FELP - Foresight Energy

[heth247]

Thanks again Picasso. I've learned a lot from you on FELP and SXC(P) these past few months.

 

Same here!

[Picasso]

Always happy to share my ideas and get feedback. 

[Picasso]

Spoke to a tax lawyer who deals with a lot of these MLP's (represents LINN and couple others getting hit with CODI) since there's the last pressing matter related to cancellation of debt income.  Depending on where the new FELP debt and warrants trade, if they trade for say $90, then there will be $10 of income generated that will be distributed across the unit holders.  If that's $60 million of CODI (10% of par), then there will be a 0.46 gain sent down to the units (poor Murray).  There's a 31 day window, 15 days after the exchange is over where they assess the value of the exchange for tax reasons.  Even though it's a $600 million for $600 million swap, for tax purposes it will depend on the market value post exchange.

 

So something to consider in case anyone thinks the value of the exchange will somehow be much less than par, or you start seeing headlines that you may get hit with massive tax bills.  Since Cline and Murray own 85% of the equity, it seems like they made this as close to a par deal as possible.  Unless they think the upside to the deal is way more than the potential tax hit.

[Picasso]

Just some back of the envelope here to calculate the CODI:

 

$300 million of 2021 2nd liens @ 90% of par = $270 million

$300 million of 2017 PIK @ par = $300 million

FELP @ $4 gives $3 or so of value to the warrants x 5.85 million = $17.6 million

 

That's $587 million instead of $600 million, so potentially $13 million of CODI.  Which would be about $0.10 of taxable income for unit.  Seems kind of de minimum but I could see how buyers of FELP will hold off until after the exchange to avoid paying the tax. 

 

Edit: Turns out the accrued interest (even though it's in the form of bonds) is adjusted into the basis.

[PullTheTrigger]

From Taylor Kuykendall on Twitter:

 

Westmoreland CEO 'excited' to report coal results for coming quarters

 

http://www.snl.com/web/client?auth=inherit#news/article?id=37289616&cdid=A-37289616-12325

 

Like many other coal producers providing quarterly results so far, Westmoreland is reporting improved demand trends due to hotter summer weather. He said the increased number of cooling days at utilities this summer has offset the softness in the first quarter and that Westmoreland is "eager to see" how trends play out.

 

Jason Veenstra, CFO and treasurer, said the company would expect a "much stronger" 2017 if pricing levels hold.

 

Tempered by this:

 

Cloud Peak CEO: Coal not 'going back to where we were'; some optimism in H2'16

 

http://www.snl.com/web/client?auth=inherit#news/article?id=37287127&cdid=A-37287127-12585

 

On a conference call hosted by Morgan Stanley, Marshall said the recent hot weather of summer 2016 is bringing back demand from coal plants that has not been around since Thanksgiving of 2015. He said there is a marked increase in shipments heading through the summer, and demand is expected to improve as utilities whittle down their coal stockpiles.

 

 

He said the changes the coal sector has made have been "miserable" but said not to worry that coal demand is "going to nothing." He added that it is mostly a matter of operators figuring out how to operate in a more volatile market, though more stability could be on the horizon.

 

"It looks like we'll get back to a much more supportive pricing environment and volume as things come out if there's any stability in gas and some sort of normal power demand," Marshall said. "We do have to accept, going forward, that coal, which used to be a true baseload business, is going to become a lot more variable, and demand will vary with the price of gas and weather, and that's just the way it's going to be going forward and we have to adapt to that."

 

 

[heth247]

Just some back of the envelope here to calculate the CODI:

 

$300 million of 2021 2nd liens @ 90% of par = $270 million

$300 million of 2017 PIK @ par = $300 million

FELP @ $4 gives $3 or so of value to the warrants x 5.85 million = $17.6 million

 

That's $587 million instead of $600 million, so potentially $13 million of CODI.  Which would be about $0.10 of taxable income for unit.  Seems kind of de minimum but I could see how buyers of FELP will hold off until after the exchange to avoid paying the tax. 

