Capital Markets Monitor 6.7

CMM Weekly

Market Commentary

Asset prices are rising.  Investor sentiment is buoyant again.  The dark days of early March are a distant memory.  Companies are deleveraging, issuing records amount of new equity as risk appetite continues to increase.  Government inspired reflation makes it feel like the go-go days of 2006.

On Friday, monthly non-farm payroll losses declined for the 4^th month in a row fuelling hopes for a return of the consumer’s contribution to economic activity.  Consequently, the yield on the 2 year Treasury jumped 34 basis points to 1.30%.  The 10 year note’s yield hit a 6 month high of 3.84%.  Interest rate futures now price in a fed funds rate of 0.5% by December and 2.0%.  Markets are clearly signaling we have turned the corner.

The question we ask ourselves is what will the third act bring?  Investors and issuers should equally appreciate the current heady time for central banks will shortly need to decelerate the priming of the monetary pump.  That difficult orchestration requires walking a fine line of controlling price inflation while muted underlying global economic growth struggles with industrial over capacity and rising credit costs.

There is of course a rosy scenario with the US consumer gradually re-engaging over a period of years a surgically rising monetary policy sapping excess demand.  Our gut tells us the real world will be a bit messier and unforeseen pitfalls wait on the horizon.  As such, we recommend issuers raise capital while investor sentiment is healthy.  Becoming aware of the unknown can change perception.

Transactions in Focus

Issuers continue to tap an equity investor universe with an apparent insatiable appetite.  With equity prices continuing there dizzying ascent, companies are happy to fix their balance sheets and re-equitize.  Investors seem happy to help companies pay off the banks and deleverage.  We note that 51% of the $92bn in equity capital raised since March has been used to pay down debt, not exactly an application of capital that generates economic growth.

59 issuers raised 19.6bn last week as deal flow rebounded to prior levels after a holiday shortened week.  Of particular note last week, the convert market saw a pickup in activity and generally saw strong pricing and upsized deals.  With markets causing investor’s ears to pop, we assume we will see more convertible activity as these issues provide investors the downside protection of a bond, yet retain the upside through the equity exposure.

With the S&P 500 breaking through the 200 day moving average for the first time since late 2007, we wonder if additional funds will be re-allocated to equities, further driving the indices and equity issuance.

The Oil & Gas industry continues to see companies take advantage of rising sentiment and share prices.  We expect more issuers will tap avail themselves of rising investor sentiment and the reflation trade.

Mariner Energy (NYSE:ME) addressed its balance sheet by amending its credit facility, selling $250m of senior notes, and selling $145m in equity.  The equity placement represents 10% of the company’s equity and was sold in a two day marketed accelerated bookbuild.  Shares were placed down 5.5% from initial announcement and ended the week essentially flat to offer.  Proceeds are to repay debt.  As seen in the credit facility amendment, the company has essentially used equity and proceeds from the note sale to reduce the bank’s exposure.  The company’s senior secured revolving credit facility of $1.0B was amended to allow the company to issue up to $300M in additional unsecured debt.  The Amendment also stipulated that upon closing of such a debt issuance, the borrowing base automatically reduces by $50M.  The company is active in the Permian basin, Gulf of Mexico, and Gulf of Mexico Shelf.

InterOil Corporation (NYSE:IOC), an integrated energy company with operations in Papua New Guinea, raised $70m in a self placed registered direct.  The shares we placed flat to the market and led to a 6.0% rally in the equity by week end.  The placement of 5.6% of the company’s equity will help fund development of issuer’s Elk/Antelope gas and condensate fields, the development of a proposed liquefied natural gas facility in Papua New Guinea, potential acquisitions, and repayment of up to $9.0 million of its credit facility with the Overseas Private Investment Corporation.

In a move long anticipated by the markets, Cal Dive (NYSE:DVR) saw Helix Energy Solutions Group (NYSE:HLX) sell 20m shares at $8.50, a 4.7% discount to last sale, but down 15.8% from announcement.  The stock opened below issue price the next day and traded poorly, ending the week down at $8.22.  While the placement represented 21% of the shares outstanding, the significant sell off and poor pricing are typical of significant equity offerings in this market.  Of particular note, DVR also bought $14m of stock directly from HLX.  Assuming the over-allotment option is exercised in full, Helix’s percentage ownership in the company will be reduced from approximately 51% to approximately 25%.  DVR will repurchase the shares with cash on hand. The company’s revolving credit facility permits the repurchase of up to $100M worth of shares of the company’s common stock.

Also tapping increasing investor sentiment for gas services companies, Union Drilling (NASDAQ:UDRL), sold $24.7m of equity versus a pre-deal market cap of $203m.  The shares were offered down 10.2% from last sale.  Proceeds will be used to repay indebtedness outstanding under the Company’s revolving credit facility.  Of note for this transaction was in the market for a day and only saw the stock drop ~2%, notable for a micro cap company with average daily liquidity of approximately $1m.  The stock ended the week flat to offer.

In addition to the E&P and services offerings, we also note the activity from the refiners.  Western Refining (NYSE:WNR) raised $380m in a common convert placement, in which the convert was upsized to $200mk from $100m.  All proceeds are to pay down debt.  While the 5 year senior convert priced 5.75% up 20%, the common deal saw the share price fall 38% from announcement to offer. The stock fell another 5.2% post offer.  Proceeds are to pay down the company’s term loan.

Valero Energy (NYSE:VLO), the $10bn refiner, sold $720m in equity at a 19.6% discount from announcement.  The company sold the stock on the back of providing uninspiring Q2 guidance on EPS of $0.50.  Reuters prior estimate was $0.74.  The company’s Q2 2009 results have been adversely affected by extended downtime at its Delaware City and McKee refineries and by the continuation of weak sour crude oil discounts and lower diesel margins.

