Times have been interesting for oil and gas E&P (exploration and production) firm Occidental Petroleum (
*Taken from Occidental Petroleum
On June 29th, management made a change to this arrangement, upsizing the offering from $1.50 billion to $2 billion. This is, of course, contingent on the company raising, through a debt offering, $1.95 billion or more in cash, up from the prior minimum it needed to raise of $1.475 billion. Because the notes the firm is seeking to buy back are based on priority listed and on the willingness of their holders to tender theirs, there’s no telling which notes and in which amounts, if any, are ultimately tendered. To have some idea as to what the end result might be, I decided to look at two different hypothetical scenarios.
The first of these was to base the tenders solely on priority. This is probably the most likely scenario to come into play. Here, the firm would buy back all of its 4.10% Senior Notes due in 2021, an amount of $1.249 billion in exchange for $1.255 billion. It would also buy back $500 million of its Floating Notes due in 2021 for $495 million, and $248.139 million of its 4.85% Senior Notes in exchange for $250 million. The end result will be a payment of $2 billion for $1.997 billion, increasing debt by about $3.08 million. For the second scenario, I focused on the notes trading at the largest discount to par. This would have resulted in the purchase of its $1.50 billion of Floating Notes due in 2022 for $1.403 billion, and $615.98 million of its 2.70% Senior Notes due in 2022 in exchange for $597.50 million. Here, debt would decrease by $115.98 million.
This gives us a rough range of what will happen to principal, but perhaps more important than that is what will happen with the firm’s interest expense. As part of its goal of retiring near-term debt with its tender offer, the company found it necessary to issue $2 billion in fresh debt. $500 million of this is slated to mature in 2025, another $500 million will nature in 2027, and the remaining $1 billion will mature in 2030. The best thing about this is that management gets to kick the can down the road regarding principal repayment, but the bad thing is how much it will cost shareholders in the process. The 2025 notes carry an annual interest rate of 8%. The 2027 notes see this rise to 8.5%, while the 2030 ones carry an annual interest rate of 8.875%.
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This translates to a rather costly transaction for shareholders. The note issuance from management will bear an effective interest expense for shareholders of $171.25 million per annum. This compares to the $78.99 million in reduced interest expense associated with the first tender scenario I ran and the $67.03 million from the second scenario. In short, investors should expect the annual interest expense for the company to rise by between $92.26 million and $104.22 million. That will certainly add up over time.
A double-edged warrant issuance
Perhaps to ease discontent among investors caused by its debt maneuver, or perhaps for some other reason altogether, the management team at Occidental decided, on June 26th, to hand shareholders something of a gift. According to a press release issued by the firm, on August 3rd, any shareholders on record on the necessary date will receive warrants to buy additional shares in Occidental. Each share a person owns will entitle them to 1/8th of a warrant. Each full warrant, in turn, will entitle a holder to buy one share in Occidental at a price of $22 per unit. Management stated that these warrants will trade individually from the stock in question, so investors who don’t want them can sell them at whatever price the market dictates.
What’s really interesting about these warrants is not that management issued them, but that they gave them a long shelf life. These warrants only expire after 7 years. With 900.02 million common shares outstanding today, the warrants should allow investors to buy 112.50 million shares. Given that shares are trading at $17.95 apiece as I type this, the amount that common units have to rise in order for the warrants to be in the money is not all that much.
On one hand, this is a gift to shareholders. If, in the next 7 years, we find shares trading at $30, or $40, or $50, or higher, they will allow the holders to cash in on the upside. There is, however, a dark side to this deal: the money left on the table. If common units trade at $30 apiece, the firm could normally raise (at that price) $3.375 billion from an equity raise of 112.50 million units. This compares to the $2.475 billion the warrants would bring into Occidental, essentially leaving $900 million on the table. At $40, the firm is leaving $2.025 billion on the table, while at $50, they are leaving $3.150 billion on the table.
Some of these price points may seem ridiculous compared to Occidental’s current share price, but consider two things. One, 7 years is a long period of time for things to change for the firm. Two, shares in the past year were trading at high as $54.05 apiece. I know a lot has happened since then, but it’s important to keep in mind how volatile the market is. One partial counterpoint to this, though, is that while 7 years is a long time, the warrants will help to limit upside in the company. Investors will price in that new shares could be handed out that will bring in potentially far less money than what the company could generate if it had just waited to issue shares at a higher market price.
Right now, things are looking interesting for Occidental. The company’s decision to refinance debt is a good one, but the terms of the debt being issued to do it look really bad. High interest expense will be painful for the firm, and management probably would have been better off trying to sell other assets on the company’s books. The warrants, meanwhile, might be aimed at satiating shareholders, and they could end up creating a lot of value for their holders. That said, these warrants are a bit of a double-edged sword, and investors should be aware of the costs as a result.
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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.