 

Edit: Turns out the accrued interest (even though it's in the form of bonds) is adjusted into the basis.

 

I hope they try their best to keep the CODI as small as possible. Just learned that for CODI, it will be counted as UBTI in the K-1 form. For any UBTI over $1000, we need to pay a tax rate of 39%, even for IRA accounts!

 

Anybody holding MLPs in IRA in the past?  For the ordinary income part from the K-1 form, you don't need to worry about tax, do you?

 

[Picasso]

I think I referenced this early in the thread but since Cline and Murray own 85% of the units that currently do not pay distributions, they would not want to create a lot of CODI.  So say you own 100k units, $13 million of CODI across all the units would hit you with a $10,000 gain.  If you pay out 40% of that in tax, it cost you $4k.  But what are the 100k units now worth?  Each $1 increase nets you $100k and if it's in an IRA, you're deferring tax on that short-term gain.  I think it's very de minimis but we'll see how the notes trade.  Much ado about nothing imo.  What investors have to worry about are the Linn energy type situations.

[heth247]

I think I referenced this early in the thread but since Cline and Murray own 85% of the units that currently do not pay distributions, they would not want to create a lot of CODI.  So say you own 100k units, $13 million of CODI across all the units would hit you with a $10,000 gain.  If you pay out 40% of that in tax, it cost you $4k.  But what are the 100k units now worth?  Each $1 increase nets you $100k and if it's in an IRA, you're deferring tax on that short-term gain.  I think it's very de minimis but we'll see how the notes trade.  Much ado about nothing imo.  What investors have to worry about are the Linn energy type situations.

 

Yeah, can't complain about the tax-free capital gains. :)  I was just surprised that I will have to work with my broker to file a 990T form for my Roth IRA account due to the CODI. I never need to worry about tax for those type of account before. Anyway, it is my first time to own these MLPs, so lots of things to learn....

 

It seems that even for taxable accounts, the future cash distribution is counted as return of capital (ROC), so they will mostly just reduce the basis of the units. Unless you sell, you can get those cash distribution tax-free. Is that so?

[Picasso]

Correct, the vast majority of the distributions are considered return of capital.  In the case of FELP if you own it at $1.50, it might only take a couple or few years before the distributions reduce your basis down to zero.  At that point all the distributions become taxable as ordinary income.  Then if you sell FELP in several years, the basis reduction becomes taxable.  Any capital gains above the ROC would be at long-term capital rates.

 

So say you owned it at $1.50 and by 2020 you received $3 of distributions, maybe $2.50 of which were ROC, and you sell the units at $10.  You would have $3.00 of ordinary income ($1.50 of that was deferred until sale), and $8.50 of long-term capital gains. 

 

If you own it in an IRA, you just have to deal with the UBTI.  In the case of FELP, if you do not own it on the date of the exchange then you won't have to deal with the CODI.  I believe we'll get news of a successful exchange before that date (not entirely sure, need to double check) which might have a favorable impact on the units.  So technically you could sell ahead of that date, but I feel like there would be investors waiting to buying after that date who do not want to risk CODI?  So you'd risk missing out on that upside.  Would it be worth saving something like 0.05-0.10 of Roth cash?  The bid ask spread on FELP is basically around that area anyway. 

 

And just a little more color on why I think it wouldn't make a ton of sense to game that exchange date to avoid CODI.

 

This was in the last SNL report on FELP:

 

The company warned the restructuring contemplates potential issuance of additional equity securities that could "significantly dilute" the ownership of existing unitholders. It also warned the exchange offer will generate substantial cancellation of indebtedness income that will be taxable to unitholders and could result in a liability per unit substantial to or even exceeding the value of a common unit.

 

That's scary for investors right?  But there's a reason for that language.  What if FELP had $600 million of 2021 8% debt being exchanged for $600 million of 2035 2% debt.  It's the same amount of debt being swapped, but in reality the 2% 2035 debt is worth just a fraction of the 2021 8% debt.  Which is basically a de facto debt reduction.  To avoid free income to those types of restructurings it makes sense to tax that market value difference. 