We note the issuance from the following Industrial companies, MasTec (NYSE:MTZ), Exterran Holdings (NYSE:EXH), and Steel Dynamics (NASDAQ:STLD)

MasTec (NYSE:MTZ), a $1.0bn market capitalization specialty contractor who builds, installs, and maintains utility, energy, and communications infrastructure, effectively sold $155m via a double barrel common convert to help refinance an acquisition.  The senior unsecured convert raised the company $100m, of which $55m was to refinance an 8% convertible note to Woznek Construction, who was the seller of 5.5m shares or $54m of MTZ stock in bought deal.  Woznek Construction, a builder of wind farms and natural gas processing facilities was bought Woznek last October for $171m in cash and an assumption of $15m debt.  The convert carried a slim 4% coupon and converted up 30%.  The bought deal was bought down 12.0% and re-offered down 9.3%.

These financings are of particular note, as MasTec had to change its original $215m all cash offer to an offer comprised of $50m cash, 7.5m shares of MTZ stock, a $55m convertible note, and a two year earn out.  One would imagine that the financing was simply not there last fall and the company was able to push through the modified deal structure.  Woznek didn’t waste any time, in selling out a majority of the equity as the lock-up expired on June 3^rd.  Barron’s over the weekend highlighted the company on it’s affordable relative valuation at 10.5x 2010 estimated EPS, vs. more than 20x for competitors such as Quanta Services (NYSE:PWR) and Tetra Tech (NASDAQ:TTEK).  The removal of the overhang could be a catalyst.

Exterran Holdings (NYSE:EXH), the builder of natural gas compressors, also tapped convertible buyers, selling an upsized $325m 4.25% senior unsecured 5 year notes which convert up 24%.  Prior to launching the offering the company announced the seizure of assets by PDVSA in Venezuela that represented 5% of annual revenue last year.  Proceeds will be used to pay down borrowings under the company’s revolving credit facility and its asset-backed securitization facility.   Investors supported the hefty issue for the $1.2bn company and only drove the share price down 2% by week’s end.

Minimill steel operator, Steel Dynamics (NASDAQ:STLD), makes structural steel and steel bar products and is a significant recycler.  This past week it cuts its dividend 25%, then proceeded to sell 27m shares at $13.50, a 13.4% discount from announcement, to raise $365m.  Along with an upsized $250m convert, the raises represented 25% of the existing market cap, which would explain the steep discount.  The convert carried a 5.125% coupon and a 30% conversion premium. The $615m in proceeds are to repay term loan borrowings under its existing senior secured credit facility.

The company’s roughly $2.5bn in debt has reportedly been an overhang on the stock.  With EBITDA expected to fall to approximately $300m in 2009 versus $1.0bn in 2008, we understand why.  This financing allowed Standard & Poors to remove the company from Credit-Watch and affirmed the company’s BB+ rating, with a negative outlook.  Investors cheered the offering, driving the stock up 9.9% by week’s end.

Transactions in Focus

Equity Capital Markets took a bit of a breather after the frenetic pace of the prior three weeks.  35 offerings raised $3.4bn last week, bringing May’s totals to 127 Deals raising $62.5bn.  We expect the equity capital markets to remain open through June, but believe investors will increasingly be more selective and demand greater pricing discounts as the broader markets settle.

Last week’s notables include several successful convertibles, a handful of bought deals, and a series of successful capital raises for companies with market caps below $300m.  In fact 7 of the 19 deals last week came from such small issuers.

Review of Healthcare Equity Issuance

Healthcare equity issuance has recently seen a spike in activity much like the broader market, particularly smaller issuers coming to market with a Registered Direct.  Year to date 71 Healthcare companies have raised $2.9bn.

Broadly speaking if the market cap of the company was north of $300 million, the companies chose a public registered equity transaction.  11 companies raising $1.7bn chose this route, with 5 of them interestingly choosing a bought deal.  The 60 companies that company had a market cap below $300m have raised $1.1bn in a Registered Direct or PIPE structure.

The deciding factor for execution appears to be liquidity.  Completed RDs in 2009 have had an average daily liquidity of $3.3m, while PIPEs have had an average daily liquidity of $315k a day.

As expected for smaller companies, the majority of capital, almost 80% has come from Private Equity/VCs and hedge funds, with the latter group more present in the more liquid registered directs.

Main Street Capital (NASDAQ:MAIN), a BDC that provides capital to small and medium sized businesses, raised $15.1m through selling 1.25m shares at $12.10, an 8.4% discount.  At offer the implied yield was 12.4%.  Of particular note for this $140m company was their ability to price above net asset value.  MAIN has the best performing stock price this year for BDCs, largely due to the nature of their investments and high percentage of senior secured loans in their portfolio.  Full disclosure, SMH Capital was a co-manager on this offering.

Terex Corporation (NYSE:TEX), capital equipment company with exposure to engineering & construction, infrastructure, mining, and utility industries, was particularly active in the capital markets last wee, pricing approximately $600m in offerings across the capital structure.  The company sold 11m shares of common stock at $13.00 to raise $143m at a 15% discount.  TEX sold $150m in convertible debt at 4% up 25%, and $300m senior notes with a 10.875% coupon slightly below par 97.63.  The $1.3bn market cap company had $1.4bn in long term debt and $344m in cash as of March 31^st.  These broad based capital structure financings are generally well received by the market, as this one was with TEX’s stock appreciating 11% from offer by week end.

REIT Equity Capital Market Issuance

We note that the surge in REIT issuance continues.  Investors appear to have an endless appetite for this equity.  Since the market lows, REITs have raised $13.5bn in equity capital.  This past week, 6 REITs raised $1.3bn at a market cap weighted 8.9% discount.

This is a market that we will watch closely for investor fatigue.  We have already heard investor’s declare that recent issuers have been lower quality.  Some issuers have come back to the well more than once this year.  Pricing has started to gap out some, and the immediate aftermarket returns are no longer there.

