Tag: bankruptcy

Connecticut Striving to Become the Municipal Equivalent of Sears

“Bloomberg – Connecticut and Hartford Get $2 Billion Offer for Properties“

Connecticut is a fiscal disaster. Their decades long episode of legislative ineptitude has put the Nutmeg State in a perilous financial position that most government officials only dream about. As it stands, CT has one of the worst public pension systems in America with an embarrassingly low 44% funding ratio, one of the largest per capita tax burdens in the nation and a shrinking tax base as corporations and citizens flee the state.

You can only operate in that way for so long before markets smell the blood in the water, and it seems like one fund just got its first whiff. Chicago-based Oak Street Real Estate Capital sent a LOI to the state capital last week, offering up to $2B in cash in exchange for certain state-owned properties structured as a leaseback, yielding 7.25%. For anyone unfamiliar with a leaseback, this is when a company sells properties and/or heavy machinery to a buyer and then leases it back for continued use. This is a common way to generate liquidity for cash-strapped companies whose fixed assets are generally worth more than the business itself, like Oak Street’s neighbor, Sears Holdings.

Sears, like Connecticut, is a balance sheet disaster. Eddie Lampert bought Sears years ago through his fund ESL Investments. In a bid to free up cash and provide some short term flexibility, he sold Sears’ best performing properties into a publicly-traded REIT called Seritage Growth Properties. The asset sale was structured as a leaseback, allowing Sears to continue using the properties as retail outlets, generating a healthy rental yield for Seritage shareholders and protecting ESL LPs from the eventual Sears bankruptcy, as they own a healthy chunk of Seritage partnership units as well. The move was savvy financial engineering which, in the face of what will be a well-publicized credit event, Lampert doesn’t get enough praise for. While the move will ultimately benefit ESL’s investors and the ridiculous corporate structure they set up with Sears, it is going to destroy the company, as the now struggling retailer has the added expense of paying rent to its own investors – and that is most likely the same fate that awaits Connecticut if they try to financially engineer their way out of this mess. They couldn’t agree on a simple budget for years, I’d love to see how they navigate the asset-backed lending markets.

 

Here’s the Thing About Energy Markets…

“Bloomberg – A pipeline shortage that’s leaving gas trapped in West Texas’ Permian Basin means prices for the fuel there are the lowest of any major U.S. hub, wresting that distinction from Appalachia’s Marcellus Shale. Prices for Permian gas, produced alongside oil in the play, have tumbled 32 percent from a year ago, while output rose to a record. And the pipeline crunch is also pummeling the region’s oil market.”

Energy production has always been a highly capital-intensive business. The dirty little secret of the U.S. shale boom is that fracing (not fracking, that’s how they can tell who the Yankees are) is not cheap, no matter what it costs to fill your car up at the pump. The costs of equipment, surveying, labor, licensing, water, sand and waste handling will run into the millions before a single well even comes online. So what did the industry do to juice their returns and ease the burden on their end consumers? Everyone, say it with me now: they levered up! It’s no coincidence the U.S. shale boom coincided with the post-crisis era of cheap money. The ability to voraciously borrow money from investors looking for anything resembling a decent yield fueled the fracing boom, as well as its eventual demise.

I spent a few years in Houston at an energy-focused PE shop, so this is a topic that’s near and dear to my heart. The U.S. energy markets have been in disarray since the end of Q2 2014. Throughout the shale boom, the strategy for oil companies was to lever up or issue equity to fund acreage development, then turn around and sell the company or specific assets to a strategic buyer to pay down debt and cash out their investors. The playbook was similar for infrastructure sponsors, except they used the capital raised to fund new pipeline assets that they would drop down into MLP subsidiaries that would be brought public. They’d use the IPO proceeds, and any dividend payments from MLP shares they retained, to fund even more pipeline construction. It was financialization at its finest. Oil companies would then pay fixed rates on long-term contracts to the MLPs in order to have their crude or gas shipped around the country to refineries. This was all well and good until 2014, when the energy complex collapsed in on itself under the weight of debt and over-production.

This brings us to today (and to this Bloomberg piece). The MLP model still hasn’t recovered and I’m not positive it ever will. The big retail pitch for owning MLPs in a portfolio was that it was yield-generating energy exposure without the commodity risk (which was true, until it wasn’t). While the MLPs didn’t have direct commodity price exposure, they had indirect capital markets exposure, and that would be their death knell. Once oil producers started defaulting on their debt due to tanking commodity prices, the MLPs were shut out of debt and equity markets as well – a little guilt by association. Without access to fresh capital, the infrastructure sponsors were unable to fund new pipeline construction and sell the assets into their publicly-traded MLP subsidiaries. Now, with massive debt loads and capex commitments to unfinished pipeline projects, the infrastructure sponsors went into survival mode: cutting dividend payments, selling assets and operating strictly out of cash flow. That last part is important – operating out of cash flow meant using huge chunks of FCF to service debt instead of building pipelines, which is why the Permian is in the odd position of having inaccessible, near-worthless gas assets. That oil and gas isn’t worth shit without the infrastructure needed to sell it into markets, no matter how prolific your acreage is.

What a conundrum. All this PE capital flooded into the Permian in 2016 looking for bargain basement acreage deals – and they got them. Now that the PE firms are all there drilling, there is too much production coming online and too little pipeline to ship the stuff. This is ironic because oil and gas acreage assets are valued by what’s in the ground, not by what comes out and makes it to market. The new problem that will (inevitably) come to the forefront is that PE firms never pay for these assets with 100% equity capital, rather they almost always issue debt or take on a revolver and collateralize it with the asset alongside some equity to fuel the drilling capex. That leads me to wonder, if pipelines aren’t built quickly enough for these PE-sponsored DrillCos to ship and sell product, will funds run into cash flow issues and be forced to start liquidating at a loss or, even worse, engage their lenders for a little restructuring? Should either of those scenarios play out, it would have a ripple effect on acreage prices throughout the Lower 48, likely kicking off a deja vu of late 2014. Round and round we go.