 

In the case of FELP we're going from $600 million of 2021 unsecured 7 7/8% debt to $300 million of 2017 15% 2nd lien and $300 million of 2021 10% (or so) 2nd liens.  Plus in the money warrants.  So the principal is staying the same, but a big jump in the interest rate, half the duration, higher in the cap structure, and extra warrants.  If FELP debt was trading at around $90 last year (December), here we have much better debt that should be trading much higher than that.  At least collectively between all the pieces. 

 

So maybe investors are nervous about that nasty language of being taxed more than the value of the units.  But it's clear that's not going to happen.  Between that and the confusion around the potential dilution, it really explains why the units are still so cheap.  My position isn't exactly liquid enough to game that exchange date, but maybe it hits a price high enough to warrant trying to avoid the CODI headache for others. 

[heth247]

Thanks for the color, Picasso.  Yeah, I don't have that many of units in my IRA, so economic wise, it is not a big deal. I was just surprised that I have to deal with it even for Roth accounts.

[Picasso]

http://investor.foresight.com/file/Index?KeyFile=35425681

 

Looks really good to me.

[heth247]

http://investor.foresight.com/file/Index?KeyFile=35425681

 

Looks really good to me.

 

Yeah, it good to see that their cost per ton has come down to $22.16 in this Q. Hopefully it will go down further as they sell more in the next 2Qs.  No updates on the deer run fire though.

[PullTheTrigger]

Yes, it would be nice to know how long they expect the mine to be sealed before they plan on checking on it.

 

It's crazy how these mines just burn for years, but maybe it's really difficult to get all the air out.

[Picasso]

If you look at how much cash they have on the balance sheet, that volumes will continue to improve through the rest of the year, API 2 prices have recovered a lot, that we haven't seen the impact of that yet, how low they're keeping costs, then it seems probable that they can pay down a significant amount of PIK debt over the next year. 

 

And to think the units were down at $1.35 after their last earnings report because "earnings missed."  Amazes me to see investors gravitate towards low multiple peak earnings stories and run for the hills from cyclical stocks when they're at some kind of trough on the operating leverage.  Fidelity could not have timed their purchase and sale any worse.

[PullTheTrigger]

Picasso:

If you look at how much cash they have on the balance sheet, that volumes will continue to improve through the rest of the year, API 2 prices have recovered a lot, that we haven't seen the impact of that yet, how low they're keeping costs, then it seems probable that they can pay down a significant amount of PIK debt over the next year. 

 

And to think the units were down at $1.35 after their last earnings report because "earnings missed."  Amazes me to see investors gravitate towards low multiple peak earnings stories and run for the hills from cyclical stocks when they're at some kind of trough on the operating leverage.  Fidelity could not have timed their purchase and sale any worse

 

And probably in the near future, we'll start to get some upgrades and then the likes of Fidelity will be back to buy again.

 

Accipiter continues to hold (neighbor with Cline).

 

 

 

Taylor Kuykendall at the American Coal Council gathering this week tweets:

 

James Stevenon, IHS director says after long feeling like an undertaker, he has good news of potetnial coal recovery

 

May not be huge, but Stevenson says “When we do get a recovery it will be a sharp one" in coal

 

Grant Quasha, chief commercial officer of Bowie Resource Partners LP, said he agrees that the coal market bottomed.

 

Hallador CEO: “We’re seeing a lot of quiet closures. When the market does respond, when we do need to rely on coal, will it be there?”

 

Hallador CEO on bankers buying coal companies: Do bondholders want to own coal companies long-term? I think the answer is no

 

 

 

All positive signs that this ride for FELP may just be the beginning.

 

 

 

 

 

[Guest roark33]

Ok, I will take the other side, just because....