U.S. listed Chinese Equity Issuance

We watch closely capital raising by U.S. listed Chinese companies, as many of these company have superior growth rates and below market valuations.  The strength of the domestic mainland stock market and economy, the confluence of increasing risk appetite and money flows toward Asia, make this group one to watch as a barometer for small cap growth financing.

There are literally hundreds of quality small cap Chinese companies listed in the US.  Most of these companies came public via a reverse merger with an associated PIPE financing from a small number of China savvy investors.  This has left the companies with limited liquidity and unbalanced shareholder structures, making them prime for a larger audience.  We believe that in the coming months, you will see some of these companies graduate from the OTC market to list on a national exchange.  These will often accompany an equity financing in part to broaden their limited shareholder base.  A broader more balanced shareholder base should help their liquidity and valuation.

While recent Chinese equity financings have been to a limited number of investors, we do note the presence of new funds not previously associated with Chinese financings putting sizeable money to work.  With domestic growth rates expected to be subdued and the potential for the dollar to decline and renminbi to appreciate, investors in Chinese equities could see substantial returns.

Capital Markets Monitor – June 1st

The U.S. government’s confidence game continues to win believers.  Equity and credit markets ended May still on fire, with the rally sustained last week, and significant new issuance absorbed.  The S&P 500 index posted its strongest three month gain (+25.0%) since June 1933.  The yield curve is the steepest in some time, with a record spread between the 10 and 2 year notes.

Despite surging U.S. consumer confidence, consumer economic data remains distressed.  Initial jobless claims are holding strong, while continuing claims increased to record levels.  At least existing housing sales appear to be stabilizing, though supply versus the current sales rate rose to 10.2 months in April.  The summer selling season will be telling.

Durable goods beat with a healthy headline, but the reality was more sobering as gains were driven by a downward revision of March’s number.  In fact, companies appear to be cautious with their capital expenditures, as new orders for nondefense capital goods fell 2.0 % after slipping 0.9 % in March.

With the government deficits inciting inflationary flames, we enter June with increasing downward pressure on the dollar.  Marching the other direction – in a repeat of recent years – the price of oil and gold are climbing strongly.  Oil prices ascent is flummoxing industry veterans who point weak fundamentals and high storage levels.  While a rapidly declining North American rig count is bound to have a lag effect on the margin, we note the spike in the domestic offshore rigs.  Commodities are certainly showing their resiliency as an asset class.

Capital markets continue to support extraordinary issuance and pricing remains generally healthy.  As long as secondary pricing holds, issuers will continue to bring financings to market and remove balance sheet uncertainty.  The question issuers must wonder is how long the window will remain open.

Capital Markets Monitor – June 1st

Transactions in Focus – 5.26

Transactions in Focus

Equity capital markets are extremely robust with investors supporting issuance from companies large and small.  44 offerings raised $24.6bn last week with 19 of those transactions from companies with market caps below $1bn.  With so much activity, we will only review the IPOs and energy offerings in detail.

With surging indices emboldening risk taking, investors welcomed two IPOs last week.  Each transaction priced above its expected midpoint, each raised more than expected, each had VCs as selling shareholders, and each had positive returns by week end.  The positive reception is bound to encourage others to join the party.

Energy companies, particularly E&P issuers, are actively raising equity capital in this environment with a flurry of issues in the past two weeks.  6 issuers raised $666.8m, the group’s most active week since commodity prices started declining last year.  Most of the proceeds are allocated for deleveraging.  Forest Oil (NYSE:FST) raised $262m in a bought deal financing sold to a pair of banks down 9.0%.  The placement of 13% of shares outstanding was re-offered at $18.25, a 5.9% discount to last trade.  The stock ended the week down 4.2%.  Proceeds were to pay down debt.

Brigham Exploration (NASDAQBEXP), raised $99m versus a $135m pre-deal market cap.  The share dilution was greeted with a total discount from announcement of 21.2%.  One of the few transactions to publically market broadly over several days, pricing came in notably better than some of the market chatter.  The company raised the equity to address their outstanding debt, which includes $158m of senior notes and $145m drawn on a credit facility.  Investor’s cheered the action, pushing the stock up 8.4% in a week energy tape.

We note the similarities to last week’s GMX Resources (NASDAQ:GMXR) deal.  GMXR raised $69m to pay down a credit line it was utilizing to fund operations.  The company had drawn $145 million on this credit line as of March 31.  Issuing equity was a necessary move by the company.  Although the company was in compliance with its bank credit line covenants, GMX disclosed that it was in violation of the minimum tangible net worth covenant of its senior note. The note holder waived compliance with the covenant.  GMXR shares ended this week up 22.2% from offer.

Penn Virginia Corp (NYSE:PVA) also raised equity to pay down its credit line.  The company sold 3.5 million shares at $19.00 per share through a bought deal financing to raise $66.5m.  The 7% of the company was re-offered down 6.0%.  The company had borrowed $390 million on it’s recently reduced $450m credit line as of March 31.  The company also had $595m drawn against a $800m revolver securitized by the assets of Penn Virginia Resources (NYSE:PVR), an MLP subsidiary.  Despite also announcing ongoing review of other long term debt financing and asset monetizations to improve the companies liquidity position, investors were underwhelmed pushing the stock down 9.0% by week’s end.

Gastar Exploration (AMEX:GST), an unprofitable unconventional gas company with a pre-offering $93m market cap, successfully raised $14.6m in a registered offering.  The transaction priced down 21.5% and traded flat to offer.  Production in 2008 was 23.3 Mmcfe/d The company has proved reserves of approximately 75bcf in the Haynesville & Marcellus shales, as well as in New South Wales, Australia.  We take note of this offering, for the speculative nature of the company and its limited liquidity.  We wonder how much institutional money participated.

Other energy companies raising equity last week included Spectra Energy Partners (NYSE:SEP), the pipeline and storage MLP, that raised $198m vs a $1.1bn market cap.

