The Long and Short
ConocoPhillips tweaks its capital structure
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ConocoPhillips has recently announced both a $3.0 billion exchange offer and a $1.8 billion tender offer, and the premium for early participation looks attractive. The company is using a standard $30 early participation premium for both and has made the tender premiums most attractive for the company’s highest priorities. Investors who want to participate in either should submit bonds before the early participation deadline on March 7 at 5 pm ET as neither the tender nor the exchange are particularly attractive without the early tender premium.
The company is using both offers to extend its maturity profile while reducing interest expense ahead of the Fed rate hikes. The exchange is targeting debt with coupons higher than 5%, while the tender is looking to tackle some maturity walls in 2027 and 2028 while targeting legacy Concho Resources Inc. (CXO) debt that was exchanged back in December 2020 (Exhibit 1).
Exhibit 1. COP Exchange Offers
Source: Company Press Release, Amherst Pierpont Securities
Understanding The Exchange
The exchange is broken into two pools with Pool 1 targeting maturities in the back end of the curve and Pool 2 targeting intermediate bonds. The tender caps are $2.0 billion and $1.0 billion, respectively, as noted in Exhibit 1. Any holder participating in the exchange by the Early Participation deadline (3/7/22) will receive one new bond ($1,000 notional which includes the $30 Early Participation payment) as well as cash payment in the amount of the current trading premium on the old notes. At time of the announcement, all of the bonds targeted in the exchange were trading roughly 30% above par. Pool 1 participants will receive a new 2062 bond while Pool 2 participants will receive a 2042 bond. All new notes issued will be guaranteed by the parent ConocoPhillips and rank pari passu with existing debt.
Those who participate after the Early Participation deadline will not receive the full $1,000 notional of new bonds, as you must subtract the early $30 participation payment. Again, a reason why we believe it behooves investors that would like to participate to get in before the Early Participation deadline expires. It presents for a much cleaner exchange for existing holders.
Exhibit 2: COP tender offer
*Tender spread includes $30 per $1,000 notional Early Tender Payment
Source: Company Reports; APS
Tender Premiums Go Away Post Early Participation Deadline
While the tender premiums are relatively attractive, especially for the first six priorities, we note that they completely disappear after the Early Participation deadline as the tender spreads include the $30 Early Participation premium. That means that after the March 7 deadline, holders who participate in the tender would need to subtract three points from the bond price. For example, based on current treasuries, the bond price of Priority 1 at a 55 bp spread is $106.93. After the March 7 deadline, that price would be $103.93, which equates to roughly a 114 bp spread. At a 114bps spread, we note that is approximately 27 bp wider than where the bond was trading at the tender announcement. That said, the tender actually makes no sense for holders post the Early Participation deadline.
S&P and Fitch Affirm Ratings
S&P and Fitch both affirmed COP’s ratings and stable outlooks on the new issue and exchange/tender announcements. The agencies note that their ratings reflect the company’s scale and diversified low cost-portfolio coupled with its relatively low debt balances. COP is in the process of reducing $5 billion of debt through 2025, which will help to address maturity walls. As we noted earlier, the tender is also targeting maturity walls in 2027 and 2028. Furthermore, the company’s recent Concho and Shell Permian acquisitions were considered to be credit friendly transactions as the Concho deal (completed 1/19/21) was all-stock while the Permian Shell assets (completed 12/1/21) were funded with cash on hand.
Moody’s Maintains a Positive Outlook
While Moody’s did not issue a press release on the new issue, we note that they currently maintain a positive outlook on their A3 rating. Moody’s moved to a positive outlook in October 2021, post the two aforementioned acquisitions given the substantial improvement to COP’s scale. Additionally, Moody’s noted that the acquisitions further help COP to achieve it long-term goal of maintaining a high-grade asset base with a low cost of supply. Furthermore, they help to reduce carbon transition risks while aiming to deliver more competitive returns throughout cycles. Moody’s views COP’s balance sheet as strong and the tender and exchange offers will further bolster its balance sheet. COP’s financial policies are considered conservative as the company has demonstrated its willingness to fund growth transactions with stock and cash on hand.
While a positive outlook is not the same as a review for upgrade, Moody’s has noted that COP’s ratings could be upgraded if the company can continue to improve leverage with a retained cash flow/debt ratio above 70%. Cash on hand is expected to remain well above needs to ensure strong liquidity throughout economic cycles. We note that COP ended the most recent quarter with $5.5 billion of cash on hand. Street estimates put fiscal 2022 free cash flow at $14.6 billion, which equate to roughly $12.0 billion after dividends. Additionally, liquidity is supported by an untapped $6.0 billion revolver.
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