 

I think the idea that "selling at the trough is stupid" is fairly egregious use of hindsight capital.  Let's take this specific example.  If you think the equity is worth 400m+, there was a greater risk than is being admitted that bondholders could have forced a bankruptcy, provided temporary DIP, credit bid their debt and wiped out the equity, thus providing yuge IRR on their debt bought at less than par. 

 

In fact, this is basically what the equity investors are claiming happened at ZINC (zinc prices have recovered 40% since the bankruptcy).  I actually think the business is better here at FELP, so it is not out the possibility that the debtholders could have done that. 

 

Secondly, I think the idea that the capital structure game theory paid off in FELP is a little bit underwhelming in terms of stock returns.  CLD, which didn't have the default risk, is basically up just the same if not more this year, and had a much lower risk of bankruptcy.  Perhaps the bankruptcy risk is still on the table until the debt gets tendered.  In other words, coal prices saved FELP, game theory....

 

I guess my overall point is FELP looks like a slam dunk, but the real risk of bankruptcy sometimes gets overlooked in hindsight.  I am not going to play the odds games, but I think this is much more akin to a lotto ticket that paid off....

 

Another point on commodity prices is that some people were buying FELP last year thinking that coal prices had bottomed.  If you are "late" to the game, it doesn't mean you are right in calling the bottom....The best example of this is John Paulson, who probably had the best IRR of any of the "Big Short" investors because he was so late to the game, not because he was smart.  His track record since then has born this out....

[Picasso]

I think the idea that "selling at the trough is stupid" is fairly egregious use of hindsight capital.  Let's take this specific example.  If you think the equity is worth 400m+, there was a greater risk than is being admitted that bondholders could have forced a bankruptcy, provided temporary DIP, credit bid their debt and wiped out the equity, thus providing yuge IRR on their debt bought at less than par. 

 

 

I've brought this up before, but my point is that investors extrapolate a cyclical asset's value based on what they've done/are doing recently.  Look at all the guys short XOM and CVX this year that are getting killed.  "But, how can it trade at 50x earnings!"  There are certain public securities where it doesn't make sense to value them on trough earnings.  Are XOM or CVX's earnings near a trough?  Maybe, maybe not.  Given their low cost structure, I'd probably argue that you can bet that their earnings today will look very "troughy" in 5-10 years. 

 

As far as the debt holders going loan to own, it wasn't too difficult to know that not to be the case.  The bondholders who sued owned FELP notes fairly close to par value (not fund vultures who bought them at 50 cents) and none of them had those type of investment mandates.  You could *maybe* argue that BlueMountain would go that route, *maybe*, but good luck getting all the other plain vanilla funds to go along with that.  And nevermind the fact that Cline made up the bulk of the buyside trading volume in the notes. 

 

In fact, this is basically what the equity investors are claiming happened at ZINC (zinc prices have recovered 40% since the bankruptcy).  I actually think the business is better here at FELP, so it is not out the possibility that the debtholders could have done that. 

 

Let's be honest here, the guys at ZINC arguing that the bondholders wanted to steal a plant that's burning money is totally ridiculous.  Yes, the bond holders could have tried to get to the "equity" in the company, but there are much easier targets that don't involve two billionaires owning 85% of the equity.  Well, maybe Murray isn't a billionaire anymore.  Did the Horsehead CEO even own 1% of ZINC?

 

Secondly, I think the idea that the capital structure game theory paid off in FELP is a little bit underwhelming in terms of stock returns.  CLD, which didn't have the default risk, is basically up just the same if not more this year, and had a much lower risk of bankruptcy.  Perhaps the bankruptcy risk is still on the table until the debt gets tendered.  In other words, coal prices saved FELP, game theory....

 

The company still isn't out of default yet, there's the issue of CODI tax, PIK debt coming up, etc.  CLD bonds were trading at 25 cents without even going into default, and FELP notes even with BK talk was trading at $70.  So I don't see the comparison here... And given that I'm arguing the current price in FELP is still quite undervalued, I'm not sure returns over a few months matter?  A lot of junk has rallied.

