DEBTWIRE BROADCAST:
PARAGON OFFSHORE VALUATION STRETCH
RAISES FEASIBILITY CONCERN
PREPARED REMARKS
DEBTWIRE BROADCAST: PARAGON OFFSHORE VALUATION STRETCH RAISES FEASIBILITY CONCERN
PREPARED REMARKS
FINANCIAL ANALYSIS:
DENIS RUDNEV, DISTRESSED ANALYST
I’ll begin by walking you through the pre-petition capital structure as well as the changes proposed under the PSA. At the top,
we have a first lien revolver with approximately USD 796m outstanding, which includes USD 87.4m in letters of credit. Under
the PSA, the company will pay down USD 165m of this amount and convert the remainder to a term loan. Aside from the
revolving credit facility, Paragon also has a first lien term loan in the amount of USD 642m. Given the current trading levels,
we think it is a bold, but strategic move to reinstate it, carrying the added effect of removing the Term Lenders from the plan
voting process. Rounding out the secured portion is the sale leaseback of the two “Prospector” rigs from July 2015, which is
accounted for as a capital lease. This would also be unaffected by the bankruptcy. Finally, we have two tranches of unsecured
notes whose holders expect to recover between 57% and 73% through a combination of USD 345m in cash, 35% of the reorg
equity, and up to USD 50m of contingent payments if EBITDA exceeds certain levels in these next two years. In a surprising turn
of events, the existing equity holders are expected to retain 65% of the new equity. After netting out USD 510m of payouts
from the current USD 778m cash balance, Paragon would theoretically have more than USD 250m left to pay administrative
fees and keep the lights on after the reorganization.
Now, based on what we’ve seen from Hercules and Vantage, we did not expect a proposal where the reorganized company still
carries a heavy debt and interest burden. If you recall, Hercules emerged from Chapter 11 in November after equitizing USD
1.2bn of unsecured notes and taking on a new USD 450m 10.5% term loan provided by the prepetition bondholders. About a
week ago, Hercules announced it is once again exploring strategic alternatives which may include a sale of the company or
certain assets. Its reorg equity has fallen to just over a dollar per share after opening at USD 14.50/share, while the TL trades
in the 40’s. Meanwhile, Vantage took a slightly different approach. Although the driller existed bankruptcy with almost USD 1bn of
debt including a USD 750m third lien tranche, the third lien interest is payable in kind, giving the company a chance to weather
the storm. As a result of this feature, on an annual basis Vantage pays just USD 8m of interest in cash and another USD 8m is
PIK for four years. Hence, we view the latter as a more advantageous structure in the current environment. We also believe
that restructuring offshore drillers should try to equitize as much debt as possible given the poor outlook for the industry.
Turning to Paragon’s projections…the company is expecting to generate USD 209m of EBITDA in 2016, followed by USD 275m
in 2017 and USD 411m in 2018. These estimates are pretty steep, especially since a lot of the backlog rolls off by 2017. With
supply outpacing demand, Paragon’s ancient fleet will continue to be challenged by low utilization and pressure on day-rates.
That being said, in addition to USD 60m of pro forma interest, the projections also call for USD 135m of capex and USD 60m of
sale leaseback amortization payments in 2016, meaning that cash outflows are highly probable for the foreseeable future. This
elevates risk for a repeat filing, which would be devastating to the secured lenders without a sizeable cash buffer the second
time around.
Finally, I’d like to draw attention to the liquidation analysis presented in the disclosure statement. In a liquidation scenario, the
debtors would expect to recover between 2% and 11% of the book value of their PP&E. The footnotes explain that the debtor’s
equipment is “early vintage and is not readily marketable as operating equipment in the current market environment.” They go
on to add that there is no economical way to scrap the assets and that each rig could be worth only USD 1.75m on average even at
the high end of recovery estimates. If we ignore the large cash balance for a moment, we can see that there is marginal liquidation
value of USD 25m to USD 124m for the core of the business, which is the fleet itself. This means that if the company runs into trouble
down the line, recoveries for the post-reorg term loans would likely be minimal. All in all, we think that USD 2bn might be an
aggressive valuation for a company with a fleet that largely dates back to the early 1980’s. We are also concerned with the
prospect of a significant post-reorg debt burden, which could ultimately have disastrous effects if Paragon misses its projections.
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DEBTWIRE BROADCAST: PARAGON OFFSHORE VALUATION STRETCH RAISES FEASIBILITY CONCERN
PREPARED REMARKS
COURT CASE:
RICHARD GOLDMAN, LEGAL ANALYST
INTRODUCTION
So, we have a couple of new legal topics to address during this webcast. Whereas past roundtable discussions provided opportunities
to discuss adequate protection, absolute priority, treatment of executory contracts and other issues germane to large Chapter
11 filings, today we will discuss restructuring strategies such as reinstatement and cram-down, plan confirmation issues such as
feasibility, spinoff fraudco liability and settlements under Bankruptcy Rule 9019.
REINSTATEMENT VERSUS CRAMDOWN
As everyone is now well aware, Paragon, by its proposed plan, seeks to reinstate the TL lenders’ USD 640m prepetition loan.
