As part of my ongoing “powerball” series, I recently discussed ATPG’s common and preferred stock (speaking of the preferreds (remember my love of preferreds!), find a great article discussing them here). In the article, I mentioned I’d be interested in the debt but couldn’t find it traded on etrade or fidelity. Some readers were kind enough to help me find them, so I researched them further. I ended up seriously liking what I found, and I’ve now gone long the bonds.
Before I begin this post, I want to note (as I did in the previous article) I am by no means an expert in this sector. This is also my first foray into high yield debt and analysis of covenants, so it’s almost guaranteed that I am both 1) missing significant facts and 2) wrong about several things, perhaps everything. I just note that to be honest upfront. Please do your own research (you can find the bond’s prospectus here, their CUSIP is 00208JAE8).
Also, I want to call attention to this Distressed Debt investing article on the bonds. It provides a great breakdown of the bonds from December of 2010, after they had run up significantly. It also points to David Einhorn’s letter from 3Q 2010, which mentions he had gone long both ATP’s equity and debt at prices very similar to today’s levels before exiting at a significant prices (his equity position was started at prices 10% higher, debt position at prices 10% lower).
Anyway, everything from my first post on ATP basically applies to the bonds. However, I do want to correct one thing. My estimate for capex was completely off. I had estimated capex at $100m, but I read the disclosure wrong. It’s $100m for the rest of the year, and $500m for next year. That’s clearly a huge difference, and when added to large interest payments from their huge debt load and preferred stock, it puts in perspective that ATP is certainly about to face some form of liquidity crisis.
But does that justify today’s prices? The bonds are trading for under 70% of par and yield 11.875% on par. This means they are selling for a yield of over 17% plus significant capital appreciation. The bonds come due in May 2015, so if the company manages to pay them off there’s certainly equity like upside in the Clearly, the market is projecting ATP as extremely distressed and forecasting a good probability of default.
While I don’t disagree with the market’s forecast, where I do disagree is with the pricing of the bonds. I think there’s significant asset coverage that would allow for basically par value recovery on the bonds in the event of default.
Basically, I think there are five scenarios from here:
1) (least likely) ATPG manages to significantly ramp up production and increase cash flow. It gets by without raising any new equity and with a bit of additional financing. Stock price goes through the roof.
2) ATPG manages to significantly ramp up production, and uses that increase to raise new equity capital. Stock still goes up, ATP survives.
3) (my default) ATP is forced to sell some assets for a haircut to their fair value to pay down debt. Equity is worth a bit more than today, but upside is significantly reduced by asset sales. I personally think this is most likely because I think their assets are worth significantly more than they are on the books for and, since they are already basically developed, represent significant value to potential acquirers
4) ATP faces serious financial distress, on the verge of default, and is bought for a song by a competitor looking to pick up assets on the cheap.
5) ATP defaults. ATP is either forced to sell their assets or the bonds become the new equity.
The market and the ratings agencies clearly think 5 is the most likely. However, I think this is the source of incredible opportunity. The bonds are high yield and rated CCC by both agencies, which basically implies they are on the verge of default. Most analysts won’t look at CCC bonds. When people refuse to look at something, that’s when I see value opportunity!
Remember the slide from the presentation I showed in my ATPG post. It pegs PV 10 between $5.8B and $7.6B. ATP has total liabilities of $3.1B. In other words, ignoring the value of their infrastucture, cash, etc, PV10 nearly doubles the value of all of ATP’s assets. That’s a significant amount of asset coverage. You may think I’m mispricing something here, but look at the chart under valuation in the preferred article I linked to earlier- most comps trade for a EV / PV10 between 0.9x and 1.1x. Now, the comps aren’t as distressed at ATPG- but the bonds are relatively close to the top of the capital structure (only $150m in debt above them, plus $350m in net profit interests that I believe are senior to everything but could be wrong on). Distress hurts the bottom of the capital structure (the equity) much more than the top.
Also remember this- management owns ~13% of the company, and they are still run by their founder. In a case that is this distressed, what is good for the common is generally good for the debt- pay off the debt so that the equity has value!
