A Spinoff Goes to Heck, after Just 10 Months

Occidental Petroleum made a sweet deal on November 30, a masterpiece of Wall Street engineering. And just about every investor that touched it is now getting their hands burned off.

That day, Oxy spun off California Resources. It held Oxy’s oil-and-gas exploration-and-production assets in California. It’s the state’s largest natural gas producer and its largest oil-and-gas acreage holder with operations in the basins of Los Angeles, San Joaquin, Ventura, and Sacramento.

Oxy was the big player in the miraculous scam of the Monterey Shale formation in California, which had been hyped for years as the largest reserves of oil in the US. Any studies that showed that this oil wasn’t recoverable with todays’ technologies due to the geological mess underground in earthquake land were shunted aside.

The EIA finally conceded that point in May 2014 and slashed the delusional estimates of the reserves by 96%. California isn’t exactly the easiest place for fracking in the US. When the EIA finally acknowledged reality, Oxy was the biggest loser.

Six months later, after the dust had sort of settled, Oxy exited in a grand manner by spinning off 80.5% of its California dream to Oxy shareholders. Shares started “regular way” trading under the ticker CRC on December 1, 2014.

Energy spinoffs were hot in 2013 and 2014. Hedge funds clamored for them. They’d buy a big stake in the parent company and push the board to do a spinoff that entailed loading the spinoff up with debt to fund a fat special dividend back to the parent. The scheme was supposed to temporarily jack up the price of the parent company’s stock. “Unlocking value,” it’s called.

Wall Street made sure that there were enough unwitting or yield-desperate buyers for the debt. Hedge funds got their way, made their money, and the lucky ones bailed out. Then came reality.

As part of the spinoff, California Resources paid Oxy a special dividend of $6 billion. To fund this dividend, California Resources issued three different bonds totaling $5 billion and some leveraged loans for the remainder. This debt now costs California Resources about $330 million a year in interest.

When California Resources reported its second quarter “earnings,” investors were confronted with a net loss of $68 million, on revenues that had plunged 45% to $609 million. It was buckling under its $7.3 billion in liabilities.

On September 15, Moody’s slashed the corporate rating two notches from Ba2 to B1, and the misbegotten bonds three notches from Ba2 to B2. All of it with “negative outlook”: these babes are deep junk and sinking deeper.

It’s ugly, after all the hype about the Monterey Shale and the glorious spinoff. Moody’s cited “weak credit metrics for leverage, cash flow coverage, and operating and capital efficiency that are more typical of single-B or Caa rated peers.” It lamented CRC’s “relatively high” costs of production, SG&A expenses, and interest costs totaling $31.71 per barrel of oil equivalent. It pointed at the low oil prices that it didn’t expect “to improve materially in 2016.” And less than 5% of CRC’s 2016 production is hedged.

California Resources has cut capital expenditures and drilling activities. It’s trying to sell assets when no one is willing to pay enough for them. But lower production, the inevitable result, isn’t going to help service this mountain of debt.

Moody’s thinks the company has enough “liquidity” – cash and access to a revolving line of credit at the bank – to get through 2016. And then what?

If it’s lucky. But the bank might cut the limit of the credit line and push the company into what S&P Capital IQ called the “liquidity death spiral.”

Now the question is if California Resources can survive without having to resort to a debt restructuring, bankruptcy, and a total shareholder wipeout to deal with the mountain of debt that Oxy stuck it with to fund the special $6 billion dividend.

Bondholders and stockholders have serious doubts. Its stock is currently trading at $3.35 a share, down 66% from its 52-week high, as bottom-fishers have jumped in after the low of $2.67 in August. And its bonds are getting killed. S&P Capital IQ’s LCD reported that all three bond issues hit record lows yesterday after the Moody’s whack-down the day before:

The 5% notes due 2020 plunged 10 points, with block trades as low as 68.25 cents on the dollar. The 5.5% notes due 2021 dropped to 66 cents on the dollar. The 6% benchmark notes due 2024 dropped 8 points to 66 cents on the dollar.

A special word of praise is due these 6% notes, and the syndicate led by Bank of America that put the deal together and shoved it into bond mutual funds and ETFs: these $2.25 billion of notes were sold just about exactly a year ago on September 11, at par, and were, according to LCD, “one of the top-25 largest single tranches ever sold.”

These kinds of deals can only be pulled off near the peak of an insane credit bubble, after the Fed has spent years trying to force investors further and further out toward the thin end of the risk branch. Now these branches are breaking off. And the mostly unwitting buyers that hold these fruits of Wall Street’s labor in their funds are made to feel the pain.

But institutional bond investors, armed with other people’s money, haven’t got the message yet. Read… Corporations in Rate-Hike Panic, Sell Bonds like there’s No Tomorrow, Investors Blissfully Eager

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  15 comments for “A Spinoff Goes to Heck, after Just 10 Months

  1. rich black says:

    “A special word of praise is due these 6% notes, and the syndicate led by Bank of America that put the deal together and shoved it into bond mutual funds and ETFs: ”

    Which ETFs?

  2. nycjeff says:

    Fracking in California.
    As an investor, would you need to read any more to decide not to invest?

    • MC says:

      Ba2 rated bonds yielding 5%… I can assure you most investors don’t need to read anything more than that to start buying hand over fist. Even if this means “investing” in a company selling lots on the Moon and Mars. Or fracking in California.
      That’s the result of six years of the most ferocious financial repression I can remember in my life.
      And we are about to see a whole lot more of this insanity.

