Hornbeck Offshore – High Hurdle For Proposed Debt Exchange Offer But Massive Upside If Deal Goes Through – Hornbeck Offshore Services, Inc. (NYSE:HOSS)

Note:

Hornbeck Offshore Services (HOSS) has been covered by me previously, so investors should view this as an update to my earlier articles on the company.

Six weeks ago, I advised investors in Hornbeck Offshore Services to prepare for near-term debt restructuring and suggested taking a speculative long position in the company’s shares:

Depending on the ultimate outcome of the ongoing negotiations, the stock could offer substantial upside from current levels, even if the total recovery for equityholders will likely remain in the low- to mid-single percentage range.

Picture: Stacked Hornbeck Offshore Services Vessels – Source: Company Presentation

As it has turned out, taking a long position was the right move at the right time but admittedly, I wasn’t expecting the type of restructuring deal Hornbeck Offshore Services proposed on Friday:

Hornbeck Offshore Services, Inc. announced today that with the support of a super-majority of the holders of the Company’s Existing Notes and a majority of the Company’s stockholders, it has commenced private offers to exchange any and all of its outstanding 5.875% Senior Notes due 2020 and 5.000% Senior Notes due 2021 for a combination of its newly issued 10.000% Senior Notes due 2023 and 5.500% Senior Notes due 2025 and a private offer to purchase for cash up to $66.7 million in aggregate principal amount of Existing Notes upon the terms and conditions set forth in a confidential Offering Memorandum and Consent Solicitation Statement dated February 14, 2020.

The Company has also entered into a Transaction Support Agreement, dated February 14, 2020 with holders of approximately 80% of the $224.3 million aggregate principal amount of outstanding 2020 Notes and 89% of the $450.0 million aggregate principal amount of outstanding 2021 Notes. Pursuant to the Transaction Support Agreement, the Supporting Holders have agreed to (i) validly tender their Existing Notes in the Exchange Offers, (ii) deliver their consents and agreed waiver and releases in connection with the consent solicitation described below, (iii) not to withdraw or revoke any Existing Notes tendered and any Consents delivered in the Exchange Offers and the Consent Solicitations; and (iv) cooperate with and support the Company’s efforts to consummate the Offers and Consent Solicitations.

In connection therewith, the Company has also received advance stockholder support agreements from approximately 52% of the holders of its outstanding common stock to vote in favor of certain proposals contained in a proxy solicitation required as a condition to the Exchange Offers. The proposals will require approval of 66 2/3% of the Company’s stockholders.

In addition to extending the Company’s upcoming debt maturities, if the Exchange Offers are consummated, the Company will contribute certain vessels and related assets to one or more “unrestricted subsidiaries” that are not subject to most of the restrictions under the indentures governing the New Notes or the Company’s existing credit facilities. The Company and certain Supporting Holders have entered into a Letter Agreement Regarding Proposed Backstop Financing, pursuant to which, subject to the terms and conditions thereof, the Backstop Lenders have agreed to pursue in good faith a financing described therein to a to-be-formed unrestricted subsidiary of the Company in the form of a senior secured loan in a principal amount of not less than $200,000,000, the proceeds of the which are intended to fund the acquisition of certain assets. The Borrower is not required to draw on the New Secured Loan, and this structure will permit the Company to immediately seek separate financings through these unrestricted subsidiaries, increasing liquidity and providing flexibility for the Company to pursue acquisition opportunities. As of the date hereof, there are no agreements or arrangements with respect to the acquisition of any specific assets.

In layman’s terms:

The company proposes to exchange an aggregate $674.3 million of its 2020 and 2021 notes into new notes maturing in 2023 and 2025 respectively. For each $1,000 in principal amount consenting holders will receive $556.12 in new 10% 2023 notes and $443.88 in new 5.5% 2025 notes which means that noteholders won’t have to take a haircut.

Concurrently, Hornbeck Offshore Services has commenced a cash tender offer for up to an aggregate $66.7 million of the company’s existing notes at 30% of face value. As this offer represents a major haircut for noteholders, I do not expect material participation.

The transaction is supported by holders of approximately 80% and 89% of the principal amount of the company’s 2020 and 2021 notes respectively. In addition, 52% of the company’s stockholders have agreed to vote in favor of certain prerequisite proposals.

If successful, the company will be gaining another three years of runway for the eagerly-awaited offshore drilling recovery to kick in.

In addition, Hornbeck Offshore Services is preparing to take advantage of current industry conditions by contributing certain unencumbered assets (five ultra high-spec 320 class OSVs) to a new tier of unrestricted subsidiaries to serve as collateral for an at least $200 million new 13% senior secured credit facility with the proceeds being earmarked for the acquisition of distressed assets (likely both vessels or competitors as a whole).

The new lenders will receive a 19% equity stake in the new entity and warrants for 4.5 million of the company’s common stock at a purchase price of $0.00001 per share.

Too good to be true?