So let’s finish with a quote from the CFO from the Pritchard Capital Energize Conference at the start of the year. Always take management’s words with a grain of salt, but I think it’s interesting.
“Now, I want to spend a little time talking about the financial overview of the company. And yes, I have read all of the information, both pro and con about ATP that’s out there. I won’t name names either way. But I think there are a lot of people that are not necessarily betting for ATP. I think some understand the story much better. And what we have in looking at all of the reports that have been written about us that are in the market today, I’ve not heard any of the reports, regardless of how negative they are that talk about a deterioration of the asset base.
So when it comes to the assets of the company, the assets are still strong and intact. You can see here on the proved and probable reserve base, and this is based on last year’s reserve report, SEC pricing as of last year, updated for strip pricing now. But what you see is that our entire debt is completely covered by our proved reserves. And sitting on top of that is the infrastructure, some more proved reserves as well as the probable reserves. Net debt and total obligations of $2.4 billion, you’ll see a chart in the back in the appendix that lays that out. But when it comes to evaluation of ATP, this is where we think that you will find that there is a very strong compelling value of the company.
Our long-term patient corporate structure, a lot of the things that are talking about is our ability to make interest payments, the ability to focus on our maturity of the bonds. These occur in 2015. Between now and 2015, we expect to have Telemark at full production which will be ’12, Clipper at full production which will be ’12, Entrada at full production which will be 2013 or 2014, and then Cheviot at full production beginning sometime in 2014, 2015. Those are the production ramps that we see occurring prior to any form of maturity associated with any of our bonds and the key component on here is in red at the bottom that there are no financial maintenance covenants and facilities can be expanded.”
As Seth Klarman notes, the nice thing about distressed debt is that it has its own catalyst. There is a payment date on it. Either the bonds pay or they don’t (I suppose they could default and become equity and thus have a soft catalyst, but that normally does something to reveal the value underlying). I think the ATP bonds will be quite volatile, but ultimately I think the reward far outweighs the risk and expect getting something close to par value. I’ve initiated a small position, and will be happy to take advantage of any volatility in the name.
Disclosure- Long ATPG bonds
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Interesting that you went with the bonds instead of the preferreds. Better liquidity, wanted to be higher up in the capital structure, or … ? Any thoughts you can share are appreciated.
Just wanted to be higher up in the capital structure. I think the prefs are interesting as well, but on a risk / return basis the bonds just made more sense to me. Couldn’t fault you if you went pref though.
I’d be pretty careful with ATPG. It is going to be very difficult for these guys to make it through the year without defaulting. Just think about all the ways this company has had to raise money. Secured bonds, preferred, selling future profits, financing a pipeline, swap contracts selling future oil production for cash now, etc. They have already explored every avenue possible. The implied interest rate on some of this non-conventional financing is 19.2%. And a lot of it comes due in the next 12-24 months and is effectively senior to the bonds (think about that number when you are looking at the yield on the bonds now). Their asset base consists of assets that other people didn’t want. They have continually underwhelmed investors and continue to have severe operational issues. The bonds have not moved up in the run up of risk assets here in January. There is a reason for that. Some people are blinded by the PV-10 numbers and the huge coupon. But even on an unlevered basis, ATPG really has never generated cash and it has to continue to spend massive amounts to get its reserves out of the ground. These are very expensive assets to monetize. In addition, the company continues to make expenditures in the North Sea that will not see any production for quite some time.
The company has spent a ton of money and I like the fact that they at least have hard assets to provide some support for the bonds. But I’ll wait for them to default before jumping in. Maybe I am wrong and they ramp up production successfully and oil prices climb. If so, then I’m okay missing out on this investment, because even in the high 60s on the bonds, I don’t see much of a margin of safety.
Good luck to those that play it though. Be sure to examine the NPIs, ORRIs, prepaid oil swaps, the Gomez pipeline financing, the Titan term loan, vendor deferrals, the ATP-IP subsidiary that gets distributions from ATP after selling an interest to GE, and the asset retirement obligations. Those are all pretty much ahead of the bonds and a lot of it needs to be repaid in 2012/13. I don’t mention all of that to be a jerk, just that you should be sure that you are comfortable with all of this unconventional financing before risking your cash in the bonds.
