Times have been tough for many players in the oil and gas industry. QEP Resources (QEP) has been no exception. Recently, rising energy prices have helped to alleviate concerns over the company’s ability to survive in the long run, but there are still issues that investors need to contend with. In an effort to create value for its shareholders and to reduce the probability of an eventual restructuring, the management team at the firm struck up an innovative and logical deal with its credit facility lenders. This arrangement, while not without precedent, doesn’t happen often and it could result in the firm saving its shareholders hundreds of millions of dollars over time.
A look at the deal
Credit facilities can be a valuable lifeline for companies, particularly those as capital-intensive as oil and gas firms. As valuable as they can be, though, they can also be dangerous. Restrictive covenants can lead to financial pains, especially when market conditions change, and the ability for lenders to change the goal posts regarding how much can be borrowed at any given time (through what are generally bi-annual re-determinations) can lead to the borrowers being pinched to pay down debt. This double-edged nature to credit facilities likely explains why management had no outstanding borrowings under its facility as of the end of its latest quarter. Any sort of amendment made to a credit facility that can ease up on its restrictions can be a boon for business. This is what we are seeing today regarding QEP Resources.
Instead of re-stating, more or less verbatim, all of the details of the amendment the company struck with its lenders, I figured it would be better to post the image above, which provides, in management’s own words, precisely how things are going to change. There’s a lot to unpack here, but the best way to sum things up is that there are four takeaways, three good and one bad. First, credit restrictions are easing up on the firm so that it can tap the facility some without fear. Second, the firm is receiving additional liquidity of $500 million as a result of these changes. The bad thing is that aggregate commitments are reducing by $400 million from $1.25 billion to $850 million, but with nothing currently borrowed, that won’t affect the company.
The biggest change, though, is management’s ability now to use up to $500 million from the facility to buy back senior notes. Generally speaking, credit facility lenders are not fond of this because they prefer to be the first lenders paid back before those who are subordinate to them. Having said that, this is not unprecedented. Even in cases where senior notes are bought back at or above par, there is almost always a lower interest rate on credit facility borrowings than there is on senior notes. Generally speaking, rate of 2% to 4% are common, though credit facility rates can be far higher than that for distressed firms. In the image below, you can see the applicable rate for the business based on the utilization of borrowings. Based on my math, with current rates in-tact, the effective rate for QEP Resources today should be about 5.315%. This includes the commitment fee if it taps $500 million of its facility.
*Taken from QEP Resources
This interest rate, though variable, is a bit lower than most of the firm’s senior notes. These range between 5.25% and 6.875% per annum. The really big benefit behind pursuing this strategy, though, is that senior notes for QEP Resources are currently trading comfortably below their par values. As of this writing, they range between 0.63 on the dollar for its 5.25% notes due in 2023 to 0.905 on the dollar for the 6.875% notes due in 2021. These prices will change and it’s unlikely that management will be able to buy a significant amount of notes back without offering some premium from their current pricing, but let’s assume that they can accomplish this (as opposed to baselessly speculating on what the future pricing may look like).
*Taken from FINRA
In the table below, I looked at three different scenarios for the firm. In the first, I assumed that the firm allocated $500 million on the basis of maturity, where the notes coming due soonest are acquired in full and the ones coming due last are effectively ignored. In this scenario, and if we assume an annual interest rate on the credit facility of 5.315%, the firm will save $11.16 million worth of interest expense each year. While this is nice, the real perk comes from the fact that the firm’s move would also result in total debt being reduced by $109.1 million.
The second scenario looks at an approach that ignores the 2026 senior notes since those are so far off into the future that management doesn’t really care about them today. Other than that, it prioritizes discount to par value. The interest savings here would be $12.17 million per year. Once again, the principal difference is what matters here and that would work out to the elimination of $274 million. The final scenario focuses solely on discount to par value, without regard to date of maturity. In this scenario, interest savings total about $15.03 million annually. Principal reduction, meanwhile, comes out to an impressive $282.1 million. For a firm with $1.93 billion in debt and only $70.3 million in cash and cash equivalents, that’s a nice change for shareholders.
Financial engineering is a beautiful thing. The ability to move paper around and create millions and sometimes even billions of dollars in value as a result is incredible alluring. It’s what made me fall in love with finance to begin with. Seeing moves like this from QEP Resources, all in an attempt to create value for shareholders while reducing risk, is great and for fans of the firm the end result, if enacted by management, could serve as just one more reason to consider buying into the firm.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.