September 29, 2016 - 11:00pm EST by
2016 2017
Price: 80.05 EPS 0 0
Shares Out. (in M): 300 P/E 0 0
Market Cap (in $M): 240 P/FCF 0 0
Net Debt (in $M): 0 EBIT 0 0
TEV (in $M): 0 TEV/EBIT 0 0

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2016.09.29 CLD 8.5% Senior 2019 Unsecured Notes due 12/15/2019 – Long

I am recommending a long position in the 8.5% Cloud Peak Energy (Ticker CLD) Senior Unsecured Notes due 12/15/2019.  While these bonds are currently subject to a distressed exchange offer, and the market price of the bonds has nearly doubled over the past several months, I believe the sensible thing to do is to hold out and not tender into the exchange offer.


All sorts of coal companies’ securities have ripped hard off of distressed levels on the backs of higher natural gas prices, less worse production declines, etc.  Several posts this year were very well timed, including thistle933’s pitch of AHGP equity and ele2996’s pitch of CNXC equity in April.  But rather than an equity bet on industry operating metrics improving materially from here, this pitch is more specific to the CLD capital structure dynamics and specifics.


The pitch is very simple – short of a complete melt-down scenario which I believe to be extremely unlikely at this point, the resulting “downside” scenario would be for these bonds to be retired at par at maturity in just over 3 years on 12/15/19, which would represent a nearly 17% YTM or IRR.  I think it is more likely these bonds are subject to future tender offers at higher prices or open market repurchases.  Then, after that has been attempted, I think the most likely scenario is that CLD calls these bonds prior to maturity.


These bonds are currently callable at 102.833.  The call price steps down to 101.417 on 12/15/16.  The call price steps down to par on 12/15/17.  That would represent a YTC (or IRR) of nearly 30%.


The Withdrawal Deadline of 9/27/16 for the exchange offer has passed.  $232.5mm of these 2019 bonds were tendered before that deadline.  The exchange offer for the 2019s was conditioned upon a minimum of $200mm being tendered, and that condition was satisfied.  So now even if those who tendered the $232.5mm of 2019 bonds would like to change their mind and hold out, they cannot do so unless CLD were to subsequently extend the Withdrawal Deadline or otherwise terminate the exchange offer.


CLD has extended the Early Tender Date, presumably to encourage more bondholders to tender into the exchange.  But CLD has not extended the Withdrawal Deadline or the Expiration Date of the exchange offer, presumably because CLD intends to accept as many bonds as possible and has no intention of returning them, or pro rating them downward, or terminating the exchange, etc.  So I think it stands to reason that the pro forma principal balance of the 2019 bonds will be at most $67.5mm after the exchange is completed ($300mm of 2019s issued less $232.5mm exchanged into $195.3mm of new 2nd lien bonds due November 2021).  And the 2019s pro forma balance may turn out to be even lower after the exchange because a total of $375.3mm of bonds (2019s and 2024s combined) were tendered into the exchange as of 9/27/16.  The exchange offer’s Aggregate Maximum Amount of $400mm implies that the pro forma balance of the 2019s could be as much as another $24.7mm lower ($400mm less $375.3mm), or a pro forma balance of the 2019s as low as $42.8mm ($67.5mm less $24.7mm).  This should just depend on how many additional 2019s are tendered after 9/27/16 and before the deadline.


Therefore, post the exchange offer, I expect the balance of the 2019s to be between $42.8 - $67.5mm.  Meanwhile, the $400mm 1st lien revolver due 2/21/19 and the A/R facility were both undrawn as of the last reporting date, so there should be no major maturities before the new 2nd lien notes being issued as part of the exchange offer are due 11/1/21.  Thus I think the most likely scenario is that the revolver gets extended until at least early 2021 (in advance of the 2nd lien maturity).


Perhaps the revolver extension doesn’t happen until the 2019 unsecureds are fully retired.  That would appear to be all the more reason to expect that the 2019s get tendered for again in the future at a better exchange ratio, or for a higher cash price, or get called prior to maturity to pave the way for an early extension or refinancing of the revolver.  In our case, the earlier the 2019s get retired, the higher the IRR.


Importantly, my read of the 2nd amendment to the Credit Agreement dated 9/9/16 and filed in an 8-k on 9/12/16 explicitly allows for the prepayment or retirement of the remaining 2019 bonds prior to maturity.  The amended language for section 6.14 notes that “so long as no Event of Default shall have occurred and be continuing, the Credit Parties may…(b) if certain of the 2019 Senior Notes have been successfully exchanged as provided in clause (a) above, prepay, redeem, purchase or defease prior to the scheduled maturity thereof some or all of the remaining 2019 Senior Notes”.


Likewise, my read of the indenture for the new 2nd lien bonds to be issued shows a large, virtually unrestricted $150mm restricted payments basket (on top of the standard restricted payments basket subject to future net income, equity proceeds, etc).  Of course, $150mm is well in excess of my estimate of the pro forma 2019s balance.


To the extent that CLD common equity continues to move up, I would not be surprised to see a follow on equity raise.  This is a company that was priced for bankruptcy earlier this year.  An equity raise to pay down debt, not dissimilar from CLF, X, AKS, etc is almost to be expected unless the stock price proceeds to crash from here.  Similarly, we could also see small, one-off debt for equity swaps for the 2019s outside of a full-fledged equity offering.


I would also note that the 2019s have subsidiary guarantees from all guarantors under the Credit Agreement (non-guarantor subsidiaries hold only ~2% of consolidated assets).  Likewise, the new 2nd lien secured notes will have 2nd lien, secured guarantees from those same guarantor subsidiaries.  I think this materially reduces the risks under the take-or-pay contracts CLD has in its logistics business.  The take-or-pay obligations for 2016-2018 were materially reduced last year.  To the extent that either the reduced obligations through 2018, or the 2019 and beyond obligations look to be particularly onerous for CLD, I would think that Westshore and BNSF would have an incentive to “play ball” and work with CLD.  Otherwise, I believe that if such take-or-pays were to be rejected in a CLD bankruptcy, then they would become general unsecured claims and thus be stuck behind the bank lenders, A/R facility, and 2nd lien notes.


In summary, absent a complete unmitigated disaster, I don’t see why CLD would have any reason to file for bankruptcy before these 2019 bonds are fully paid off.

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


Current exchange offer is consummated, pushing out CLD’s maturity profile materially, leaving 2019 unsecured bond holdouts as the main piece of funded debt to be retired prior to 2nd lien notes in November 2021.


Future tender offers and/or open market repurchases off these bonds.


Call of these bonds prior to 2019 maturity to clear the maturity runway until November 2021 and facilitate the extension or refinancing of the revolver.


Retirement of these bonds at maturity at par.

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