Value Investors Club / HIGHPOINT RESOURCES CORP (HPR) (HPR)

Description

not pay more than $.50 for these bonds. You could be rewarded with ~50% return within 1 year and maybe even a little more if the “static tradeoff theory”

of corporate ﬁnance is right.

High Point Resources (HPR ) is a small E&P in North East Colorado that is being forced into a merger with Bonanza Creek (BCEI) by the HPR

bondholders. Speciﬁcally, Franklin Resources owns ~70% of the bonds and has orchestrated the deal. The HPR bonds will become equity & debt in

the combined HPR/BCEI entity. They already share many operations and the synergies created will be real. Upper management for Highpoint

appears to be exiting the stage. Here’s a map showing where the 2 companies operate:

This part of Colorado is making a lot of news related to local NIMBY restrictions and Federal ban on drilling news. These maps indicate Bonanza Creek and Highpoint are relatively safe from both Federal and local restrictions on drilling.

When they announced the deal oil was around $40 a barrel (vs. $58 now). HPR and BCEI were both hunkered down at $40 a barrel - both were

worried about the future, HPR more so because of debt coming due in ’22. Either way, no big drilling programs for them at $40/barrel. The proposed

deal would help them both be more competitive at low oil prices - less G&A, less interest expense.

The plan (sponsored by Franklin) wants the remaining bondholders to tender so they don’t have to force an exchange via bankruptcy.

The plan says they need 97% to tender to make the deal go without bankruptcy (they have 83% as of the deal announcement).

If you just look at the share price allotment you see the bonds are worth between $.45 and $.56 depending on how many bondholders tender.

I’m going to use PV10 to discuss the value opportunity instead of looking at the share allotment & current share price.

I realize there are ﬂaws in valuations based on PV10 but in this case I believe it is a reasonable and consistent starting point since the companies

operations are so similar.

With that in mind, here’s the value proposition for buying the bonds and supporting the merger:

HPR’s 2019 PV10 was $962 million

BCEI’s 2019 PV10 was $858 million.

Combined it will be $1,820 million + $150 million in synergies = $1,970

The combined entity will have between $230 million in debt, leaving $1740 available to equity.

HPR bondholders get 30.4% of this which works out to $528 million of net PV10.

Currently, BCEI equity-only capital structure trades at 67% of PV10. It is logical and conservative to believe the new entity will trade at a similar

discount to what BCEI trades at now because like BCEI, it will not be burdened by the risk of default. So, using BCEI’s current discount, HPR

bondholders equity piece will be worth 67% of the $528 million of net assets (PV10-debt), which equals $354 million.

That $354 million works out to be $.56 per $1 debt outstanding, assuming all bonds tender. I’m being extra conservative here by including a tiny bit of

the HPR RBL in the total debt outstanding. I believe that the amount outstanding on the RBL is at least $30 million less than what I used here.

HPR bond holders will also get a $.025 consent fee and up to $.16 in new debt … making the deal worth up to $.75 per $1 of bond, or ~50% more

than current price.

Let’s talk about the “up to $.16 in new debt”: In addition to the 30.4% equity, HPR bond holders get up to $100 million in new debt. The $100

million is lowered by the face value of the amount of bond holders that do not participate. If no more HPR bondholders agree to the tender than the 83% supporting the plan as of the announcement, then that works out to be $106 million, soaking up the entire $100 million. Regardless of how many

of the remaining 17% of bondholders participate, the new entity will have ~$100 million in debt relating to these bonds… whether it is (1) the old

bonds themselves, (2) the newly issued bonds to participants - or mix of the two. So, I think BCEI management doesn’t really care if bondholders

participate in the tender.

Currently, HPR debt trades at 68% discount to PV10. HPR and BCEI could be a case study on capital structures. According to the “Static- Tradeoff Theory” of corporate ﬁnance the combined entity could maximize value by having an amount of leverage somewhere between what BCEI and HPR have now. Unfortunately, the theory stops shy of telling you the actual magic number. I used BCEI’s discount in my above valuation. Theoretically, it should be even less of a discount - that is all upside.

The downside is limited:

(1) If everything falls apart and commodities turn south there is almost no

debt senior to these bonds. At the end of the 3q they had $130 million on

revolver (RBL) but they have been paying that down since then. If these

bonds were converted to equity at the current price, the equity would trade

at 27% of PV10. That’s likely less than liquidation value in a bankruptcy.

(2) These bonds traded at over $.90 in January of 2020 when commodity

prices were as they are now. The bonds traded at $.30 prior to the

announcement, and traded up to $.45 after the announcement. Oil went to

negative $38 in 2020 and these bonds were trading higher than they trade

now. These bonds traded at an all time low of $.22 in mid-2020 at the

darkest, covid-induced moments when many energy companies like CHK

ﬁled for bankruptcy.

(3) HPR had 95% of their commodity price exposure hedged during 2020.

They have 50% of their 2021 production hedged at $50+. I don’t know

what hedges they added recently but I’m hoping they didn’t hedge at lower

than their lifting costs!

(4) Franklin Resources is full of cash and conﬁdence after raping &

pillaging the unsecured bondholders of Chesapeake. This deal makes a lot

of sense for them from all angles. I don’t think they want to get dragged

into court again to defend their aggressive deal, behind-the-scenes

negotiation or non-arm’s length transactions. Bankruptcy introduces a lot

of uncertainty. Why would Franklin NOT waive the minimum required

consent agreement (they’re up to 83% now?).

Here is my estimate of what Franklin makes in various support results

(assumes equity in new entity trades at 67% of net PV10):

IF all bondholders tender/consent Franklin nets: $.75

IF only 83% of bondholders tender/consent Franklin nets: $.70

IF they go BK and they force the deal I estimate Franklin will have $10

million in bk-lawyer fees, the company will have $30 million in additional

fees, thus Franklin will net $.69

It will not be a smooth bankruptcy with oil prices where they are and the

BS-plan. The judge will look at equity prices of HPR and it will not pass the

sniff test.

Legal fees for BK:

CRC, quick, uncontested, $34 million in legal and professional fees relating

to reorganization

WLL, quick, uncontested, $47 million in cash paid for reorganization items

Balance that against what it could cost to payoff the remaining bondholders

($106 million): the breakup fee if the deal doesn’t happen ($6 million) and

BCEI has plenty of room on their revolver for the loser, short-sighted

bondholders who don’t participate in the tender in hopes of making a quick

buck. Or I should say quick buck and penny because there is a 1 penny

change of control premium.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

March 12 meeting:

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			2021	2022
Price:	0.45	EPS	0	0
Shares Out. (in M):	4	P/E	0	0
Market Cap (in $M):	52	P/FCF	0	0
Net Debt (in $M):	625	EBIT	0	0
TEV (in $M):	0	TEV/EBIT	0	0