Description

Thesis

California Resources Corporation is insolvent, seriously low on liquidity, and highly likely to file for bankruptcy in the next 3 months. The company will almost certainly skip a ~$73MM interest payment due on June 15th for its second lien notes given the company’s precarious liquidity position. Earlier this year, CRC attempted an exchange offering to push out its 2021 maturities. In March, the exchange offer failed, making a restructuring inevitable. Levered over 10x on stale consensus estimates for 2020 EBITDA (more like 20x leverage on strip pricing), CRC equity is clearly worthless in a restructuring. Bizarrely, CRC equity is up 134% since April 1st providing investors with an attractive short opportunity into the company’s restructuring. Interestingly, CRC’s bonds did not experience the same rebound as its equity did in April. CRC’s first lien debt trades around 50% of par implying an enterprise value of $1.4 billion versus the $5.0 billion enterprise value priced into the equity. CRC second lien bonds and unsecured bonds currently trade at or below 5% of par implying that CRC’s equity and its unsecured and second lien debt are unlikely to receive much if any value in the inevitable restructuring. While CRC stock borrow is difficult (and the stock is a very attractive short if you can get borrow), the company also has a reasonably liquid options market. I recommend buying August put options or selling call options if you can’t secure borrow. 

Overview

A capital structure arbitrage trade in CRC was written up by surf1680 6 months ago. That write up did a good job in outlining the situation that existed before the collapse of the oil market caused by COVID-19 and the Saudi-Russia price war. 

https://www.valueinvestorsclub.com/idea/CALIFORNIA_RESOURCES_CORP/8369117020#description 

CRC is the largest oil producer in California. 

The company has F&D costs of around $8.75/barrel and has grown. The company’s cash operating costs per barrel (before overhead costs) are around $19/barrel.

The company was overlevered at the time of its spinoff from Occidental Petroleum (which occurred at the beginning of the 2014 oil price crash) and the company has spent the last 5.5 years trying to delever. Management has done a good job keeping the equity dream alive throughout the last 5.5 years through aggressive balance sheet restructuring actions. 

In the 2017-2019 time period the company did several joint ventures with capital providers in order to accelerate development of the company’s reserves.

That said, management has been pretty deceptive in its communications with investors. For example, in its March 2020 presentation (when Brent prices were already in the low $50s) the company was using $55 brent prices as the “low case” for its reserve values it was showing shareholders. 

In reality, at current oil prices below $20/barrel, the company has few economic drilling opportunities.

Capital Structure

Note: In addition, the company has a $517MM Asset Retirement Obligation

These numbers are adjusted to include the complete monetization of the hedge book for $76MM as well as the use of the revolver to pay off the $100MM of unsecured bonds that matured in January 2020. CRC’s debt maturities are heavily concentrated in 2021 and 2022.

Note: CRC’s first lien debt trades around 50% of par implying an enterprise value of around $1.4 billion versus the equity which implies an enterprise value of around $5 billion. 

CRC’s second lien bonds currently trade at under 5% of par.

CRC’s unsecured bonds likewise trade around 5% of par value

The failed exchange offering

On Feb 22nd, CRC launched an exchange offer for most of the company’s second lien and senior unsecured notes the option to exchange them for debt and equity in a new entity that holds a royalty interest in Elk Hills or a new term loan and warrants convertible into common stock. The transactions were designed to cut debt by $1 billion and reduce annual interest expense by $64 million. 

On March 2nd, the company presented at the Raymond James conference. 

On March 5th, the company issued a press release indicating that demand to participate in the exchange offer was strong. 

On March 9th, CRC announced that it was reducing its capex to “mechanical integrity” levels. The company also announced that it had monetized all of its crude oil hedges post Q1 2020 bringing in $76MM in cash. 