Perhaps. Out-of-court restructurings generally face very high hurdles as non-consenting parties typically cannot be bound against their will to changes in their fundamental rights. As a result, virtually all affected creditors and a majority of shareholders will have to support the transaction and, unfortunately, Hornbeck Offshore Service’s proposed debt restructuring is no different (emphasis added by author):

The consummation of the Offers is conditioned upon (i) holders of at least 99% in principal amount of each of the 2020 Notes and the 2021 Notes tendering Existing Notes for New Notes or cash at or prior to the Expiration Time and (ii) approval by 66 2/3% of the Company’s stockholders of (a) the issuance of the New Notes as well as the Company’s common stock, issuable pursuant to the terms of the New Notes, the securities underlying the New Notes and certain warrants issuable in connection with or coincident with the Exchange Offers as required by the New York Stock Exchange and (b) an amendment to the Company’s certificate of incorporation to amend certain provisions of the Certificate of Incorporation as set forth in the Offering Memorandum at a special meeting of stockholders of the Company in connection with the Offers. Subject to applicable law and agreements with certain of the Eligible Holders, the Offers and Consent Solicitations may be amended, extended or terminated.

Please note that only “qualified institutional buyers” as defined in Rule 144A under the Securities Act of 1933 will be able to participate in the offers.

In addition, the new notes will be convertible into 98% of the company’s then outstanding common stock upon the occurence of certain events of default:

For as long as any of the New Notes remain outstanding, upon the occurrence of certain events of default that have not, in certain cases, been permanently cured or permanently waived under the New Notes or any of the Company’s existing or future debt instruments, at the election of holders of a majority of the outstanding principal amount of the New Notes voting as a single class (i) the Company will issue to the holders of the New Notes shares of the Company’s preferred stock $0.00001 par value per share that on a post-issuance basis represents 98% of the economics of the Company and the right to vote 98% of the voting interests of the Company, and/or (ii) the New Notes will convert into shares of the Common Stock after giving effect to an amendment and restatement of the Company’s Certificate of Incorporation, representing 98% post-issuance of the then outstanding shares of Common Stock.

That said, the 99% minimum participation condition could be reduced or waived with the mutual consent of the company and a requisite 66 2/3% of the noteholders being party to the Transaction Support Agreement.

With an aggregate 86% of the aggregate outstanding principal amount of the company’s 2020 and 2021 notes already supporting the transaction, I would expect the deal to be consummated even in case of more than 1% holdouts.

Bottom Line:

Once again, kudos to CEO Todd Hornbeck for not taking the easy way out and trying to preserve value for current equityholders by kicking the can further down the road. In fact, the proposed transaction pretty much resembles the vision outlined by management on the company’s Q2 conference call:

We have had a number of discussions with various strategic capital providers, including several deep pocketed private equity and institutional investors who proactively sought us out that lead us to believe that there is an appetite to support acquisitive growth under our stewardship.

(…)

While the Company remains optimistic regarding its ability to come to mutually agreeable terms with a multiple parties I referenced with respect to holistic deal structures that will permit both the addressing of our senior note maturities and the completion of our acquisition efforts.

That said, the deal is facing high hurdles. Even after Friday’s rally, the company’s 2020 and 2021 notes are still trading at approximately 45% of face value thus incentivizing potential holdouts. Given this issue, achieving 99% of principal amount being tendered for new notes will be difficult, to say the very least.

On the flipside, I fully expect the transaction to be approved by shareholders as they would be among the major beneficiaries, suffering very little dilution and gaining three years of runway thus massively increasing the option value of the stock.

In addition, with the vast majority of noteholders already supporting the transaction, the 99% minimum participation condition might ultimately be reduced or waived entirely.

In sum, there appears to be a reasonable chance for the deal to be consummated which obviously would be great news for equityholders.

Should the transaction fall through, expect the company to file for bankruptcy protection with the plan of reorganization likely resembling parts of Friday’s transaction support agreement. That said, in case of bankruptcy the company would also have to deal with almost $600 million in debt due under the company’s credit facilities which might very well result in current equityholders being ultimately wiped out.

Even after Friday’s 130%+ rally, the company’s market capitalization only calculates to a paltry $17.5 million. Assuming the transaction being approved, upside for the common shares could be massive but given the above discussed hurdles for the deal, Hornbeck Offshore Services might still end up in bankruptcy.

Existing equityholders should vote “Yes” on the proposed transaction and hope for a very low number of holdouts among eligible noteholders.

More than ever, the shares represent an ultra-high risk / high-reward scenario only suited for the most speculative investors.

Early tender results should be out by the end of this month. Until then, expect the stock to exhibit some major volatility. I could easily envision the shares doubling, tripling or even quadrupling from current levels over the next couple of sessions solely on speculation of the transaction being consummated.

Embarassingly, I missed out on the news on Friday morning and instead sold the remainder of my position at day lows, even celebrating the sale in the comment section of my most recent article on the company only to watch the shares more than doubling over the course of the session.

That said, I consider entering another trade on Tuesday morning should the stock open near Friday’s closing price as I firmly expect speculative investors and traders to start chasing the shares next week.

I will update investors on the story going forward, so stay tuned.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in HOSS over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: While I am expecting speculative investors to chase the shares over the next couple of sessions, the proposed transaction might ultimately fail. Given this issue, I am only looking to trade the shares.

Editor’s Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.

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