 

Another point on commodity prices is that some people were buying FELP last year thinking that coal prices had bottomed.  If you are "late" to the game, it doesn't mean you are right in calling the bottom....The best example of this is John Paulson, who probably had the best IRR of any of the "Big Short" investors because he was so late to the game, not because he was smart.  His track record since then has born this out....

 

Buying FELP isn't a bet that coal prices bottomed.  That's just optionality you didn't have to pay for.  The idea is that you get to buy into a very profitable, low cost company that is beaten down on the idea that massive dilution or bankruptcy might take place.  If coal does bottom or recovers, that's some optionality you get for free.  I don't think I ever mentioned to buy FELP as a coal is bottoming play... Which is why I don't own any other coal producers.

[valcont]

Has anyone read the recent report from FBR

http://www.com-unik.info/fbr-co-analysts-give-foresight-energy-lp-felp-a-2-00-price-target/

 

They have a $2.00 price target. Is it because of the restructuring overhang or is it more earnings based? Hard to value it at $2 now that the note holders have consented.

[Picasso]

I have a hard time getting their reports.  I'm not sure how they get $2.  Maybe they think that the PIK notes will dilute at less than $1.

[valcont]

Picasso,

  Do you mind sharing your thoughts on range of expected dilution? If you have already discussed it,let me know the pages. A big part of my thesis centers around Murray's investment in the subordinates. If you dilute the unit holders too much then the billion plus investment is just sitting there until recovery. But these agreements have become too complicated for me to figure out.

 

[Picasso]

There are a couple different scenarios that could play out.

 

If you take a look at Murray, they do have a very large set of assets to potential drop down into FELP.  I think it's a big part of why they paid $1.4 billion for 50% of FELP.  Since FELP itself has a good base load, low cost business (which became lower cost by sharing certain expenses with Murray) there should have been some downside protection even though FELP was a bit levered.  Use it as a stable yield co, sell down assets from Murray, collect on the value of the IDR's and their FELP stake etc.  If anything coal conditions the past year have shown that to be even more of an important thing for them to do.  And I think FELP's coal assets are better than Murray's coal assets.

 

Anyway, Murray was going to pay a $48 million consent fee from the very beginning to avoid a change on control trigger.  But all this FELP bankruptcy talk really tanked their notes and loans.  They've been able to reduce a lot of leverage through open market repurchases, and a lot of that leverage was used to acquire FELP.  So in a way they've already reduced the purchase cost down somewhere in the low $100 millions.  Add back in their legal expenses to take care of the change of control, and it may end up costing about the same as just paying the consent fee.  Maybe even better because they'll keep reducing leverage at prices well below par over the next year.  It will probably cost the same as paying the consent but they took on major aggravation in the process.

 

Once the tender and exchange is over, the company is out of default, the going concern issue goes away (their 10Q's and K look ridiculous right now), they can probably just issue some new refunding 9% or 10% debt to redeem all the new 2nd liens and PIK's.  The 2021 2nd liens are restrictive in that anything to refund the PIK's can't be cash pay or mature before 2021.  It'd be hard to issue 5 year PIK paper, but that's a possible outcome.  As far as Murray is concerned, he can just pay a couple percent points more on new debt to preserve his stake.  2% on $600 million is only $12 million of extra expense a year.  But they can't do that while there is going concern language in the 10-K, they're in default, etc. 

 

If that happens (and it seems more likely to me), then dilution will only be these warrants being issued.  Which is only about 6 million units?

 

Now if Murray no longer sees the value in his IDR's, then he'll just dilute at the VWAP for the $250 million or $300 million coming due next August.  They'll have enough cash flow to repurchase a fair amount of it beforehand.  But I don't see how Murray doesn't see the value in the IDR's (look at Murray's assets, why sell them off in bankruptcy when you can sell them to FELP), and if he does dilute he's handing out half the new shares to investors who aren't him.  And one of those investors is taking most of that from money that Murray paid him a year ago.  I don't see Murray being cool with that...