One final comment, you mention in your base case (#3) that the assets are basically developed. That is not true. 81% of the assets are undeveloped.
Hey BC,
Thanks for the insightful comments. I’m going to respond further in a response to your main comment. Just quick clarification on the development comment- I didn’t mean all of their properties are developed and producing. I more meant that their main assets are no longer completely unreachable and undeveloped- the infrastructure is set up for them.
I think you are still a little confused. 81% of their assets are PUDs. Proved undeveloped. The wells have not been drilled so the infrastructure is not set up. The assets are “proved”. They won’t have exploration costs. But they still need to develop these assets and build the infrastructure to get them out of the ground. And operational execution is not exactly ATP’s strong suit.
Hi BC,
Great ponts. I’m going to ask a couple of questions if that’s ok with you.
My understanding was the NPIs only applied to the properties they are granted on. In other words, let’s say the company went bankrupt. The NPIs wouldn’t be able to reach into any assets at corporate. I ask because I was assuming that was the case.
If I’m right there, doesn’t that create a huge margin of safety for the bonds? First, it would mean that in the default and liquidation scenario, their overall liabs MAY be less than their balance sheet shows if any of the wells are so disappointing that the NPIs are worth more than an underperforming well. More importantly, it would mean any cash from selling infrastacture or other assets is untouchable by the NPIs and such and would flow straight to corporate.
Second, even including all of those other liabs in the EV valuation, ATPG trades for a huge discount to peers on a PV-10 basis. Doesn’t that say that there’s still asset protection for the bonds even with those concerns???
Again, I’m completely new both to high yield and the E&P sector. The position is extremely small, and this is just the type of criticism Iwas looking for as I was looking to lern from the investment. Happy to hear any other comments, thoughts, criticism you have!
On the NPIs, the general assumption people are making is that these are basically ahead of you in the bonds. These are like payday loans. ATP is selling future production for cash today (on what I believe are currently producing assets, or the bonds collateral!). We don’t have the nitty gritty details of these, but you have to assume that they are pretty friendly to the other party. As of now, they basically PIK at 19.2% and most are due in the next 18-24 months. I would definitely assume that these are ahead of the bonds.
I don’t have the corporate structure in front of me, but these deals are likely done at the operational level, which would most likely put them in a structurally senior position to the bonds.
The PV-10 is based on a lot of estimates. Like I said before, even on an unlevered basis, ATPG has struggled to generate any cash. I put more weight on the company’s history and execution vs. its PV-10 based on lots of future assumptions that have never come true. I think this company will default and may even need a capital injection from the bondholders in a rights offering which would increase your investment size and exposure to the company (but in most rights offerings, you will need to participate to not get diluted by others).
Someday, as long as oil prices remain in the $100+ range, investors in the bonds will make some money on these assets. But just as the other commenter said, there will be a lot of pain between now and then. I would avoid in the high 60s. But this is definitely an interesting name to cut your teeth on in distressed debt. It’s just WAY more complicated than most people realize.
I wanted to ask because I am new to this how do I go about buying bonds for ATPG ?
Thanks
I’ve spent a little time on the company I’ve basically come to the conclusion that the comment above me did. I would be very surprised if this company doesn’t default by the end of next year. This is a really shitty company. Serially unprofitable, horrid use of leverage, and they have basically been the highest cost producer for a long time.
When the default happens, the bonds, even the senior bonds, will be trading at a much healthier discount to par, regardless of whether buying at 70% will prove profitable or not in the long run. There will be pain in the middle. By the way, the Jan 2014 $3 puts have basically a 3 to 1 payout right now if the company defaults and wipes out equity in the next two years.
