Demand for Talos Energy‘s refinancing is coming in steady from investors focused on the offshore driller’s prospects of returning to normalized operations following this year’s disastrous hurricane season and incremental supply chain challenges brought on by COVID-19, according to five buysiders, two desks analysts and two sellsiders. Particularly enticing is the juicy yield offered on the deal, backed by expectations of stable free cash flow and that the company will eventually be able to grow its production levels, they said.

Lead JPMorgan earlier this week floated whispers on the new USD 400m second lien notes due 2026 at a 12% coupon with a steep 90-92 OID, pinning the yield at 14.25% to 14.8%, said two of the sources. Although generous at face, the all-in pricing would fall roughly in line with Talos’s existing USD 348m 11% second lien notes due 2022, which last traded on 10 December at 96.25 to yield 14.227% and changed hands earlier in the month at 95.125 to yield 15.188%.

In its favor, nearly 70% of the issue is spoken for via reverse inquiry, one of the sources said. And the notes are expected to price tomorrow (17 December).

Whipsawing in Talos’ second lien bond has been pronounced this year, with the notes dropping to an all-time low of 55 on 24 April, after opening the year with above-par trades at 103.5 to yield 8.18%, according to MarketAxess.

At the root of the volatility, the issuer’s adjusted EBITDA plummeted 61% to USD 182.3m excluding hedges for the nine months ended 30 September, compared to USD 465.6m for the same period in 2019, according to SEC filings. Contributing to the lower earnings, WTI oil prices reached a low of negative USD 37.63 per barrel in April. WTI was last quoted today at USD 47.33 per barrel. 

Meanwhile, the pressure is on for Talos to get its bond deal across the finish line, due to a springing maturity that will accelerate payment on its USD 1.15bn revolver if the company does not address the bond 120 days before its 10 May 2022 due date, the sources said. Proceeds from the new bond and a USD 75m equity offering executed last week will also reduce borrowings on the revolver due 2022.

Based on conservative expectations that the company’s oil production remains in line with 2020’s depressed levels, its 2021 free cash flow should shake out anywhere between negative USD 3m to positive USD 30m, taking estimates of USD 372m- USD 405m in adjusted EBITDA, less USD 300m of capex and USD 75m of pro forma interest expense, two of the sources said. 

Management’s financial objective is to maintain capex at 65%-70% of EBITDA, three of the sources noted. 

“Keeping capex proportional to EBITDA means you have to keep leverage low and free cash flow will stay within a modest range. For an offshore company to be able to do that, that’s a pretty good plan,” one of the sources said. 

Moreover, the company’s history with hedging supports the outlook for modest free cash flow, the sources added. Talos has a target of hedging roughly 70% of production on a rolling 12-18 months basis. The company’s hedge book indicates that management started layering additional hedges recently to account for prices in the USD 30 per barrel to USD 45 per barrel range, two of the sources noted. 

Its pro forma leverage sits at 2.2x through USD 480m of adjusted EBITDA including hedges and USD 1.05bn of total debt. Removing the hedges, leverage increases to 3.1x through USD 340m of adjusted EBITDA. 

And once the company is able to grow through acquisitions and realize the benefits of its recent purchases, production could increase more than 20% to 25% annually, versus 2020, two of the sources said. For context, through 3Q20, Talos recorded a pro forma average net daily production of 57.9k barrels of oil and gas (MBoe) per day, versus 71.4 MBoe per day in full-year 2019. 

At the same time, investors in the new debt will be vulnerable to the risk that the company faces another severe storm season, which would thwart future growth plans, the same sources added. 

The offshore driller’s pro forma liquidity is set to amount to USD 407.4m through USD 64.9m of cash and USD 342.5m of unused RBL borrowing capacity. 

Since its formation in 2012, Talos has grown through acquisitions such as its merger with Stone Energy in 2018 and recent asset purchases from Castex Energy, ILX Holdings, and Venari. 

In the longer term, Talos’ interest in a Mexican project Zama–an offshore discovery made in Mexico– is expected to add production and generate free cash flow, the sources said. The company is working toward a final investment decision (FID) to develop in the Zama discovery, which is delayed because of a dispute with Mexican oil company Petroleos Mexicanos over operating rights and which company holds a majority in the region. 

Talos has drilled four total wells and has a 35% participation interest in the reservoir, or an estimated 670 MBoe. Fitch Ratings guided in its 14 December ratings report that first oil can be achieved in 30-26 months following the FID, which is targeted for 2H21.

Unsure about offshore

Sources also pointed to the potential regulatory impact from the new Biden administration as a deterrent to participating in the deal. Environmental activists are piling on pressure for the president-elect to fulfill his promise to ban new offshore drilling, after the Bureau of Ocean Energy Management proposed another lease sale to take place in March 2021 offering nearly 78.2m acres for the Gulf of Mexico. 

For relative value, sources placed Talos between smaller Gulf of Mexico operators such as EnVen Energy Ventures and W&T Offshore and a larger, more diversified operator such as Kosmos Energy. 

On the wider end, EnVen contains more risk compared to Talos dbecause of its smaller scope and private ownership, two of the sources said. W&T is also on the smaller end compared to Talos, the sources added. 

EnVen’s USD 325m 11% second lien notes due 2023 traded at 89.5 to yield 16.963% on 11 December, compared to trades earlier in the month at 84.5 to yield 20.131%, according to MarketAxess. W&T’s USD 552m 9.75% second lien notes due 2023, meanwhile, traded at 63.5 to yield 29.162% on 30 November, in line with recent levels.

On the higher-quality end, Kosmos Energy has higher production compared to Talos and is also more geographically diversified, three of the sources said. 

Kosmos’ USD 650m 7.125% senior unsecured notes due 2026 last traded at 90.5 to yield 9.425% on 27 November, compared to trades at 87.375 to yield 10.193% in October, according to MarketAxess. 

Talos is the latest in a series of E&P issuers to recently tap the high yield market. This week alone Tallgrass Energy, New Fortress Energy, Valvoline, EnLink Midstream and Ascent Resources all priced bonds, signaling a resurgence in appetite for deals in the space.  

EnLink’s USD 500m senior unsecured notes due 2028 priced Monday (14 December) at 5.625% and par, tight of official talk at 5.75% to 6%. The notes traded today at 101.375 to yield 5.373%, according to MarketAxess. Ascent’s USD 300m senior unsecured notes due 2028 also priced Monday at 8.5% and par, in line with talk in the 8.5% area. The notes changed hands today at 101 to yield 8%.

Talos and JPMorgan did not respond to requests for comment.

2020 Debtwire