  3. Tone says:

    I was a novice investor way back in the Dot Com meltdown, and I was swayed by an acquaintance to come on board to the Investment company he represented…the pitch was that everyone shaved, used toothpaste, and drank coke, which were companies that his firm invested in…stocks were flying high and he showed me the returns that his Investment company was producing…it was great, just leverage your house and reap the rewards…moving on to today, I have a cousin who works for one of the Canadian big banks, and he oversees a group of people in the investment side, and his cronies have quotas, so whatever it takes, get the people (that do not know much about stocks) to invest into the banks mutual funds…no funds…no problem…you can borrow…just look at the returns you are missing out on.

    On a side note, I was at a function a few days ago, and another cousin of mine who is a real estate agent was going on about leveraging to buy poperty (I live in Toronto)…there were a few others there and they were asking her to check out various properties for them…they were throwing out numbers like 1.5, 1.25 million like it was pocket change…and all for investment purposes.

    There is too much euphoria right now.

    • hidflect says:

      Yeah, everyone drinks Coke. Sure, but everyone knows that so that’s already built into the price and then some. Nowadays the mantra is everyone owes the bank so buy banks. But again, they’re all priced for perfection. And there’s no upside. There aren’t suddenly going to come along 10 Million new Coke drinkers or Mortgage borrowers. Only down side as Coke fades for health reasons or borrowers default.

      I only buy small caps that have a steady revenue stream and so are inoculated from the meaningless up and down swings of the blue chips. Sounds obvious but you’d be amazed how many decent, solid small caps just go ignored while all the chartists and analysts endlessly spend their days scrutinizing every tick of BoA. Chartists are frauds in my opinion. At best, there’s enough of them that they become somewhat of a self-fulfilling prophesy.

      As a result I’m up 30% this year since3 June while the market is down 15%.
      (ASX:SBM, ASX:EPD if anyone’s interested…)

      • d says:

        “Chartists are frauds in my opinion.”

        Charts are good for indexes, commodity’s, and currencies.

        In this QE created false matkett even in those fields they are becoming only vague indicators.

        A market that runs on FUD and QE is an unpredictable beast, as FUD is human, and herd driven, without fundamental reason.

        Charts are of little use in a commodity like gold that overreacts to a f deliberatly false media release, made by the people that have taken a long or short based on the predicted Visceral FUD reaction. Gold has been moved by a baseless tweet more than once..

        Applied to individual stocks, there are to many variables, and more importantly, deliberately hidden variables. For charts to be any more than an indicator of what may.

  4. NotSoSure says:

    Well where are the people that are so certain about a rate increase today?

    The next time the Fed increases rates is to defend the currency. Full stop.

    • d says:

      Failure to raise confirms O bummer answers to china inc, and iran, so will do nothing without their consent..

      Which suggests the “No raise till O bummer is gone” mantra may have some basis.

      The lady is not pleased with her instructions via Valerie Jarret, as she is still waving the “it will happen this year” stick around.

      I see potential for December as it is not a normal tactic.

      She should have done it, it was priced in, if 25 points can tip over the US and world Economies .

      Both have huge structural problems, nobody is being told about.

      Happy now.

  5. Petunia says:

    The whole thing stinks and there’s a word for it, fraud. Oddly, I don’t feel sorry for anybody holding this crap.

    • Wolf Richter says:

      Petunia, unfortunately, the dividend and spinoff were disclosed in advance. So it’s not “fraud” by the company. It’s “stupidity” by yield-hungry investors (usually bond mutual-fund owners who end up with it unwittingly). They bought this crap. This is exactly what the Fed has worked so hard to engineer … that people will buy ANYTHING, even the worst crap, to get one tiny bit of yield.

      • d says:

        This was and act of legalized robbery.

        Is this part of a system the FED is engineering to recapitalize banks and certain sectors of the Economy so that they can eventually start to shrink their balance sheets simply by not rolling what is on them as it matures?

  6. Michael says:

    Why would anyone at this point trust Wall Street?

    • NotSoSure says:

      It’s not about trust, it’s about playing the game. Everyone higher up in the industry knows that ultimately everything these guys do will end up as some sort of scam, but in the meanwhile you can suck percentages left and right.

  7. “Moody’s cited “weak credit metrics for leverage, cash flow coverage, and operating and capital efficiency that are more typical of single-B or Caa rated peers.” It lamented CRC’s “relatively high” costs of production, SG&A expenses, and interest costs totaling $31.71 per barrel of oil equivalent. It pointed at the low oil prices that it didn’t expect “to improve materially in 2016.” And less than 5% of CRC’s 2016 production is hedged.”

    A ‘bad bank’, in other words. One has to wonder what sort of reserve numbers were used to calculate interest-per-barrel when this deal was offered? Likely it was the same sort of propaganda that floods the media today about the so-called ‘fracking revolution’ and the massive, stupendous, colossal amounts of oil these companies have access to.

    Share- and bondholder suits are coming and the lawyers will take aim @ Occidental and its executives. This story is straight outta Enron; maybe some bosses will go to prison.

    One can only hope …

  8. rjs says:

    it’s all going down, wolf…industry wide debt service now exceeds cash flow from operations; when their economically recoverable reserves are reevaluated by the banks in their semi-annual review on October 1st, their bank lines of credit will almost certainly get cut off; unable to float anymore junk bonds, we’ll see a wave of bankruptcies by Thanksgiving…

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