Interestingly, power and utility companies are also tapping the equity capital markets.  Covanta Holding Corp (NYSE:CVA) raised $400m in an upsized convertible priced with a coupon of 3.25% up 22.5%.  This was one of 8 converts priced to raise $3.0bn last week.  UIL Holdings Corp (NYSE:UIL) raised $84m in a common stock deal down 12.5%.  FPL Group (NYSE:FPL) raised $345m in a convertible preferred sale at 8.375% up 20%.  Until Corp (NYSE:UTL) raised $48m in a fully marketed transaction.  Lastly from the renewable energy sector, Evergreen Solar (NASDAQ:ESLR) raised $66m in equity.

Without extensive review other transactions of note last week include: Beckman Coultier (NYSE:BEC), the medical device and diagnostic tool company, priced a $250m forward sale offering, that in conjunction with a $500m senior note offering, will help pay for the acquisition of Olympus Corporation’s life science business.  Prospect Capital (NYSE:PSEC), the BDC with an energy legacy, successfully sold an increased 6.75m shares to raise $64m versus a $297m pre-offer market cap.  MSCI Inc (NYSE:MXB), the financial products company, saw major shareholder Morgan Stanley (NYSE:MS) sell the remainder of its position in the company to raise $595m, one of the few pure secondary offerings seen recently.

Equity capital markets are extremely robust with investors
supporting issuance from companies large and small. 44 offerings
raised $24.6 billion last week with 19 of those transactions from
companies with market caps below $1 billion. With so much
activity, we will only review the IPOs and energy offerings in detail.
With surging indices emboldening risk taking, investors welcomed
two IPOs last week. Each transaction priced above its expected
midpoint, each raised more than expected, each had VCs as
selling shareholders, and each had positive returns by week end.
The positive reception is bound to encourage others to join the
party.
Energy companies, particularly E&P issuers, are actively raising
equity capital in this environment with a flurry of issues in the past
two weeks. Six issuers raised $666.8 million, the group’s most
active week since commodity prices started declining last year.
Most of the proceeds are allocated for deleveraging. Forest Oil
(NYSE:FST) raised $262 million in a bought deal financing sold to
a pair of banks down 9.0%. The placement of 13% of shares
outstanding was re-offered at $18.25, a 5.9% discount to last
trade. The stock ended the week down 4.2%. Proceeds were to
pay down debt.
Brigham Exploration (NASDAQBEXP), raised $99 million versus
a $135 million pre-deal market cap. The share dilution was
greeted with a total discount from announcement of 21.2%. One
of the few transactions to publically market broadly over several
days, pricing came in notably better than some of the market
chatter. The company raised the equity to address their
outstanding debt, which includes $158 million of senior notes and
$145 million drawn on a credit facility. Investor’s cheered the
action, pushing the stock up 8.4% in a week energy tape.
We note the similarities to last week’s GMX Resources
(NASDAQ:GMXR) deal. GMXR raised $69 million to pay down a
credit line it was utilizing to fund operations. The company had
drawn $145 million on this credit line as of March 31. Issuing
equity was a necessary move by the company. Although the
company was in compliance with its bank credit line covenants,
GMX disclosed that it was in violation of the minimum tangible net
worth covenant of its senior note. The note holder waived
compliance with the covenant. GMXR shares ended this week up
22.2% from offer.
Penn Virginia Corp (NYSE:PVA) also raised equity to pay down
its credit line. The company sold 3.5 million shares at $19.00 per
share through a bought deal financing to raise $66.5 million. The
7% of the company was re-offered down 6.0%. The company had
borrowed $390 million on it’s recently reduced $450 million credit
line as of March 31. The company also had $595 million drawn
against a $800 million revolver securitized by the assets of Penn
Virginia Resources (NYSE:PVR), an MLP subsidiary. Despite
also announcing ongoing review of other long term debt financing
and asset monetizations to improve the companies liquidity
position, investors were underwhelmed pushing the stock down
9.0% by week’s end.

Capital Markets Monitor 5.26

The U.S. capital markets remain the most robust in the world.  U.S. companies have raised $117.7 billion ($27.1 billion high-yield and $90.6 billion equity) across the high yield and equity markets in Q2 facilitating a deleveraging and extension of debt profiles.  This ongoing re-equitization is a natural and needed part of the healing process post credit bubble.

As investors rightfully question the sustainability of the current market rally, issuers need to ask themselves how much issuance the markets can absorb before investors say no more or start asking untenable pricing.  Among other signs, we watch secondary pricing and changes in new issue pricing to determine if supply is overwhelming demand and causing investor fatigue.  For example, issuers and investors should heed the rising yield of the 30 year bond, particularly as we learned this past week that Chinese authorities are shifting their purchases toward shorter maturity paper.

As to the current market rally, the proof is not in the pudding, but in corporate earnings.  Q2 was generally better than expected, though driven largely by cost cutting.  In light of the combined headwinds evidence of top line revenue growth will be essential for any continuation of the current market rally.  As we look toward Q3, current consensus estimates calls for an 21.0% decline year over year in S&P 500 EPS, but a 34.0% sequential increase quarter over quarter.

Capital Markets Monitor 5.26.2009

Past Capital Market Monitors

May has been an extraordinary month for the capital markets as well as for my family with the arrival of our first child.  Please find attached the Capital Markets Monitors for the past few weeks.

As always, you can submit a request to be added to the distribution list.

Capital Markets Monitor 5.4.2009

Capital Markets Monitor 5.11.2009

Capital Markets Monitor 5.18.2009

Credit Markets – 4.27

Credit Markets

This week saw the leverage loan and high bond markets continue their Spring thaw.  We saw significant new issue activity in the bond market with 5 deals closing that totaled $2.43 billion.  We highlight in the Energy section one of those issues; Encore Acquisition Company’s $225 mm in senior subordinated Notes that are rated B and yield 11.125%.  This is one of the few B-rated issues this year in the E&P space.  Out of 12 E&P bond issues in the USA so far this year,

Secondary corporate HY bond market volume was robust at $24.3 billion, up from $22.9 billion for the prior week.  The Merrill Lynch HY Master II Index gained over 5 points to close at 488.76, giving a return of 108 bp for the week and 12.39% YTD. 

