On April 1, 2020, Whiting Petroleum (NYSE:WLL) filed for Chapter 11 bankruptcy protection. In an agreement with the majority of its creditors, holders of existing WLL stock will get 3% of the new common stock after recapitalization.
The problem however, is that the deal will not be finalized until late July, according to the company’s legal restructuring website. Moreover, as best as I can tell, the final term sheet showing the total number of new shares outstanding, including potential warrants, has not yet been finalized.
So in effect, it’s anybody’s guess whether the present price for WLL stock really represents any kind of bargain.
Most serious investors in this kind of situation would be better off buying into the senior or convertible notes. As a group, those buyers will receive 97% of the newly issued common stock in the recapitalization of Whiting Petroleum.
Assessing the Value of WLL Stock
So the question for investors is whether WLL stock, trading at 70 cents per share on May 31, 2020, is worthwhile.
First of all, as of May 7, 2020, the recent 10-Q filing for Whiting Petroleum said the company had 91.412418 million shares outstanding. That implies that the market value of WLL stock stands today at $64 million.
Next, the 10-Q says that the senior debt and other general unsecured claims, which will control 97% of the new equity, amounts to $4.1316 billion.
So, using algebra, we can estimate the implied value of the newly restructured equity. For example, in this case, the value of the equity will be x. Now we know that x is equal to 3% of the sum of x plus the debt.
So here’s the math: x = .03 (x + $4.1316 billion). This simplifies to x = .03x + .03($4.1316 billion).
That reduces to: 1-.03x = $123.948 million. This reduces to: 0.97x = $123.948 million.
Finally, x = $123.948 million / 0.97, so we can determine, x = $127.78 million.
Here is what that algebra answer means. The new equity will be worth $127.8 million. We can use that to analyze whether buying WLL stock today is worthwhile.
Today’s valuation for all of WLL stock is $64 million. So this implies the stock is worth more, since x, the new equity after restructuring, will be worth $127.8 million. In other words, WLL stock should be trading 100% higher or double today’s price of 70 cents per share, because $128 million is double the current market value of $64 million.
Adjustments to the Valuation
But not so fast. I didn’t deduct the company’s cash and other current assets. These can be used to lower the total debt outstanding. Remember, however, that a lot of that will depend on the final term sheet.
Nevertheless, using the same algebra equation, the equity works out to just $88.17 million. This is only slightly higher than the $64 million existing stock market value of WLL stock. However, it still implies that the stock should be at 96 cents per share, not 70 cents per share.
Like I said, a lot will depend on the final terms of the restructuring. There could be other assets, including a buildup of cash flow and cash since the bankruptcy was filed. This will lower the value of the equity as the remaining creditors will pick up more shares.
Nevertheless, in any case it makes a lot more sense to buy the debt rather than the equity. Right now, the convertible and senior debt trade at just 7 percent of their March 31 value, based on the 10-Q “fair value” estimates of the debt. That implies you stand to make well over 10 times your investment buying the debt.
What to Do With WLL Stock
One blindspot here is not having access to see the exact trade prices for the company’s debt. But it’s quite likely they are still trading for less than the implied value of the equity in the restructured company. Based on historical experience, I suspect the debt is a much better deal than WLL stock.
Therefore, I would wait to buy WLL stock just yet. Call your broker to get quotes on the trading prices of the convertible and senior debt.
Using the algebra equation I introduced in this article, you can determine whether the WLL stock price or the secured or convertible debt price is a better deal. You have until just before July 22, when the bankruptcy is set to close and the new WLL stock will start to trade.
The above math is the hyperrational approach to valuation analysis of distressed securities. But there are so many variables in this deal. The final term sheet will set things in concrete, but that hasn’t been determined quite yet.
Sometimes it makes sense to buy just a little bit of the non-restructured equity, as well as the debt, to see how they both fare. Both will receive shares in the newly restructured capital structure of Whiting Petroleum.
However if you do that, make sure to buy a lot more of the debt than WLL stock. That weighting seems better poised for success.