Notwithstanding some of our subscribers’ frustration over the treatment of the TL compared to unsecured noteholder cash and
equity recoveries, reinstatement is a legitimate legal strategy as well as a tried and true mechanism for debtors to employ in an
effort to avoid or eliminate the need to generate exit financing in a down market. Reinstatement also sits perfectly within the
purpose of the Bankruptcy Code, which allows a debtor to shed bad/onerous debt while maintaining good/serviceable debt.
And while reinstatement may not be a common vehicle these days to obtain exit financing, it was a prolific issue in connection
with Charter Communications’ prepackaged Chapter 11 cases back in 2009, which, for anyone who is interested, can be found
at 419 B.R. 221 (Bankr. S.D.N.Y. 2009).
Now, reinstatement has a very specific meaning within, and legal standard under, the bankruptcy context, and should not be
confused with a cram-up or cram-down, which is another legal strategy that debtors sometimes employ to obtain exit financing
in a difficult market. To ensure that there is no confusion with respect to Paragon’s restructuring scheme, let’s discuss these two
concepts briefly.
At its core, a cram-up or cram-down governed by Bankruptcy Code section 1129(b) essentially occurs when an impaired class of
creditors—secured or unsecured—that is entitled to vote on a plan, and in fact votes to reject the plan, nonetheless has the
plan “crammed upon it” because a different class of impaired creditors votes to accept that plan. With respect to a secured
class of creditors, a debtor typically seeks to cram when it wishes to maintain that secured creditor’s loan as post-emergence
financing, and impairs that creditor by proposing to pay off the loan over a period of time rather than satisfying the debt in full
on the plan effective date.
Reinstatement, on the other hand, effectively removes a creditor class from the plan voting process. By proposing to cure any
and all defaults and restore any maturities accelerated by the bankruptcy filing, reinstatement effectively renders the secured
creditor class “unimpaired”.
More specifically, Bankruptcy Code section 1142(2), which governs reinstatement, generally provides that a debtor can reinstate a
defaulted prepetition secured loan if the plan:
 cures all defaults (except for ipso facto defaults on account of the bankruptcy filing, insolvency or other financial condition of
the debtor),
 reinstates the maturity date;
 compensates the lender; and
 does not “otherwise alter the lender’s legal, equitable, or contractual rights, including any security interests granted to the lender”.
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DEBTWIRE BROADCAST: PARAGON OFFSHORE VALUATION STRETCH RAISES FEASIBILITY CONCERN
PREPARED REMARKS
COURT CASE:
RICHARD GOLDMAN, LEGAL ANALYST
REINSTATEMENT VERSUS CRAMDOWN (CONTINUED)
Now what does this all mean and specifically with respect to Paragon? It means that within Paragon’s term loan, there cannot
exist any non-curable defaults—such as change of control or affirmative or negative covenants—that are unrelated to Paragon’s
financial conditions. If non-curable defaults exist or arise as a result of Paragon’s restructuring, reinstatement cannot occur. As
a result, Kaye Scholer, if it has not already, is likely scouring the precise terms of the term loan to see if it can dispute whether
certain defaults are capable of being cured.
FEASIBILITY
When lenders are loathe to allow loan reinstatements because the original terms of the loan are too loose in the current
lending environment, they frequently argue that the plan is not feasible under Bankruptcy Code section 1129(a)(11).
Feasibility, the burden for which rests with the debtor to establish in connection with plan confirmation, essentially requires the
debtor to show, through factual evidence, that its proposed restructuring is not likely to be followed by another restructuring or
liquidation. Essentially, with the amount of cash on hand upon emergence, coupled with revenue generated from its daily operations,
taking into account industry and market elements, will Paragon be able to service its debt? If yes, the plan is feasible. If no, then it
is not, and the plan should not be confirmed.
As for Paragon, I think Denis’s presentation answered this question with a resounding no when examining and discussing Paragon’s
valuation analysis. If Kaye Scholer and its term loan lender group are able to establish the same, and rebut the evidence that
will be put forth by Lazard and AlixPartners on behalf of Paragon, then Judge Sontchi may have no choice but to reject the plan
and force Paragon back to the drawing board.
Obviously no one has a crystal ball, so there is no way to tell whether the holes that the TL lenders’ financial advisors poke into
Paragon’s valuation will weigh heavier with Judge Sontchi than the debtors’ analysis. Though, maybe Hercules’ current situation
will play favorably to rebut Paragon’s revenue projections given the age of its rigs and assumptions tied to Paragon’s ability to
obtain profitable contracts in the future.
Maybe the easiest way to analyze this is to examine three options and see which of them gets the TL lenders to their ultimate
goal—a cash or equity recovery.
They can vote to reject the plan, but wait, they are unimpaired, so they cannot even do that. That door is closed. They can argue
feasibility, but if so, to what end? Even if the TL lenders are able to convince Judge Sontchi that Paragon’s proposal is not feasible,
it doesn’t guarantee that the TL lenders won’t still be reinstated. What it does guarantee, however, is six more months in bankruptcy,
accruing administrative fees and expenses, as Paragon returns to the drawing board to revise its valuation analysis, which,
again, may not undo reinstatement. That is why reinstatement, the TL lenders third option for upending Paragon’s plan, needs to be
the TL lenders’ focus. Only by challenging reinstatement can the TL lenders possibly obtain the relief they are seeking. All other
challenges are frosting, reinstatement is the cake.
