Recapitalization has become a watchword for E&Ps in 2015, with more than $20 billion raised in capital markets to help E&Ps buy time and regain their footing.

Other producers are choosing to restructure, taking a step back from the control levers.

In either case, the goal is to reassure investors and financial backers while positioning to emerge from the downturn stronger, refocused on core strengths and with the capability to seize opportunity in the upcycle.

Dean Swick, Alvarez & Marsal managing director, said the bottom has been reached. Swick has guided more than 100 upstream, midstream and downstream, as well as service companies, through out-of-court and in-court restructurings.

“We are already headed into a new cycle where there are unique and wonderful opportunities awaiting the sector,” Swick said at Hart Energy’s Energy Capital Conference, held in Austin.

The magnitude of the pain still being felt by E&Ps is evident in the numbers, however: Energy issuances that are trading at or below 50% of par approximate $10.5 billion, or 55% of all high-yield bonds trading in that range, said Swick, who called the amount “staggering.”

Whether recapitalizing balance sheets or restructuring, companies will need to examine themselves, create a plan and focus on their business while making room for flexibility.

Swick outlined three phases, noting that timing, uncertainty and levels of distress will determine the emphasis placed on each.

Stabilization and initial evaluation.

Critical to this phase is management of liquidity.

“I complement the industry on how it is dealing with uncertainty,” Swick said. “Clearly, cash is king, and you see that in efforts to preserve liquidity and to bring additional capital in.”

Digging deeper into liquidity management uncovers aspects that are unique to oil and gas, he said.

“I have never financed or worked with a producer that didn’t think it was the best operator around. And I love that. If I put money to work with someone, I want them to believe they are the best,” he said. “But there is a working capital burden that goes with that belief, and it is the carried nonoperated interest.”

In downcycles, Swick urged producers to unlock working capital liquidity by paying attention to AFEs and collection of LOEs.

“These are often forgotten, and during frothy times projects are sometimes kicked off before AFEs are collected from nonop partners,” he said. “We often find there is past-due AFE collection stemming from lax efforts to collect payments or from items that are in dispute.”

Similarly, LOE expenses are a huge burden on an operator’s balance sheet and present some risk.

“If you are paying attention to working capital and digging into liquidity issues, you’ll be ahead of the game, and you’ll extend your liquidity runway,” Swick said.

In other instances, larger companies may be “AFE’ing to death” a smaller independent. Situations also arise in which an operator doesn’t have capital but its nonop partner wants to move more rapidly and outspend the independent.

“This can be troubling,” he said. “So managing liquidity has both offensive and defensive aspects.”

It’s also important for companies—particularly public entities—to speak consistently, and with one voice, when talking externally. “Channeling your communications through one voice or person will remove uncertainty and give observers confidence that you know what you are doing,” he said.

Incentives should be in place to motivate executives based on the current environment and objectives. Driver in the current climate may be cash flow or cost reduction, he said.

Assessment and planning.

Swick said that assessments mean being brutal.

Makings plans to reshape a business mean focusing on what is core and noncore.

The left-hand side of the balance sheet should be scrutinized for assets that are must-haves and others than can be monetized or targeted for reduced investment.

Competing interests will surface, he said.

“Equity holders may have a different view than management. You’ll need to have responses to maximize value for all stakeholders,” he said. “You’ll want to ask yourselves, ‘How can I survive this and be the healthiest and best company when I come out of the downturn, as well as best-positioned to take advantage of opportunities?’”

While the amount of capital in the market for E&Ps is currently “fabulous,” Swick worries that companies are not looking at their business carefully enough.

“Don’t burn the capital on things that don’t work in this environment or that won’t have value when the recovery comes,” he said.

Final steps in assessment include planning are determining the risk/reward for each stakeholder group; the fulcrum security or capital partner; and finally, changes to the right-hand side of the balance sheet.

It is a sequential approach, he said. Responsibilities stretch across many different stakeholders and no single one can drive business interests.

“It may have a pivotal position, but as a management team you must do what is best for the company to survive today and be positioned for the long term. That’s the battle you need to fight,” he said.

Growth and recovery.

Even with a plan, companies have to stay on their toes and watch their business.

Monitoring production rates and understanding costs help gauge whether improvements are working.

“If things aren’t going right, stop, reassess, realign and go forward,” he said. “Remember, it’s a messy, sloppy business, with uncertainty, but if you remain flexible on the back end, you will have the best probability of success.”

Such factors largely determine whether recapitalization or restructuring/change of control is the better way forward.

For recapitalization, the company needs:

  • Sufficient support for management
  • Support of the fulcrum security or other key stakeholders
  • Belief that improved core asset(s) focus and cost structure can be realized
  • Incremental second lien debt combined with some or all of the following:

–Reduced level of first lien funded debt

–Acceptable borrowing base redetermination and covenant reset

–Selective asset sales

–Additional equity

  • Bridging to 2017 and beyond with long-term view of commodity prices

Recapitalization is likely to be an out-of-court process unless a change of control is involved.

On the flip side, if key stakeholders are not supportive of the core—and the company can’t define near and long-term value—then restructuring is worth a look, Swick said.

Companies take such a path when they face:

  • Too many challenges with core asset base characteristics
  • A desire for change of control
  • Insufficient support from the fulcrum security holders, and
  • Conversions of debt to equity or auction of asset base have occurred.

Restructurings are likely to be an in-court process, Swick said, and are time-consuming and expensive.