 

In the loan market, we saw healthy primary activity with notable deals launched by Michael Foods, Sears, and PharmaNet.  In the secondary market, bids continued to move upwards, up about a point to 67.1 as measured by Thomson Reuters. 

Notably in the energy sector, Rosetta Resources succeeded in upsizing their Second Lien Term Loan to $100 from $75 mm.  We highlight that in the Energy sector.

On the downside, S&P thinks HY defaults could reach 14.3%, even in light of economic growth starting in 3Q09.  In our opinion this is an echo of some rather weak underwriting standards a few years ago.

 

A quick search shows that LBOs were heavily financed with weak bonds in the recent past.  As an indication we provide a table of HY bonds outstanding that are were issued to fund LBOs in 2005 – 2008.  In 2007 alone, a remarkable 77% of the bonds are CCC.

 

Along side these bonds are loans, many of which are being amended.  With a little help from S&P and Fitch, we thought it might be interesting for our readers to review some of the current trends in leveraged loan or middle market loan amendments.

During the first 3 months of 1Q09, the pace at which companies sought amendments on bank loans accelerated.  In fact, they nearly doubled each month: 16 in January; 31 in February; and 51 in March.

This trend may well continue as non-investment grade US companies have about $177.5 billion of debt (loans and bonds) maturing in 2009 and $179 billion coming due in 2010, according to S&P.

Essentially, banks are pressing for rate increases and fees for middle market borrowers as part of the covenant relief process.  The trend in the first quarter was sharply up 125% for amendments requesting relaxed covenants tests, according to S&P.  The driver was year-end reporting which has usually requires tests on covenants and asset-based lending criteria.

In the first quarter of 2009, S&P reported that 18 middle market issuers requested relief through amendments, up from eight in the fourth quarter of 2008.  Pricing can be obtained on eight of the ’09 amendments.  In these cases, banks re-priced loans an average of 253 bps, about double the 129 bp increase in 4Q08 (sample of six). Admittedly, the middle market data pool is small, but it provides a helpful snapshot of market dynamics.  Most of these issuers had loans of $75-100 million or greater.

As a result, post-amendment credit spreads have increased to an average of L+475.  That compares with L+438 in 4Q08. The date from 2008 includes NaviSite, which suffered a double whammy spread increase: (i) 100 bp in cash and (ii) 200 bp in PIK.  S&P did not include the PIK portion  in the data component for 2008.  Of the 8 2009 cases, three issuers got new pricing at L+600 or higher. Only NaviSite reached as high as L+600 for 2008 names.

Of the 18 in ’09, S&P can track approval fees on six transactions.  Lenders charged an average of 60 bps, up 9% from 4Q09. Notable is a trend among several 2009 deals that had approval fees of 100 bps: St John Knit (rated B) and Medical Staffing (Unrated).

Compared to the broader leveraged loan market in 1Q09, mid-cap companies suffered larger spread increases, although fees were nearly the same. The overall market saw pricing rise by an average of 204 bps, while amendment fees averaged 57 bps.

In the first quarter banks also continued to push for reductions in leverage.  Asset-based revolver availability was reduced by an average of $40 million, based on 6 middle market issuers that suffered adverse redeterminations. We expect more of the same in the second quarter in the energy sector from annual Borrowing Base Redeterminations.  By contrast in 4Q08, only 2 issuers saw their revolvers reduced by $50 million and $15 million, respectively.

In general creditors are granting a maximum of 20% margin for error on covenants.  However, if Sponsors are actively supporting their portfolio companies with equity injections or debt repayments, then more headroom is available.  Banks are trying to keep some borrowers on a short leash; the duration of the covenant relaxation lasts from two quarters to as much as a year or more.

A recent example of the interactions between creditors and Sponsors can be gleaned from Houghton International, a private chemical company.  In recent weeks, arrangers gave Houghton International one year to pull out of the recession.  They creditors successfully introduced a $15 million capital call if the chemical concern does not meet current covenants by early 2010.  Houghton is a larger middle market issuer with several institutional accounts among its lending syndicate.  It paid lenders a 50 bps amendment fee, agreed to a 150 bps rate increase that took pricing to L+600, and agreed to less RC availability.  AEA Investors is the financial sponsor.

By contrast, sources to S&P say that the issuer “Friends & Favors Club” got the benefit of relationship lending in below-market rates.  Its no surprise that companies with strong banking ties and ancillary business for banks are more likely to negotiate tighter spread increases. Because banks assess a relationship from the perspective of the total economic return (those ancillary fees and the credit spread), it’s still possible to get avoid a full mark-to-market on amended pricing. 

Club-size loans, which S&P LCD does not track widely, are seeing amendment fees in the 25-50 bps range depending upon the borrower, they said. Typically, these loans are $75 million or less and held by two to three lenders. Commercial bankers today often loosely target in the L+650-675 area.

The trends described in the S&P review are in line with some of the amendments announced in the last week. 

 

Ø      Krispy Kreme Doughnuts Inc. amended its credit facility with revised pricing and the consolidated leverage and interest coverage ratios. Pricing on the facility is now LIBOR plus 750 bps with a commitment fee of 100 bps. The leverage ratio was changed to 4.75 for the 2009 fiscal year, declining ratably to 2.00 for the 2013 fiscal year and thereafter. The interest coverage ratio was changed to 2.50x for the 2009 fiscal year, increasing ratably to 4.50 for the 2013 fiscal year and thereafter. Also, as part of the amendment, the revolver was reduced to $25 million and the company prepaid $20 million of its term loan.