 

I think number wise, maybe you can expect $4 unit issuance in a worst case scenario.  That would double the common unit count, put the sub units way out of the money, and the earnings would accrue to common unit holders.  Murray would own maybe 30 million common units paying him $30 million of income @ $1 of distributions, plus whatever might be leftover for the sub units?  The interest on the debt they issued to buy FELP is costing them over $100 million per year.  So $4 issuance is a killer for Murray. 

 

Anyway, I've played with a few different scenarios but unless Murray wants to hand over his life's work to Cline and other unit holders I bet they'll just refi out all this debt once they're out of default and keep the dilution to the warrants.  FELP itself is performing pretty well, I don't see why they couldn't get new debt issued.

[Picasso]

Since someone asked me about Cline's right to exchange his PIK's for common units, I thought I would clarify one more thing.

 

There are different options to repay the PIK's.  They can either be refinanced for new debt, they can issue new units, and/or they can pay from cash on hand at Foresight.  Since a refinance of the debt can be super dilutive (maybe Murray would want to issue some crazy debt that coverts into 90% of the equity with 30% interest that he or related parties funded), Cline has the right to see the terms of that refi and participate at 60%.  So Murray can't come back in and steal the company away from Cline and other unit holders.  If there is a regular bond refinance that everyone agrees to, then Cline doesn't get to convert to units.  He just gets his warrants and what he's owed in principal and interest. 

 

The other option is for Murray to exercise their purchase right on the PIK's.  Murray can put out an offer to buy all the PIK's and Cline can choose to keep his and everything would covert into new units at the VWAP.  There's a lot of strange outcomes here (IDR's get killed off, Murray's sub stake is worthless) if the units are trading low enough to cause a lot of dilution.  For example if the units were trading at $4.  It's a right Murray has but I can't see many situations where it would make sense to exercise it?  Plus where would they get that cash.  And they would simultaneously hand a lot of value back to Cline because it's likely Cline would not exchange his PIK's.  But maybe there's a point where Cline would want out and let Murray take as many units as he wanted?  I just can't imagine what would cause that kind of outcome.  And I haven't had any inclination that these two are in cahoots together.

 

So to calculate the dilution, I think it's either a refi or some amount of additional units issued if the debt markets don't let them refi.  I don't think the Cline option to exchange for units in a purchase offer for the PIK's would really make much of a difference in determining the outcome.  It's either going to be dilutive or it's not.

[Picasso]

Okay one more point, because like I said I'm sick at home with nothing to do but joke around on twitter and investing forums. 

 

There's one thing I've always liked about this investment and it kind of shows with the lingering PIK issue.  If it was just Murray owning 85% and another 15% with everyone else (no Cline), we could easily get screwed on the refi.  Then I would agree with the FBR price target of $2 or the headlines of 75% dilution.  But if Murray screws the unit holders, he's screwing Cline and Cline won't let that happen.  And if Cline tries to screw the unit holders, he's screwing Murray and Murray won't let that happen.  It's a nice check and balance for the minority holders.  Plus in this case it's even better because of all the suborindated units that are "out of the money."  Which is kind of cool because if you can dig in and figure that out, I don't know if it's something that markets can easily figure out?  It doesn't pop up on a screener or reading through news articles.

[PullTheTrigger]

But maybe there's a point where Cline would want out and let Murray take as many units as he wanted?  I just can't imagine what would cause that kind of outcome.  And I haven't had any inclination that these two are in cahoots together.

 

If Cline and Murray were in cahoots, wouldn't Gabe Hoffman get screwed? If we can speculate that Cline and Hoffman are buddies, seems unlikely to happen?

[Picasso]

Cline and Hoffman might be buddies, but Hoffman has no control over what happens.  He's really just along for the ride.  Murray can't do anything without Cline and Cline can't do anything without Murray, which is different.  Even though it might make it awkward to go pick up the newspaper in the morning after losing a lot of money for your neighbor.