Friday, September 6, 2019

Distressed Debt Watch - September 2019

See previously: the August Distressed Debt Watch.

  • Approach Resources (AREX, EDGAR) bond due June 2021 trading in the 20 cent range (small pieces), ytm's of  over 100%. Market capitalization at 18 cent share price of $17 million. Net debt of $400 million on about $2 million of EBITDA the most recent quarter. They keep rolling their forbearance agreement with their lenders, one week at a time, negotiating a restructuring. The January 2020 $1 put options are usually 80 cent bid and 85 cent offered.
  • Frontier Communications (FTR, EDGAR) bond due April 2020 trading at 63 cents, ytm of over 100%. Market capitalization at $0.81 share price of $87 million. Net debt of $17 billion on $1.5 billion of operating income. There are restructuring talks, with some creditors favoring a Chapter 11 (in-court) restructuring. Shareholder equity is $1.5 billion, but that includes $6.4 billion of goodwill and $1.4 billion of other intangibles. The January 2021 $2 put options are $1.35 bid and $1.55 offered. On the second quarter earnings conference call (where they didn't take questions), the CFO closed by saying, "I want to touch briefly on our capital structure. The Finance Committee of the Board of Directors is evaluating Frontier's capital structure. This includes considering, evaluating and negotiating capital markets and/or financing transactions and/or strategic alternatives. Frontier remains committed to reducing debt and improving its leverage profile." There is also a September 2020 8.875% bond trading at 55 cents, a ytm of 80%. Moody's downgraded in mid-August: "Frontier's decision to write down $5.45 billion of goodwill in the quarter reflected, in part, concerns regarding the long term sustainability of the company's capital structure and reduced expectations for the overall wireline industry. The company's potential to improve weak fundamentals in advance of sizable debt maturities beginning in 2022 remains difficult given a shortening runway to stabilize business trends. The potential for distressed debt exchanges in the next year or so is further elevated based on these operating results and other developments, including recent appointments of new Board members with restructuring and bankruptcy experience. Moody's continues to anticipate a heightened focus on potential capital structure optimization efforts given the mixed evidence of sustained progress from ongoing operational improvement initiatives." They just sold their "Northwest Operations" (Washington, Oregon, Idaho, and Montana) for $1.35 billion, which represented 7% of revenues, but chose not to disclose what proportion of operating profit these operations represent. Often when a distressed company is  selling assets, it is an adverse selection process where the best stuff can find a buyer (like real estate at a failing retailer) and what remains with the company becomes more and more concentrated sludge.
  • J.C. Penney (JCP, EDGAR) bond due November 2023 still in the 40 cent range, ytm of over 30%. Market capitalization at 77 cent share price is $241 million. From the second quarter results: "For the quarter ended Aug. 3, 2019, total net sales decreased 9.2 % to $2.51 billion compared to $2.76 billion for the quarter ended Aug. 4, 2018. Comparable sales decreased 9.0 % for the quarter." Book value has declined to $963 million, but I would subtract $657 million of "other assets" like capitalized software and intangibles, and further the $392 million of capital expenditures in 2018 for things like "investments in our store environment and store facility improvement," leaving an adjusted equity value that may be negative. The capital structure subject came up on the quarterly call: "First, our capital structure. Since my arrival to JCPenney, we have been very focused on reviewing the overall dynamics of our capital structure. We have outlined key tenets that we will abide by when evaluating our capital structure. First, we will continue to maintain more-than-adequate liquidity to fund the operations of our business. Second, we will proactively manage our existing outstanding debt maturities. And third, we will maintain flexibility in how we fund the business and options we have to ensure sustainable and profitable growth. With that, we are taking positive and proactive measures to improve our capital structure and the long-term health of our balance sheet." The January 2021 $1 put options are about 52 cent bid and 63 cent offered. 
  • Denbury Resources Inc. (DNR, EDGAR) bond due July 2023 trading at 35 for a 38% ytm. Market capitalization at $1.13 share price of $516 million. For the first half of 2019, they had $213 million of cash from operations less $158 million of capital expenditures, for a net of $55 million of free cash flow, which would be $110 million annualized. Against that, they currently have $2.5 billion of debt outstanding. The January 2021 $1 put options are 45 cents. 
  • California Resources Corporation (CRC, EDGAR) bond due Setember 2021 is trading at 58 for a 37% ytm. Market capitalization at $10 share price of $489 million. Total net debt outstanding at the end of the second quarter was $5.1 billion. For the first half of 2019, their operating income was $179 million. The DDAX was $239 million but capital expenditure was $170 million. This suggests that "cash flow" is something like ~$500 million annually, which is small compared to the $5.1 billion of debt. Interest expense is like $400 million annualized now. The January 2021 $10 put is ~$4.50.
  • Mallinckrodt plc (MNK, EDGAR) bond due April 2023 trading at 25 cents, ytm of 56%. "The company has been implicated as a major contributor to the prescription opioid scandal around the over-prescription of oxycodone in the United States." The January 2021 $3 put is $2.15 (with the stock at $1.87). Moody's just downgraded: "Mallinckrodt's liquidity will be weak over the next 12 months as it faces a large upcoming notes maturity of $700 million in April 2020. It also reflects Mallinckrodt's full draw on its $900 million revolver, using up all of its committed external liquidity. Mallinckrodt's liquidity benefits from substantial cash (exceeding $550 million at the beginning of September 2019, inclusive of proceeds from its full revolver draw) as well as good free cash flow. Moody's believes that Mallinckrodt would likely be able to meet the April 2020 maturity with available cash and cash flow. However, given the sizeable debt maturity, there is minimal cushion to absorb any litigation or other required payments. For example, there is risk that Mallinckrodt would have to make up to $600 million in retroactive payments to Medicaid related to Acthar. Even without this payment, Mallinckrodt faces considerable uncertainty around the timing and amount of possible opioid related cash outflows. In Moody's view, risks stemming from Mallinckrodt's exposure to opioid litigation are high, in both its branded and generics businesses, potentially posing a challenge to capital market access."
I would guess that common stocks of companies that mention "capital structure" on their conference calls underperform. I am pretty sure that common stocks of companies with debt yielding more than 30% underperform.

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