The GeoTeam has come across yet another bankruptcy play in Patriot Coal Corporation (PINK: PCXCQ). On July 17, 2013 and July 29, 2013 we wrote about K-V Pharmaceuticals (PINK:KVPHQ), a story that for a moment offered a glimmer of hope that common shareholders could survive a Chapter 11 process. Unlike KVPHQ, we believe that shareholders of bankrupt company PCXCQ have a ZERO percent chance of retaining any equity ownership, if and when the company emerges from Chapter 11 proceedings. All of the facts support an imminent scenario that will see current common interests being wiped away, on or before October 31, 2013.
On August 23, 2013, an article by Ashraf Eassa was published on Seeking Alpha that effectively highlights the financial bind that Patriot is in. Here is our take on the story, with additional facts that should convince even the irrational investor that common shareholder interests will be ignored during a Chapter 11 restructuring process.
Misplaced Hope of Equity Shareholders
Given the dire state of Patriot’s operation (to be discussed later), we see no chance that a funding party will come to the rescue of common shareholders. On the contrary, potential funders would likely require that current equity interests be cancelled so that new shares can be issued to them.
There are facts that indicate that on or before October 31, 2013 Patriot could file its restructuring plan. At the same time, we anticipate that filings will likely state that current equity interests will be cancelled; this should set off a mass exodus from PCXCQ stock.
As Mr. Eassa pointed out, many investors appear to be misinterpreting recent developments. On August 20, 2013 Patriot stated that the court approved a decision that pension obligations totaling $1.4 billion could be transferred away from the company to its former parent company, Peabody Energy (NYSE:BTU). Employees to whom the related pension funds are entitled will receive 35% of the Post Reorganization Equity. For some reason, it seems that some current equity investors have taken this development to mean that their ownership interests will be retained upon PCXCQ’s possible emergence from bankruptcy. This couldn’t be further from the truth.
This development alone begins to tell us that current equity interests are beginning to be compromised. In the end, the creditors, potential funders and the Union representing the workers are not going to approve a plan where they would not own all the interests in the new equity – especially in a case like Patriot where risks to survival seem large.
Other additional clues exist that should warn the bullish equity shareholder that their shares in Patriot will soon be worthless. Each builds a progressively stronger case against holding shares of PCCXQ.
Clue 1- Verbiage from the Stock Fund Plan Amendment
“This Amendment is being filed to deregister any and all unsold securities registered pursuant to, and to terminate the effectiveness of, the Registration Statement. Effective June 28, 2012, the Company ceased offering the Common Stock pursuant to the Plan and all shares of the Common Stock then held in the Patriot Stock Fund of the Plan were sold. Participants can no longer invest in the Common Stock through the Plan.”
Clue 2- Verbiage from Patriot’s Web Site
“At this time, we do not know what will happen to Patriot’s common stock as a result of the Chapter 11 reorganization. Typically, the common stock of a company in Chapter 11 is cancelled upon its emergence from the reorganization process and stockholders usually receive no value for any common stock they hold at that time.”
Although the above passages are grim, their lack of 100% conclusiveness as to how the courts will approach shareholder rights unfortunately offers a misguided glimmer of hope to equity shareholders.
If the previous two points weren’t convincing enough that the courts are not even going to consider the ownership interests of common shareholders, clues 3 and 4 are the big hitters.
Clue 3- The Trustee Speaks Out
September 17, 2012:
“The U.S. trustee objected Friday to Patriot Coal Corp. shareholders’ request for an official committee, saying they failed to show that their interests are not being adequately represented or that it’s even likely they’ll get a meaningful recovery.
U.S. Trustee Tracy Hope Davis objected to the motion by Patriot shareholders CompassPoint Partners LP, Frank Williams and Eric Wagoner for the court to order her to appoint an official committee of equity holders, saying there is nothing to suggest that her initial refusal Aug. 24 to appoint one…”
Clue 4- Court Slams the Hammer
More recently, on May 13, 2013:
“The bankruptcy court overseeing the Chapter 11 proceedings of Patriot Coal ruled that it would not require the appointment of an equity committee in the case, saying in a May 10 order, “there appears to be no substantial likelihood that equity will receive a meaningful distribution in these cases to justify appointment of a committee.”
