New Walter Energy bond leaves investors hurting

Reuters

By Natalie Harrison

NEW YORK, March 20 (IFR) - Investors in the new USD350m payment-in-kind (PIK) bond from Walter Energy are nursing big losses after the risky security dropped six points immediately after pricing.

The bond plummeted on Wednesday to 94 in cash terms and stayed down around the same level in the after market Thursday, leading bankers to say the trade had been mispriced.

The six-year PIK toggle, part of the coal company's plan to push out its debt maturities, priced at par with a 11% cash coupon and 12% PIK via left lead Morgan Stanley.

Barclays, Citi, Credit Agricole, Goldman Sachs, JP Morgan and Scotia were also bookrunners on the deal.

The yield-to-worst jumped to around 13.6% after the price of the bond fell - a level at which the PIK should have initially priced, one observer said.

"The deal was mispriced and jammed. There is no other explanation. Bonds only drop like that on the break when they have been poorly allocated," said one observer.

Morgan Stanley declined to comment on the PIK's performance, or to offer any further clarity on how they arrived at the pricing levels, demand for the deal, or any details on how it was allocated.

Walter Energy declined to comment.

Others pointed to a negative equity research note published by BofAML, which cut the price target on the stock to USD2 from USD8 and contributed to a 20% fall in the company's share price to USD7.27.

Given that the note was published on Thursday, however, does not explain Wednesday's bond performance and the general consensus was that market conditions were unlikely to have been a factor.

Indeed, other new high-yield issues have been trading up - including Walter's USD200m first lien add-on, which priced alongside the PIK at 101.5. Multiplan's USD1bn bond, for example, carrying similar Triple C ratings and having priced on Tuesday at par, was bid at 102.5.

Two investors said left-lead Morgan Stanley had told some portfolio managers that they would only get allocation on the add-on, which was doubled in size, if they also bought the PIK.

"That's how it looks to me," said one investor, who played in the PIK.

"Some investors have clearly sold it immediately, and that's why it has fallen so dramatically."

He said the 12% PIK coupon had looked very attractive, offering a chance to get exposure to a rare name after recent high-yield deals from sector peers Westmoreland and Arch Coal.

"We just have to move on," the investor said.

BREATHING SPACE

Overall, of course, the coal industry faces some tough headwinds that have already hurt liquidity. For metallurgical coal companies like Walter Energy, weak global steel production has been the Achilles heel.

"The company is very sensitive to met coal, which is very sensitive to the slowdown in China. Walter was essentially terming out loans to give themselves enough time for that cycle to turn (if they're lucky)," said another investor.

Analysts at CreditSights recently said Walter was in the worst shape of the coal producers it covers, with 2.4 years of cash at its projected burn rate without tapping its revolver.

According to them, Walter Energy had a cash balance of USD261m in the fourth quarter of 2013, and they assume a negative USD109m free cash flow in their analysis.

And overall, they are bearish on the sector.

"We are continuing our long-held view that coal producers will underperform the broad HY corporate bond averages and would prefer to miss the upturn in coal prices than risk further downside in the bonds," the analysts said in a note.

The uncertain outlook had already unnerved some of the company's lenders, as some decided not to extend the maturity of the revolver - a move that three market sources said was very unusual.

According to Moody's, only 82% of the revolver lenders voted for the amendment, which means the size of the facility will shrink to USD314m from USD375m until April 2016, and to USD245m until October 2017.

New leverage covenants on the revolver could also make it difficult for the company to use unless its situation improves.

Thus, even though Walter has pushed out its debt maturities to 2018, its liquidity position is still fragile.

"The company will generate negative free cash flows absent a meaningful recovery in metallurgical coal markets. In addition, if metallurgical coal prices remain weak, the revolver's covenants could restrict availability," Moody's said.

Even so, Walter has won itself some breathing space with the USD550m bond deals under its belt.

Indeed, the sale of the second lien PIK - which sits in the company's capital structure between its first lien 9.5% bonds and unsecured 2020 and 2021 bonds, yielding a massive 14-15% - was crucial to refinancing plans.

Before even getting to this stage, the company had to first get an amendment allowing it to repay its roughly USD406m Term Loan A maturing over the next two years, without having to refinance its Term Loan B maturing in 2018.

The proceeds from the new bonds will repay the TLA, and will now allow for the company's revolver to be extended by 18 months.

(Reporting by Natalie Harrison; Editing by Marc Carnegie and Shankar Ramakrishnan)

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