If you want to get really conservative, you could buy the bonds, take the expected coupon over the next two years, and buy the Jan 2014 puts $3. If ATPG does well the puts will go worthless but the coupon should cover the losses, and capital appreciation could provide some profits (or light losses if things muddle along to the negative). If there is a default like I suspect, the puts will pay, and will return your original investment capital if you structure the trade right, and then the bonds should still have some value left, which is your profit. It is a capital intensive trade, and negative biased, but it is much safer and can make money in many different outcomes.
Hester,
I think the puts are an interesting idea as a hedge. But why go out to 2014?The company is having liquidity concerns, and people are worried they won’t be able to make their next interest payment as they continue ramping up their fourth well.
Instead, why not buy the Jan. 2013 $2.50 puts for $0.50 at a rate of 2 puts for every one bond? Your total cost would be $100, which would be covered by $118.75 of interest from the bonds over the year. If the company went bankrupt, your puts would return a profit of $400, which with the bonds trading at 70% of par would represent almost 60% of the bond price. If the stock price didn’t crash, it’s likely cause the company avoided the liquidity crisis and your profits on the bonds would still be good.
Hey Whopper!
I started to follow your site recently and I foind your ideas very interesting.
Following your analysis on preferred, If you have the chance have a look at SPPRO and SPPRP (supertel). They are about to be bail out by IRS and the preferred are both below par.
The REIT is heavily indebted but the capital injection will improve the covenants with the banks and that should take the preferred to par value.
It would be great if you could have a look at them and read your thoughts on this case
All the best and keep the good work!
Thanks for the kind words!
I looked into supertel prefs, and i’m not sure. There’s obviously huge upside, but MAN are they leveraged. The big problem is they are superleveraged and all of their debt is recourse to the company (at least at first glance to me). While the recent capital injection is nice, it came at very expensive terms and i’m not sure if it will be enough for the company to avoid bankruptcy.
Being a bit generous, it looks like the company will generate ~$20m in pre-interest cash from ops this year (not including anything for maint. capex). Applying a simple 7x multiple would give you a suggested EV of $140m, which basically equals their debt and leaves nothing left over for equity. Obviously a turn around in REVPAR and occupancy would greatly increase cash flow, but it seems a bit equivalent to betting on the come, no?
Thanks Whopper for the quick response.
Agree on the leverage and that it is key to improve operational performance
I was looking more on an asset basis. They’ve been selling the non performing hotels at book value (on average).
On a liquidation they should be getting at least book value and given the seniority of the preferreds you should be getting your money before the common.
At a current yield of 10% plus the 2 existing preferreds have more safety that the new ones (although you don’t have the warrant attached to convert at $1.20)
Please also note that if the common does not go back to $1 the stock will be delisted by NASDAQ, unless that is the move of the people of IRS (IRSA not the actual IRS) to take the assets at liquidation value. (they did a similar move with Hersha recently which worked out well)
I’m still iffy on this one but I will keep monitoring developments
Thanks again for the time taken on these one
Cheers
The general situation for bonds during bankruptcy has changed lately. Bondholders who should have been paid in full or nearly so received virtually nothing in several instances. These include the General Maritime bankruptcy and the A&P reorganization. There are others.
What happened was that some powerful creditors were able to force a reorganization in their favor before the bankruptcy proceeding commenced, or as part of the bankruptcy. Truly, the bondholders were robbed, but somehow it was legal.
The same might happen here if ATPG busts. So, the reward vs risk profile may be higher for the ATPGP preferreds than for the bonds. I believe that in any bankruptcy these days the little guys will usually get zip. If the company prospers and the share price rises substantially the holders of the convertible preferreds may do much better than bondholders.
My only point here is that the thoughtful careful reasoning and research that went into liking the bonds better is unfortunately subject to being overridden by others’ greed and machinations.
The bonds were trading around 73-74 today after a cash dividend was declared on the preferred.
(Company can pay stock dividend if they wanted to). Their last term loan financing was also well received:
http://www.bloomberg.com/news/2012-03-09/atp-oil-gas-155-million-term-loan-rises-in-initial-trading.html?cmpid=yhoo
I know the cash div sends a good signal, but I’m sure everyone in the capital structure would have preferred them paying a stock divi and using the cash to pay down debt!
Interested to see results (think they come out tmr)