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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