Special Opportunity in ATP Oil & Gas Credit Structure

(This is a highly-abbreviated version of a full SumZero report republished with the author's consent)

Quick Thesis:
Now that it is almost certain that ATPG will file for reorganization, the recovery value of the 2nd Lien Notes offers a potential 64% upside over the current market price of 35. The Company has an attractive portfolio of offshore oil and gas assets that was beset by liquidity issues and an unhealthy capital structure. A restructuring should provide much needed liquidity and capital structure relief.

Completion of new wells in Q3 and Q4 could conservatively increase production by 85%. The 2nd Lien Notes currently trade at $15 per Boe vs $22 per Boe for comparables, an overly high discount for a Company that has a deep production pipeline and significant undeveloped reserves.

Liquidity Issues and Bankruptcy Filing
The Company’s liquidity problems began in 2009, when a 60% collapse in global oil prices led to a 69% drop in EBITDA. Leverage soared from 2.4x in 2008 to 6.7x in 2009, and capital markets were inaccessible due to the financial crisis. To fund its large capex program, management turned to overriding royalty (ORI) and net profit interests (NPI). Common in the industry, these funding arrangements are collateralized by and repaid through future sales or net profits from oil and natural gas production.

ATPG’s problems continued with the April 2010 explosion aboard BP’s Deep Horizon drilling rig. Though production and world oil prices both recovered in 2011, management continued to rely on ORI’s and NPI’s to plug its financing gap. Though ATPG deferred a $229mn construction payment on its Octabuoy facility, the working capital deficit grew 320% to $347mn. Operational problems in Q1’12 led to a 14% yoy drop in both production and EBITDA. Concerns mounted over an $89mn interest payment due in Nov. On August 10, 2012, Bloomberg reported that ATPG will receive a $600mn DIP and file for Chapter 11.

What the Market Is Missing
• Completion of Telemark and Clipper wells in Q3 and Q4 could grow production by 85-100% in 2013. The Clipper wells could add 16.4 MBoe/d, while two wells at the Telemark hub are expected to add 5.5-6.5 MBoe/d. Even after applying a 10% discount, 2013 production could grow from Q1’s 20-21 MBoe/d to 37-40 MBoe/d.
• Major infrastructure capex has largely been incurred. The Innovator and Titan floating platforms account for $1.4bn of BV infrastructure that have been deployed and are currently producing. A third floating platform, the Octabuoy, will be operational in the North Sea in 2014, though a $103mn deferred payment remains on it.
• Restructuring should provide much needed liquidity relief. Using 1.8x gross leverage and a $650mn run rate EBITDA, public debt drops by 48%. The valuation also assumes that the ORI’s and NPI’s will be prepaid from either a new debt issuance or a combination of new debt/equity. Factoring those in, total balance sheet debt could emerge 57% lower.

Why the 2nd Lien Notes are Cheap & Opportunity Summary
• Notes are subordinate to $1.8bn of debt. $600mn DIP, $584mn of ORI’s and NPI’s, $650mn of 1st Lien TL
• Company has missed production targets in the past. Q1’12 production was 11% lower sequentially due to operational difficulties. In July 2012, S&P estimated that management will not meet Q2 production goals.
• Specialized assets that might draw limited interest from potential suitors. ATPG might receive limited interests as it acquires reserves that are noncore to its competitors, and large capital expenditures remain to develop its North Sea and Mediterranean fields. Consequently, the 2nd Lien Notes trade at a 32% discount to peers on a Sales/Boe basis.

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