In light of clues 3 and 4, we conclude that this is game, set, and match. But the financial mess Patriot is in solidifies our conclusion.
Financial Mess
Equity investors need to realize that:
“Under the priority rankings established by the Bankruptcy Code, unless creditors agree otherwise, pre-petition liabilities and post-petition liabilities must be satisfied in full before stockholders are entitled to receive any distribution or retain any property under a plan of reorganization.”
The above passage was taken directly from one of PCXCQ’s SEC filings. So what is the price tag of some of these liabilities?
To summarize, as it currently stands and as Mr. Eassa pointed out, Patriot needs to address total creditor liabilities of about $1.8 billion that are not subject to compromise. As we will explain later, this has to occur by October 31, 2013.
Mr. Eassa shows that as of the most recent 10-Q filed on August 9, 2013, Patriot can utilize liquid assets (current assets) of $474 million against the $1.8 billion non-negotiable liabilities.
In actuality, as per its updated financial statements disclosed in an 8-K filed on August 21, 2013, PCXCQ:
- Current assets have shrunk to $400 million.
- Cash on hand is has been reduced by $50 million to $145 million.
- Is losing nearly $20 million per month ($52 million quarterly loss, excluding reorganization items, divided by three months).
So, Patriot’s financial standing is quickly getting worse, especially considering that the company sported a $206 million cash balance at the end of May 2013.
In order to “save” Patriot, it appears that equity investors would essentially have to find some way to bring $1.4 billion ($1.8 billion debt minus $400 million in current assets) to the table to settle prior debts. This, of course, also assumes that the current asset balance will not decline any further.
Furthermore, they would need to convince special situation investors to overlook the fact that the Debtor-in-Possession (“DIP”) vehicle set up to fund Patriot during the Chapter 11 reorganization process was recently on the verge of default (terms have now been amended):
“Patriot Coal notified lenders in late July that the company’s operating earnings would likely fall short of third quarter targets required in the DIP credit agreement.”
To make matters worse, the new DIP agreement requires Patriot Coal to obtain committed bankruptcy-exit-financing by October 31, 2013.
More on the DIP
If we take a close look at how severe the condition Patriot Coal is facing in the DIP situation alone, we would know that the value of those equity shares of Patriot Coal is about to diminish.
According to Patriot Coal’s second quarter 2013 SEC filing, the letters of credit from the First Out Facility and the Second Out Facility (both of them are part of DIP plan with super priority for creditors) totaled $58.2 million and $279.4 million, respectively. Combining the knowledge that the company needs to obtain committed bankruptcy-exit-financing by October 31, 2013 along with its troublesome cash generation capability (losing money rather than generating more cash), it is not hard to imagine that Patriot would need to seek an extension for the repayment of DIP obligations. Given the worsening financial condition of the company, we believe that the likelihood of additional flexibility from creditors of the DIP plan has been substantially reduced. If default occurs, according to the DIP agreement, the company would have to liquidate its assets to repay the DIP principle and accrued interests incurred…in other words, going into the liquidation process (Chapter 7).
Conclusion:
Barring a miracle, it is almost assured that if you own or buy PCXCQ today it will be worthless within two months or sooner once the irrational investor is convinced that the bullish thesis is flawed. When we wrote about KVPHQ there was a chance that its equity interests could have been preserved due to improving business conditions and a chance that a legislative decision would give K-V a near monopolistic position. We postulated that this scenario would attract investment into the company in order to settle past creditors’ obligations. Unfortunately, it appears that Congress will not come through on time. In the case of Patriot, betting on the equity is like throwing your money into a wood chipper. The bet is not a calculated one at all.
Disclosure: Short PCXCQ
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