 

Ø      Quicksilver Resources Inc. amended its senior secured revolving credit facility, increasing pricing and the unused fee. Pricing on the revolver can now range from LIBOR plus 225 basis points to 325 bps, based on usage, up from a previous range of LIBOR plus 137.5 basis points to 212.5 bps. Spreads will decrease by 25 bps upon full repayment of the company’s second-lien term loan. The unused fee is now set at a flat rate of 50 bps as opposed to being able to range from 25 bps–37.5 bps. In connection with the amendment, the borrowing base was reaffirmed at $1.2 billion.

 

Ø      Las Vegas Sands Corp. completed the amendment to its credit facility that allows for the repurchase of up to $800 million of its term loan debt through Dutch auctions. All repurchases must be done before Sept. 30, 2010, and there is a minimum tender amount of $25 million.

 

 

Ø      Wynn Las Vegas LLC amended its senior secured credit facility, modifying covenants, extending the maturity on some of the revolver commitments and increasing pricing. The amendment waived the leverage covenants until June 2011 and increased leverage thresholds thereafter. In addition, flexibility was gained under the interest coverage ratio. Under the revolver, about $610 million of the remaining $697 million commitments was extended to July 2013 from August 2011. Pricing on Revolver 1 is LIBOR plus 162.5 basis points, pricing on Revolver 2 is LIBOR plus 300 bps and pricing on the term loan B is LIBOR plus 187.5 bps. Furthermore, the amendment removed the dollar cap on the equity cure for covenant calculations over the life of the loan.

 

Ø      Select Comfort Corp. amended its credit facility, waiving compliance through May 8, 2009, with certain covenants. Compliance was waived for the minimum interest coverage ratio for the fiscal periods ended Dec. 31–March 31, the maximum leverage ratio for the fiscal period ended March 31, 2009, and the EBITDA covenant for the fiscal period ends Dec. 31, 2009. In addition, the requirement to deliver audited fiscal-year 2008 financials without a going concern qualification or exception was waived as well. The amendment also transferred about $23 million in company funds previously held in a cash collateral account to reduce the outstanding balance under the credit facility. Also, an availability covenant was added that caps the amount outstanding under the credit facility at the aggregate commitment less $18 million, or a net aggregate availability of $67 million. The net effect was to reduce outstanding debt by $23 million and provide about $5 million in additional availability.

 

Energy in Focus

Energy In Focus

 

This week we highlight a few notable financial developments in the energy sector; (i) the Encore Acquisition Corporation bond issue, (ii) 2009 year-to-date E&P bond issuance, (iii) Rosetta Resources’ second lien loan amendment, and (iv) downstream asset valuations.

 

Encore Acquisition Corporation

This week saw EAC price $225 mm of B rated senior subordinated bonds with a 9.5% coupon due May 1, 2016 (7 years).  The bonds were priced at 92.22% of par to yield 11.125%.  They are already actively trading in the secondary market (a good sign) with yields ranging from 10.47% (price = 95.25) to 10.67% (price = 94.25). 

 

There are several take-aways from this deal.  One, in a pattern consistent with other offerings this year, issuers must offer bond investors good value.  The pop in price of 2 to 3 points is a healthy mark-to-market for holders.  In this case the yield enhancement was about 50 bp, which is less than many deals earlier this year.

 

Two, EAC is a known issuer, now with four issues outstanding totaling $825 mm.  This is consistent with the pattern this year; only known issuers are not coming to market.

 

Three, the use of proceeds is to reduce (reload) bank lines.  Although this is a financial purpose, as opposed to an economic purpose (ie acquisition of assets), the net debt position of EAC remains almost unchanged at $1.324 billion. 

 

The Standardized SEC PV-10 for EAC as of 12/31/08 was $1.2 billion (after tax and P&A) and the pre-tax PV-10 was $1.4 billion.  The proved reserves are 80% PDP.  Excluding probables and acreage, EAC has an LTV of 1.1x ($1.32/$1.2) and 0.94x ($1.32/$1.4).  Although we have not adjusted for changes in the PV-10 price decks, it seems the bondholders have adequate asset coverage. 

 

As we have discussed before, B rated issues have suffered this year in a flight to quality compared to BB rated issues.  We believe there are several other B rated E&P issuers waiting in the wings to tap the markets.  Now that the log jam seems to be breaking, we expect more B rated issues in the weeks to come. 

 

E&P Bond Issuance in 2009

So far in 2009 we have tracked 11 E&P bond issues from domestic US companies.  Pemex also issued two bonds, but as a national oil company we will put them aside for this review.  We provide a table that shows 2009 E&P bond issuance year-to-date.

 

There are not many surprises in the results, but we do point out that the volume and average maturity decline with rating.  The average yield spread between BBB (6.649%) and BB (9.772%) issues is about 3.125%.  This is considerable when compared to the 55 bp step-up from a BB to a B (10.327%). 

 

Furthermore, it’s no surprise that the average maturity of BBB bonds (7.8 years) is longer maturity than the BB (6.5 years) or the B bonds (5.7 years).  Given the rising yield curve, if we were to adjust for differences in maturity, then the yield spreads would be even wider.

 

We also find the yield dispersion on the bonds to be interesting.  We can see the impact of maturity on BBB yields with Devon; five years difference in maturity results in a 100 bp increase in yield.  Moreover, Devon and Noble Energy both have comparable 9.8 year maturities and differ in credit rating by 1 notch, yet there is a rather significant 140 bp difference in yield. We also see that the BB rated PXP bond with 6.8 years life is yielding higher than single B rated issues from Encore and Forest Oil, and almost as much as Petrohawk.

 

The impact of liquidity premium can be seen between two bonds that are equally rated B-; the $1.4 billion Chesapeake (CHK) 9.5% issue and the $420 mm Denbury (DNR) 9.75% issue.  The liquidity premium is about 60 bp.  The yield differential of the CHK bond compared to the Plains Exploration (PXP) bond, also rated B-, is even wider at about 160 bp. 