On March 16th with the collapse in oil prices the company abandoned the exchange offer. At the time the company stated: “The Company is terminating the Offers as a result of recent developments in the commodity and financial markets that render the Offers inadvisable and impractical. The Offers were subject to conditions in the Offering Memorandum and Solicitation Statement, dated February 20, 2020, that will not be satisfied given current market conditions. The Company has determined not to extend or amend the Offers but rather to pursue other alternatives, which could include a similar but modified exchange, to delever its balance sheet and protect the value of its business during this market dislocation.”

On March 27th, in response to articles in Bloomberg saying the company was considering a bankruptcy filing, the company issued a press release stating: ““Over the past five years, we have consistently pursued options to preserve and enhance the value of CRC and we are fighting hard for the best outcome for our shareholders and other stakeholders. We have significant operating flexibility and are focusing on controlling what we can control, including reducing our capital program and operating costs. We will continue to consider all options with our advisors as we work through this unprecedented downturn and do not intend to provide updates on on-going discussions.”  -- Not exactly a denial of the bankruptcy speculation. 

According to media reports, CRC is being advised by Perella Perella Weinberg while the first lien lenders are working with Davis Polk and Evercore. 

CRC is in the middle of a liquidity crisis

CRC had a May 1st borrowing base redetermination under its revolver. The revolver and cash on hand are the company’s only sources of liquidity at present. CRC has not yet announced whether there were any changes in borrowing availability under the revolver in response to the recent collapse in oil prices. Reductions of the borrowing base of under $1.4 billion will only reduce available liquidity by $100MM though larger borrowing base redeterminations would have larger impacts on liquidity. 

“We cannot assure you that the lenders under the 2014 Revolving Credit Facility will not reduce our borrowing base by a material amount as a result of the proposed exchange offers or otherwise. Any reduction in our $2.3 billion borrowing base would only have the effect of reducing the commitment under the 2014 Revolving Credit Facility by up to $100 million unless the borrowing base reduction exceeded $1.4 billion, at which point the reduction and loss of availability would be dollar for dollar. Any reduction in our borrowing base could materially and adversely affect our liquidity and may hinder our ability to execute on our development plan. We would seek to reduce our capital program and expenses and potentially monetize assets among other things to address tighter liquidity constraints. However, there can be no assurances that such actions will be possible or adequate to address such a reduction in our borrowing base. If the reduction in our borrowing base were sufficiently severe that we were unable to maintain adequate liquidity to conduct operations and meet our obligations, we could ultimately be forced to seek bankruptcy protection.”

In its 10-K, CRC reveals that the company had $317MM of available borrowing capacity under its revolver as of 12/31. The company used $100MM of this borrowing capacity to pay the maturity of its senior unsecured bonds which matured in January. With the borrowing base almost certainly revised lower by at least $100MM, we estimate that at best CRC has $117MM in remaining borrowing capacity under its revolver and total remaining liquidity of under $200MM when taking into account the impact of the monetization of the company’s hedges. 

Catalyst

CRC faces a $72.6MM interest payment on June 15th on its second lien bonds. Given the company’s very low liquidity level and lack of additional sources of capital in the near term it seems highly likely that the company will choose to skip the June interest payment on the second lien bonds. This default will give the company a 30 day grace period with which to finalize its restructuring plan. We expect the company to file for bankruptcy by the middle of July with a plan that includes no recovery value for CRC equity. CRC also has a $4MM interest payment due on May 15th on its unsecured bonds that it may elect not to make given the company’s dire liquidity position.

If CRC were to make the June 15th interest payment, the company would likely burn over $300MM over Q2 and Q3 which would exhaust the remaining liquidity of the company and likely make obtaining a DIP facility even more difficult. 

Appendix

I’ve attached the GS Model which uses a $20 brent oil price in Q2 going to $40 by the end of 2020 and a $52.50 price in 2021. Even under these quite generous oil pricing assumptions the company is levered 20x in 2020 and over 7x in 2021.

Catalyst

June 15th interest payment on the company's second lien bonds is likely skipped. 

The company files for ch.11 bankruptcy with a plan that results in no value for the company's equity.