Unit Corp’s announcement yesterday that it plans to launch an exchange offer for its subordinated notes marks a turn in the company’s strategy as oil & gas valuations sink and access to capital markets for levered E&Ps becomes less than assured. If the company is unable to strike a deal with holders to exchange the notes, it faces a growing restructuring risk ahead of a November 2020 springing maturity in its revolver, according to four sources following the company.

Although Unit said yesterday that it plans to launch an exchange offer for its USD 650m 6.625% senior subordinated notes due 2021, it hasn’t yet launched the offer – and instead announced a few broad strokes of the expected transaction. The company, a natural gas E&P that also has midstream and contract drilling assets, wants holders to swap into second lien paper, and for bondholders as well as revolver lenders to waive restrictive covenants.

The public announcement of the forthcoming strategy put bondholders on notice that the company needs to negotiate a deal with them – after dialogue at non-deal roadshow meetings back in July failed to yield a traditional refinancing transaction.

Around the time of those investor meetings, numerous bondholders had pushed the company to sell the remainder of its midstream interests and use the proceeds to pay down debt. That would pave the way for Unit to come to the market for a secured transaction, backed by its contract drilling rigs and other collateral, they said. At the time, the notes traded at 89.25 for a 13.4% yield.

Now, with the bonds trading at 65, and no asset sales announced, Unit’s options appear more limited. Its USD 275m revolver due 2023 has a springing maturity in November 2020 if the subordinated notes are not refinanced with a maturity date six months after the revolver maturity. The revolver had USD 115m drawn as of 30 June, and the company had a cash balance of less than USD 1m.

“The company is basically saying that the midstream asset sale and a larger refi is off the table. Instead, the plan forces bondholders to the table for an exchange as a last resort,” one of the sources said. Unit sold a 50% interest in its Superior Pipeline in April 2018 for USD 300m, but valuations and sentiment towards energy have eroded since then, two of the sources said.

Sources are expecting a double-digit coupon with a steep discount to swap into the new second liens. Critically, Unit’s rigs aren’t included in the proposed collateral package, but the company is open to negotiating the collateral, two of the sources said.

The S-4 filed yesterday outlines the collateral package for the proposed second lien exchange notes as comprising 80% of the company’s PDP PV-10 and a 50% stake in the Superior Energy pipeline.

Meanwhile, as Unit’s refinancing needs close in, its liquidity is constrained. On an LTM basis, the company burned roughly USD 183m of cash, based on USD 315m of adjusted EBITDA, USD 452m of capex and USD 46m of interest expense.

Liquidity is around USD 350m at 30 June, comprising USD 160.2m under the USD 275m revolver due 2023 (borrowing base reduced in September from USD 425m), and USD 188.65m available under a USD 200m Superior Pipeline credit agreement. Leverage is around 2.4x, based on USD 771m of total debt and USD 315m of LTM adjusted EBITDA.

Though Unit’s leverage is not as high as some of its peers, capital markets conditions have been challenging for below-investment-grade oil and gas operators. Issuance volumes for E&P credits were lackluster in 3Q19, with just three companies in the sector tapping the high yield bond market, compared to nine issuers in 3Q18, according to Debtwire data. Fellow E&Ps CNX Resources and Whiting Petroleum held non-deal roadshows last month without amounting to syndications.

Weak natural gas prices have led to reduced cash flow from Unit’s E&P business, and reduced spending by third-party E&Ps has led to underutilization in Unit’s contract drilling segment, commented analysts and Standard & Poor’s in a 22 August report in which the agency downgraded Unit’s corporate rating by two notches to ‘B-’. Moody’s cut the issuer’s corporate rating by one notch to B3 on 21 October. The USD 650m subordinated bonds are rated B/Caa3.

Unit did not respond to a request for comment.

2019 Debtwire