NOBLE SPINOFF SETTLEMENT
In addition, the Noble spinoff settlement could hit some roadblocks, though it remains to be seen what party will stand up and
challenge the settlement, which I’ll discuss in a second.
Back in October, Debtwire’s legal analyst team examined Paragon’s August 2014 USD 1.7bn spinoff from Noble Corp. As part of
its analysis, the legal team reviewed the fraudco elements under Bankruptcy Code section 548 and compared Noble’s spinoff of
Paragon to Anadarko’s 2006 spinoff of Tronox. Opposite of Paragon, Tronox actually challenged its spinoff after filing for bankruptcy
in 2009, which resulted in Judge Gropper of the SDNY issuing a damages award ranging from USD 5.15bn to USD 14.46bn
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DEBTWIRE BROADCAST: PARAGON OFFSHORE VALUATION STRETCH RAISES FEASIBILITY CONCERN
PREPARED REMARKS
COURT CASE:
RICHARD GOLDMAN, LEGAL ANALYST
NOBLE SPINOFF SETTLEMENT (CONTINUED)
Although Paragon or any other party in interest could attempt to argue that the Noble spinoff set Paragon to fail, crippling it
with unserviceable debt and subpar assets for the sole benefit of Noble in an effort to evade its creditors, Paragon appears to
be taking the path of least resistance and settling. My problem with the settlement is the consideration. Given the spinoff saddled
Paragon with almost USD 2bn in debt, the contingent tax liability assumption, which at worst would only accrue to, I’m sure
Paragon will be prepared to argue that fraudco spinoff litigation is timely, intensive, costly, unpredictable and disttens of millions
of dollars, coupled with Noble receiving a comprehensive buffet of releases, just seems light.
Now, I’m sure Paragon will be prepared to argue that fraudco spinoff litigation is timely, intensive, costly, unpredictable and
distracting from the primary purpose at hand, which is to rehabilitate Paragon’s operations and balance sheet so that it can
quickly emerge from Chapter 11 administration. Paragon will also argue that Bankruptcy Rule 9019 only requires it to establish
that the settlement does not “fall below the lowest point in the range of reasonableness”—not a high legal standard by any
measure—which this settlement very well might.
But that is where a creditors’ committee typically comes in to play—to provide a balance that checks against Paragon’s possibly
hasty settlement with Noble.
UNSECURED CREDITORS’ COMMITTEE DELAYED ROLE
The problem, however, is that Paragon walked into Chapter 11 with 77% of the outstanding unsecured notes supporting its proposed
restructuring and trade creditors set to receive 100 cents on the dollar in satisfaction of their claims. Thus, if a creditors’
committee is appointed, and that might be a big if, on whose behalf would it challenge the Noble spinoff settlement? Why would the
debtors, who are obligated to pay fees and expenses incurred by counsel and advisors that the official creditors’ committee
retains, agree to fund an objection to a settlement that doesn’t benefit any interest represented by that committee?
Thus, as things currently stands, it seems unlikely that a group will step forward to challenge the settlement. But, as discussed, the
current Chapter 11 landscape is subject to significant change.
For instance, what happens if the TL lenders are successful in challenging reinstatement or plan feasibility? In either event,
Paragon will have to revisit its valuation drawing board and rejigger plan recoveries. When that occurs, noteholders may not
receive as lucrative a recovery as currently contemplated. In that event, unsecured creditors may then seek to challenge the
Noble settlement to leverage an additional recovery for unsecureds. In that event, the UCC’s would be significantly enhanced.
CONCLUSION
In sum, I think it is safe to describe the TL lenders’ forthcoming opposition as the running theme of this panel presentation,
which, without a doubt, will take center stage in the coming months of these Chapter 11 cases. The statements that Kaye
Scholer made yesterday during Paragon’s first-day hearing were not unexpected and were purposefully disclosed to set the
tone for the battle to come. As a result, is not a matter of if, but when, the TL lenders will first present their comprehensive
opposition, and if an opportunity does not present itself before the currently-scheduled April 6 disclosure statement
hearing, expect that occasion to be the time and place.
And yes … I know … as do many of our listeners … that the TL lenders’ objections are plan issues, not disclosure statement
issues, and therefore should be reserved for the plan confirmation hearing. However, if the TL lenders are able to establish
at the disclosure statement phase of these Chapter 11 cases that Paragon’s plan is patently unconfirmable and it is in the
interests of no parties to proceed with the time and cost of soliciting an unconfirmable plan, well I think Judge Sontchi would
hear that argument, even if presented during the disclosure statement hearing.
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DEBTWIRE BROADCAST: PARAGON OFFSHORE VALUATION STRETCH RAISES FEASIBILITY CONCERN
PREPARED REMARKS
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