Under Peabody’s bankruptcy plan a simplified summary of the classes, amount and treatment of claims and interests is given in the table below:
First-Lien Lenders (Class 1). The plan assumes that first lien creditors will be paid in full out of the proceeds of new first lien term loan and the issuance of new preferred and common equity securities. Although first lien creditors are expected to receive a full recovery of their claims and interest, they are classified as impaired (and hence entitled to vote on the plan) because of the possibility that they might have to take back some new first-lien notes, if the company is unable to raise the full amount necessary to repay them completely.
Second-Lien Noteholders (Class 2). The second lien noteholders will receive $450 million face amount of new Second-Lien Notes with a six-year maturity and interest rate 300 basis points above the rate on the new first-lien term loan. That would give the new Second Lien Notes an interest rate of 3-Month LIBOR plus 1,200 basis points, according to the plan documents. The Second Lien Noteholders would also receive 2.1% of the new common stock and subscription rights to purchase units consisting of common equity and penny warrants.
The subscription rights are nontransferable, except through the transfer of the underlying claim. If the Second Lien Noteholders exercise their subscription rights fully, they would obtain 6.5% of the new common at a 45% discount to plan value and warrants exercisable at $0.01 per share for 90 days after plan confirmation for 0.4% of the new common. The cost of the penny warrants is 55% of the per share plan equity value (which is the same as a 45% discount). In total, if the rights are fully subscribed, the Second Lien Noteholders would obtain an 8.9% stake in the new common, according to my estimates.
My estimate of the recovery on the 2nd lien notes is given in the table above. I assume that the new Second Lien Notes are valued at par or $450 million. I also assume that the 2nd Lien Noteholders’ share of the residual equity value is worth $64 million (which is equal to 14.8% of the total residual equity value of $432 million or 2.1% of the total plan equity value of $3.105 billion). Finally, I assume that the intrinsic value of the equity subscription rights (both stock and warrants) is $96 million (which is equal to 6.9% of the $3.105 billion plan equity value times the 45% discount). In total, these components of value are estimated to be worth $610 million which represents a 53% recovery on the $1.158 billion claim. The disclosure statement estimates the recovery for 2nd Lien Noteholders at 52.4%.
My estimated recovery percentage of 53 is above the most recent trade on the 2nd Lien Notes of 44 on February 7. Recent quotes on the Notes have been in the high 60s. My recovery estimate is based upon the assumed plan equity value from the company’s disclosure statement, which in turn is derived from its financial projections. In order to justify a high 60s value for the 2nd Lien Notes, the market probably has a more optimistic view of Peabody’s projected financial performance.
Another way to look at recovery value is to consider the potential return on the 2nd Lien Notes at their current value plus the cost of exercising the subscription rights (both equity and warrants). Here, besides the current value of the 2nd Lien Notes of $510 million, I estimate that Noteholders will have to pay $117 million in order to gain an additional 6.9% stake in the reorganized equity.
That $627 million investment will generate two cash flow streams: one for the new 2nd lien notes and the other for the new equity, which I assume will be cashed out at the end of the five-year projection period. The new Notes generate $59 million of interest annually at an assumed rate of 13% (3-Month LIBOR plus 1200 basis points) plus a return of the $450 million of principal, assuming the sale of the notes at the end of year 5. I value the equity investment in year 5 at $469 million, based upon an 8.9% stake and a projected equity value of $5.25 billion.
That $5.25 billion in future equity value is equal to 10 times projected 2021 EBITDA of $627 million minus $1.02 billion of debt and ignoring cash. My future equity valuation estimate represents an 11.1% annualized return for shareholders over the five-year period, assuming a starting equity value of $3.105 billion. Since the 2nd lien noteholders are purchasing most of their equity at a 45% discount, their IRR on the stock is higher at 31.9%, according to my estimates.
The bankruptcy plan’s estimate of $3.105 billion for the starting equity value represents a forward EBITDA multiple of 4.8 times, based upon projected 2017 EBITDA of $1.05. My valuation assumption therefore assumes that the forward multiple will increase from 4.8 to 10.0 times, primarily as a result of an expected decline in projected EBITDA from $1.05 billion in 2017 to $627 million in 2021.
Some might therefore argue that a 10 times terminal value multiple is too high for a company that is projected to have flat or declining EBITDA; but I believe that Peabody’s financial projections are conservative, so that its future equity value could come from a bump in the multiple or (more likely) a more optimistic outlook for 2021 EBITDA. Said another way, the low 2017 forward EBITDA multiple anticipates a decline in projected EBITDA and half of the increase in 2021 equity value comes as a result of reduced debt.
Putting the cash flow streams together for the new 2nd Lien Notes and equity, as given in the table above, yields a total cash flow projection, given in the column on the far right. This cash flow stream translates into a projected IRR (or compounded annualized return on investment) of 16.1%.
General Unsecured Claims (Class 5B). Most of Peabody’s general unsecured claims, totaling $3.7 billion out of the estimated range of $4.0-$4.2 billion, consist of the unsecured senior note issues, including the 6% Senior Notes due 2018, the 6.50% Senior Notes due 2020, the 6.25% Senior Notes due 2021 and the 7.875% Senior Notes due 2026. Under the bankruptcy plan, the unsecureds will receive $5 million in cash as well as straight equity and subscription rights representing a potential stake of 51.4% in Peabody’s reorganized equity.
Using a similar methodology for valuing the equity stake and subscription rights, I estimate the value of this recovery package at 24% of par value. The disclosure statement puts the recovery value at 22.1%.
Likewise, I estimate a potential IRR of 12.0% for the unsecured claims, assuming the additional equity investment and using the same projected equity value as for the second lien notes.
Current valuations for the unsecured debt issues seem to be all over the map, from very low trading prices for odd-lot positions to a high of about 40 cents on the dollar for the 7.875% Notes. Recent quotes for the unsecureds have been in the 40s. Those quotes are well above my estimate of 24 for the recovery package; but here too, investors may be assuming that Peabody’s future performance will be stronger than the bankruptcy plan projections.
Convertible Junior Subordinated Note Claims. Under the plan, the noteholder co-proponents have agreed to give the holders of these claims their warrants exercisable into a 1% equity stake provided that the entire class votes in favor of the plan. Under the plan equity value, that 1% equity stake is worth $31 million, which would give the junior subordinated noteholders a recovery of 8.5% of their $367 million in claims. I have assumed that the junior notes will receive those penny warrants at no additional cost. However, the disclosure statement puts the recovery value for this class of creditors at 4.2%, which suggests that they will have to pay for the warrants.
As with the other securities, the junior notes are trading above this theoretical value. The last trade that I saw was 9.75. The notes could be overvalued; but the investor who bought in at that price may also be anticipating a stronger future financial performance.
Links to related posts:
Peabody Puts Its Plan to a Vote (Part 1)
Peabody Puts Its Plan to a Vote (Part 3)
February 15, 2017
Stephen P. Percoco
Lark Research, Inc.
839 Dewitt Street
Linden, New Jersey 07036
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