Distressed Debt: Morningstar Note Review
January 3, 2016
(Pricing as of 12/16/15)
- Debt Stack
- Unsecured Senior Notes (USNs): $9,345
- Convertible USNs: $1,515
- 2037 2.5%: $47.80 (puttable 5/15/17)
- 2038 2.25%: $33.10 (puttable 12/15/18)
- USN Due NTM: $500
- Total: $11,360
- Market Value: $32.30
- Cumulative Convertible Preferred
- Total: $3,062
- Interest Rate: 5.58%
- Market Value: $16
- Yield to MV: 35%
(As a quick aside – CHK’s equity market cap last closed at approximately $3B, while the cumulative convertible preferred traded at a $490 million market cap on 12/16/15). Perhaps there is a bit of a liquidity/optionality premium in the common…but this dichotomy largely does not make sense – likely, the common is incredibly mispriced to the upside.)
As I discussed yesterday on the Scratch Notes and Trading pages, it appears we are entering the final stages of the Energy meltdown. With an extremely complex, highly liquid capital structure, I believe CHK has the potential to be the ‘Lehman Brothers’ of the Energy crisis; as such, I plan to devote an out-sized portion of my time in the coming weeks and months getting to know the CHK capital structure in preparation for a final capitulation bottom.
This review of Morningstar’s recent CHK note is not an endorsement of MS’s research capabilities (they have a potentially silly equity price target of $13 on the Company), but rather a fact-based platform from which to begin an analysis of the situation. And FWIW, I believe their financial projects conservatively embody the highly depressed operating environment that is currently in place. I say conservatively because I believe the extreme conditions in the natural gas market are positioned to rebound sooner than MS’s projections imply…a discussion for a later write-up.
Debt Exchange. CHK recently initiated a debt exchange involving $9,345 of existing USN principal for up to $3B of new second lien (2L) principal. On 12/21/15, the Company announced that $2,355 of 2L principal had been taken up, reducing outstanding USN principal by $3,834. The exchange offer remained outstanding thru 12/31/15, so the final tally could amount to the $3B total exchange offer; and, CHK has the ability to issue an additional $1B of 2L principal beyond the current exchange offer.
Pro Forma LT Debt Structure. Assuming the 12/21 exchange results hold (i.e. no more USN principal is tendered), the pro forma long-term debt structure looks as follows:
- Senior Secured Credit Facility: $0
- Second Lien Notes: $2,355
- Unsecured Senior Notes: $5,511
- Convertible USN: $1,515
- Total LT Debt: $9,381
CHK has $821 million of cash on hand. Morningstar projects that CHK will maintain a minimum of $5 million of cash on hand thru 2019, thus assuming the balance of the cash on hand will go toward CHK’s projected funding gap. I believe that is too aggressive, so I assume the full $810 million remains on hand; though I do apply the full cash balance to the Senior Secured Credit leverage calculation purposes.
Projected Financials. Morningstar’s commodity price deck, EBITDA and net cash flow projections are as follows:
- 2016: $2.31 HH/$41 WTI
- 2017: $2.77/$47
- 2018: $2.93/$51
- 2019: $4.06/$65
- 2016: $925 million
- 2017: $1,134
- 2018: $1,479
- 2019: $3,769
- Net Cash Flow
- 2016: -$1,121
- 2017: -$2,792
- 2018: -$1,626
- 2019: -$1,078
17M Analysis. Using MS’s projections as a base, I attempt to calculate a worst-case scenario analysis for the USNs. Conservatively, I assume the entirety of CHK’s projected funding gap ($6,617) is filled via the Senior Secured Credit facility, and the newly-issued 2L debt is ‘money-good’. In the event MS is correct in its projections, and CHK ‘makes it’ to 2019, even the common stock could have terminal value – the problem is getting there. Unfortunately for common stock holders, with the CDS over 4,000 bps there is almost no question CHK will be reorganized. So the key questions are: when is it reorganized, and at what multiple of depressed EBITDA.
The longer CHK attempts to hold on, the greater the duration of the funding gap, and thus the higher the associated Senior Secured Credit facility balance. There will be puts and takes to the final reorganized enterprise value; but FWIW I assume the ‘fair’ EV/EBITDA multiple to progress as follows thru 2019:
- 2016: 7X
- 2017-2018: 6X
- 2019: 5X
Applying 50% of cash on hand to the EV available to USNs, the USNs’ ‘fair value’ progresses as follows thru 2019:
- 2016: $48.53
- 2017: $13.47
- 2018: $19.79
- 2019: $146.36
Conclusion. The most depressed USN is the 2023 5.75% note trading at $28.30 as of 12/16/15. So in a worst-case scenario where CHK is reorganized in 2017 (or in 2016 using 2017 projections), the 2023 5.75’s have approximately 50% downside remaining. However, the upside thru 2019 – assuming the USNs are reorganized into common equity – is over 5 times from current levels.
Given the conservative nature of my USN valuation work, my preliminary conclusion is that the time to begin averaging into CHK long-term debt is likely incredibly close…if not here. If I am correct that large distressed debt investors held off buying in late 2015, and they begin a buying program in early 2016, there is a chance we have seen the ‘lows’ in CHK debt. I will be on close watch as I continue my analysis.
UPDATE – 1/4/16
I made a modeling mistake in yesterday’s write-up: I did not reduce the USN principal balance from 2017-2019 in line with the debt repayment included in the funding gap; as such, terminal debt outstanding was approximately $4B too high. Making the appropriate adjustment, the USNs’ fair value progresses as follows thru 2019:
- 2016: $48.53
- 2017: $18.81
- 2018: $33.55
- 2019: $338.94
If I assume the USNs are recapped alongside the 2L notes, the FV walk is as follows:
- 2016: $57.07
- 2017: $39.14
- 2018: $51.31
- 2019: $226.91
This update only reiterates my conclusion from yesterday that the time to begin averaging into CHK debt is likely here. With the longest maturity debt trading circa $30, the downside to the worst-case scenario of $18.81 is only 37% versus upside of ~7.6 times in the 2L 2019 scenario.