for awhile. If someone buys Argent out, these are going to get 100%, no? I’m not sure I can short the stock so an arb play looks out of the question. I’m not suggesting this is risk free, but just one way to play a potential recovery.

Another question: How would this end up getting converted? A negotiation with the bond holders? Could I hold out if I owned this? I’ve only played in the investment grade space as an issuer and as an investor so I have no experience or knowledge when shit hits the fan. I’ve bought some high yield before, but never this high yield with the expectation of a default.

you are correct that in the case of a buyout, if it is a foreign acquirer, you’re likely to get $100 right away and if it is a healthy large North American company, you will keep getting interest and get paid at the maturity date. i recently bought the Talisman prefs in the mid-teens betting on a takeover by Repsol to get my $25, so this type of play can work.

in the case of Argent, my argument is that with the debs trading at $30, as an acquirer there is a major incentive to let the company die and pick the assets up during liquidation or after reorganization. why pay some sort of premium on the common shares and a 230% premium on the debs when you can basically pay zero for the common and virtually nothing on the debs. unless the assets are really amazing, which in Argent’s case, they are not, there is no incentive to jump in and acquire a mediocre company at an expensive price.

as for holding out and getting your interest, the banks will get more and more skittish if oil keeps dropping.

these securities will be great if betting on a recovery as you could make 100% plus interest in short order with a 20-30% rally in crude. that said, you’d still be exposed to news risk (i.e. small companies are more exposed to well related issues, other business risks) you could make a similar return by investing in something like Legacy or Trilogy common stock which used to be much larger and has better (i.e. lower cost) and more stable production.

^ +1 Great post thanks. Lots to consider here.

correct. management would make a deal on behalf of common stockholders with bondholders/bankline providers to dilute common shareholders by converting some bond/bankline debt in order to preserve some common shareholder value. this would occur in Argent’s case of the banks called the bank line when it matures or is set to rollover (i don’t care to look when this is but virtually all bank lines have a maturity and/or renewal date) in order to attain greater control and a greater stake of the company. management at this point could only do their best to preserve value for the common shareholders and would provide debenture holders with a premium to the trading price as an incentive to vote for the deal. as long as the majority of debenture holders vote for the deal, i don’t think you can withhold.

before a reorganization is proposed, we’d have to see further declines in the stock or debentures which could be caused by many things: natural decline due to falling oil prices, corporate raiders/short sellers, arbritrageurs (likely not as the senior debt is a bankline not tradeable bonds), etc.

there’s no telling what will instigate a reorganization but further decline in the stock and oil prices would surely help trigger it.

EDIT: if the majority of debenture holders don’t vote for the deal, then the alternative is usually full-blown bankruptcy and liquidation in which case debenture holders are likely to get $0. i’ve never seen debenture holders vote against a reorg deal and force bankruptcy because you’re both likely to get less in liquidation and have to wait several years for your money. typically not worth it.

What is the 574mm in assets in? The collectibility of assets varies greatly, especially in liquidation. And do you know how much of that is encumbered by bank lines? Banks can repossess more than the outstanding loan balance in the USA – but it’s rare, because if there is equity generally a borrower will just sell it to pay the debt down. But the bank’s may have a blanket lien on all business assets

^ Its oil and gas properties & working capital. Bank lines are, I think, $122M drawn, $180M available. This company is still paying a monthly distribution, says they can maintain distribution and reduced capex plan for 2015 at $6x WTI. So its not entirely distressed, per say. But as MLA points out, the assets are ok, but scattered, making it hard to sell as a package deal. But they do have some value, no doubt. Their 2015 capex is focused on plays where they can generate positive cash flow at current crude levels. I’m not saying this is a long equity play by any means, was just curious about being a vulture on the debt. Edit: I updated the credit facility #'s. I’m also not sure if this is a Canadian facility or US credit facility. The assets are primarily American but the company is Canada HQ’d.

Shoreline Energy announced yesterday that they will not make payment on their debs, heading for restructuring. There is a $35 bid on those bonds. Why is AET debs trading lower than this? Hmm…


i wouldn’t consider last price as being indicative of true price due to illiquidity.

SEQ.DB only has 6000 in bid volume down to $25 whereas AET.DB has tons of volume between 31 and 32 so in my mind, AET.DB trades higher than SEQ.DB for anyone who needs to trade in volume.

further, it appears that the SEQ debentures are the bulk of SEQ’s long term debt (senior loans = 9M, debentures = 17M) so there is a good chance that the recovery rate on SEQ’s debentures will be higher than that of AET’s. this is especially true considering Shoreline has some Montney assets which are 10x more attractive and saleable than light oil assets right now.

^ I plan to dig in on the analysis of these two tomorrow on the holiday, check out the assets in depth. You’re right though, the liquidity on these makes prices hard to grasp.