 

The PXP bond definitely shows signs of poor treatment in the market compared to DNR and CHK.  The best explanation for this, in our opinion, lies in the rating dispersion.  PXP has a split rating between Moodys (B1) and S&P (BB).  The result is a composite rating of BB-, but in fact the market is pricing PXP at the lower of the two ratings.   By contrast, both DNR and CHK have solid BB ratings from both rating agencies.

 

Second Lien Loans

Rosetta Resources^[1] (ROSE) announced this week (April 21) that it increased its borrowing under the Second Lien Term Loan Agreement from $75 mm to $100 mm. This increased was achieved in two ways.  One, a fixed rate loan bearing interest at 13.75% for $20 mm, and two, an added $5 mm in a floating rate.

 

Given the general interest in second lien loans in the E&P sector, we thought it might be interesting to review ROSE from the perspective of creditors.

 

As background, the Houston-based oil and gas company has acreage in several Basins, of which the core plays are in the Bakken, the D-J, San Juan, South Texas (Eagle Ford shale), and the Sacramento basins.  As of Friday’s close, the company has market capitalization of $362 mm, and an Enterprise Value of $639 mm. 

 

Based on the most recently released financials, year-end 2008, the company has LTM EBITDA of $367 mm. However, EBITDA dropped from $96.80 mm in 3Q08 to $55.3 mm in 4Q08.   Using the 4Q09 numbers as a better indicator of performance in the current environment, we get last quarter annualized (LQA) EBITDA of $221.2 mm. 

 

Total Debt stood at $300 mm on 12/31/08, made-up of $225 mm in senior bank lines and $75 mm of Second lien debt.   This equates to a total debt multiple of 1.35x LQA, with senior debt at about 1x.  This may be leverage multiple that credit investors are looking at, as opposed to the 0.82x multiple based on LTM EBITDA. 

 

The Standardized SEC PV-10 on 12/31/08 was $741 mm, down from $954 mm at the end of 2007.  Proved developed reserves are 82% of total reserves, which suggests around $600 mm of the year-end 2008 PV-10 is related to PDP.  ROSE reports $269 mm is required in future development capex of PUDS and PDNP.  

 

The PV10 numbers alone show good asset coverage for debt holders.  Total debt has about a 50% LTV ratio based only on PDP PV-10 and excluding PUDS, acreage and other assets.  The extra $25 mm of second lien debt increases the LTV only a marginal 4.2%.

 

As of 12/31/08, ROSE had $43 mm in cash on its balance sheet, which equates to 0.2x LQA EBITDA, or 0.12x LTM EBITDA.  The company’s leverage multiples would be reduced by those amounts on a net debt basis to 1.15x and 0.7x respectively for TD/LQA EBITDA and TD/LTM EBITDA.

 

The impact of the upsized second lien should raise the TD to $325 mm, which would change its EBITDA leverage multiples to 1.47x based on LQA, and 0.885x based on LTM EBITDA, without adjustments for net debt.  No matter how you look at these metrics, ROSE is well within the second lien covenants of 4x.

 

The company has PDP reserves of 235 BCFE of gas, based mostly (135 BCFE) in South Texas and the Sac Basin.  After taking account of the $25 mm second lien increase and excluding adjustments for cash, the total debt load per PDP Mcfe of $1.38.  Plus, there is another 92 BCFE of PDNP reserves, which when added to the PDP reserves, gives a total debt per developed Mcfe of reserves of $0.99.

 

There are hedges in place for 2009 production at $7.65 and also collars for some 2010 production at $8 and $10.05.  This gives the company some stability yet still has exposure to the upside.  In December 2008 the company entered into a comprehensive settlement with Calpine whereby it paid $97 mm over a dispute related to sales of gas assets.

 

After spending between $233 mm and $335 mm per annum on capex the last 3 years, like many of its peers, ROSE announced it will now live within its means.  For 2009 capex will be funded through organic sources of cash flow. 

 

These numbers paint a portrait of ROSE’s financial position that is balanced and benign.  In fact, ROSE has unused borrowing capacity of $175 mm under its revolving line of credit.  The company is taking a prudent path in managing its total debt load and keeping its powder dry.

Downstream Valuations

Sunoco (SUN) announced that it will sell its 85k bpd Tulsa refinery to Holly Energy Corp. (HOC) for $65 mm plus adjustments for working capital.  On an annual through-put basis (bpa), that price comes to $2.09 per bpa.  Assuming, say a 10 year remaining life (there are no young refineries in the USA), the $65 mm investment can be recovered at a charge of about 21 cents a barrel processed.

We were not surprised when Fitch said they did not expect the sale to impact SUN’s credit ratings, which are senior unsecured BBB, commercial paper F2. However, Fitch did note that the low sale price indicates the tough conditions faced by sellers of brown-field refineries in the current stage of the economic cycle.  This is especially true for sellers of smaller facilities with limited conversion capacity and potentially significant capital exp-enditure requirements.

The $65 million refinery price tag comes to a price of just $745/bpd of refining capacity. This is sharply lower than metrics for other comparable recent refinery sales.  For example, in July of 2008 Valero sold its 85k bpd Krotz Springs refinery in Louisiana to Alon (ALJ) at a price of $3,920/bpd, and in July 2007 sold its 160k bpd refinery in Lima, OH to Husky (HSE, Toronto) for $11,875/bpa.  Moreover, Fitch describes both the Tulsa and Krotz Springs refineries as being less complex facilities.

Perhaps the key to understand the sale and valuation of the Tulsa refinery was SUN’s desire to dodge $400 mm in capex required to bring it into EPA compliance with off-road diesel rules. As a result, SUN had previously announced that it would sell or convert the refinery for other usage (eg storage terminal).

The low values in the downstream sector are driven by a combination of falling demand for refined product due to the global economic downswing, the near-term increases in U.S. and international refining capacity, and ongoing dislocations in capital (credit) markets. 

The capital costs for potential buyers have risen sharply since mid 2008 and 2007, the dates of the other sales mentioned above. The drop in equity prices in the energy sector also currently diminishes the usage of stock as a part of the consideration package, which further constrains deals.  Fitch remarks that the low price for the Tulsa refinery does not bode favorably for independent refiners or integrated oil companies looking to the sale of marginal refineries as a source of cash to fund other priorities in the current period.

Other refineries that could be sold in the near future include:

·        Western Refining’s 70k bpd refinery in Yorktown.

·        Valero’s 275,000 bpd Aruba refinery.

·        Dow’s sale of its stake in the 146.5k bpd Dutch refinery in Vlissingen, held in a jv with Total.

·        Petroplus’ 117k bpd Teesside refinery in the U.K., which will be sold or converted into a storage terminal.

Equity Capital Markets Transactions in Focus

The equity capital markets continue to see significant deal activity.  Investors are supporting these issues as deals continue to price and trade well. This week saw several bought deals indicating investment banks are taking more risk. We still await the broader expansion of the current robust market to smaller less liquid issuers. We know of several sub $500 million issuers that are gearing up transactions. Without any major negative surprises, we expect these to come in the next few weeks.

 

We saw a pair of Energy equity bought deals this week. Sandridge Energy (NYSE:SD), the west Texas natural gas company, sold 15.2 million shares to Morgan Stanley at $7.46 or a 7.9% discount in a block trade. The shares were re-offered at $7.60, a 6.2% discount to last trade. The CEO, Tom Ward, sold 3m shares and retains 26m shares or 14.5% of the company. The shares traded well on Friday, a good day for energy stocks, climbing on decreasing volume throughout the day to end at $8.08, 1% above the pre-offer price. Post block volume was 15.2 million shares or 1x the deal volume and 4.5x ADTV.

 

Plains Exploration (NYSE:PXP), a domestic oil and gas E&P company, sold an increased 12 million shares at $18.20 to Barclays and JP Morgan, raising $218 million. That represents a 9.5% discount to the close the prior day. The stock was re-offered at $18.70 to investors, a 7.0% discount. The stock opened at $18.60 and has generally traded below the re-offer price for a couple days, until ending the week with a strong move up on Friday, closing at $19.10. The first day post offer saw 17 million shares trade or 1.4x the deal volume and 6.8x ADTV. This indicates a high number of shares in the offering were recirculated. For comparison Petrohawk Energy’s (NYSE:HK) 22 million share bought deal on February 27th was bought down 8.0% and re-offered down 5.9%. Petrohawk saw 15 million shares trade the following day or 0.7x deal volume and 2.5x ADTV.

 

On a European note, Snam Rete Gas SpA (BIT:SRG), the Italian natural gas transportation and distribution company, announced the terms for its rights issue. The company will seek to raise EUR 3.5 bililon by selling shares at EUR 2.15. The rights issue starts this Monday and is expected to end on May 15th. Remember Snam Rete is 50.7% owned by Eni. Snam Rete announced last week that Q1 profit fell to EUR 116m a decline of 13% reflecting lower gas demand and the disruption of supplies via Ukraine.

 

There was one energy private placement of note last week, Precision Drilling Trust (NYSE:PDS), a Canadian gas driller raised $220m from the Alberta Investment Management, a government backed investment entity. The equity infusion represents 26.7% of the company. The funds to repay a 17% bridge note came through a $86m common stock investment, priced down 39% and a $144m 8 year convertible debt bearing a 10% coupon.

 

Power producer Calpine Corporation (NYSE:CPN) also saw a bought deal, but these shares came from the investor Harbinger Capital Partners. Phil Falcone’s investment group sold the shares to Morgan Stanley at a 10.9% discount, who then re-offered them at a 9.8% discount. Judging by the way the shares traded, investors were not eager to pick up the remnants of Phil’s trade. Harbinger will continue to own 53 million shares after the offering or approximately 12.5% of the company.

 

On the insurance front, Old Republic (NYSE:ORI) sold an upsized $275 million coupon priced at 8% up 20%, the middle of initial price talk. ORI launched the deal on the back of poor Q1 earnings. Revenues came in 5.4% below estimates, with weakness in their general insurance group responsible for most of the decline.

 

Jarden Company (NYSE:JAH), the branded consumer products company, raised $210 million in a bought deal. The company sold 14.4% of the company at a 8.8% discount to the public. The stock rallied on Friday to end the week up 8.2%.

 

Two small registered offerings from the BDC space are worth mentioning. Triangle Capital Corp (NASDAQ:TCAP) raised $12.9 million versus an $81 million market cap by selling 1.2 million shares at $10.75, a 7.3% discount for 17.5% of the company. The stock opened at $10.50 and ended the week at $10.31, not a terribly strong placement, but the company should be happy. The company intends to invest the net proceeds in lower middle market companies in accordance with its investment objective and strategies, and for working capital and general corporate purposes. The other BDC offering came from Prospect Capital Corp (NASDAQ:PSEC). The company raised $24.8 million, by selling 3.2 million shares at $7.75, an 11.7% discount for 10% of the company. The stock offering from this slightly larger company traded much better, opening at $7.75 and ending the week at traded up to $8.57.

 

While, we may be getting tired of writing about REIT offerings, REIT issuers and investors are not. 6 offerings raised $1.9 billion. In short order, Host Hotels & Resorts (NYSE:HST) raised $435 million. Lasalle Hotel (NYSE:LHO) raised $125 million. Vornado Realty Trust (NYSE:VNO) raised $741 million in the largest deal of the week. Regency Centers Corp (REG) raised $325 million. Parkway Properties (NYSE:PKY) raised $86 million in a bought deal. Alexander Real Estate Equities (NYSE:ARE) raised $225 million through a convert.