Distressed Debt Research - Dynegy

Yesterday, Dynegy Holdings, LLC and four affiliated entities filed for Chapter 11 bankruptcy protection in SDNY.

For those looking to play along, you can find the Dynegy docket here:

Before we dive into the filing, I first want to lay out the Dynegy organization chart as it is imperative to understand the case:

The Chapter 11 filing comes with Restructuring Support Agreement, and associated Term Sheet, signed by Dynegy as well as prominent distressed investors (that hold $1.4 billion of Dynegy senior notes) including:
  • AEGON USA Investment Management
  • Avenue Capital
  • Caspian Capital
  • Franklin Advisors
  • Venor Capital Management
As was reported in the press, Dynegy, Inc (the public company) is not filing for bankruptcy. The bankruptcy filing really relates to the leases on the Roseton & Danskammer facilities and the associated 7.67% Pass Through Certificates.

The plan contemplates unsecured noteholders of Dynegy Holdings receiving a package of cash and securities:
  • $400M in cash
  • $1B of 11% Secured Notes issued out of Dynegy, Inc (the public holding company) backed by equity in GasCo and CoalCo (more on this later) - this amount if fungible based on lease rejection claims coming from the Roseton-Danskammer leases
  • $2.1B of Convertible PIK Notes again issued out of Dynegy, Inc due 12/31/2015. If the notes are still outstanding at maturity, they will convert into 97% of DYN equity
  • Specifically to the holders of the subordinate 8.316%: The plan contemplates, a 25 cent on the dollar treatment in lieu of contractual subordination ($200M outstanding for a total claim consideration of $50M)
We will attempt to value this package shortly.

A bit of background: Earlier in the year, Dynegy announced a restructuring and refinancing that moved and ring-fenced the majority of the company's assets to two entities known in the credit markets as GasCo and CoalCo. These entities secured bank debt financing which was used to refinance debt, extend the maturity profile, and bolster liquidity at Dynegy Inc. Legacy bondholders though still benefited from significant equity value in both of these entities. In a second step though, contested by other prominent distressed funds (now stayed), CoalCo's equity was transferred from Dynegy Gas Investments to the ultimate parent company, which sets above the bondholders, and thus out of their reach.

You can read more about that transaction here:

It is important to note that the Delaware Chancery Court did not view this transaction as constituting fraudulent conveyance.

Moving on to Roseton-Danskammer: In his declaration in support of the Chapter 11 filing, Kent Stephenson, EVP and General Counsel of the Debtor stated:
"It is my understanding that, before the commencement of these chapter 11 cases, the Debtors engaged in discussions with representatives of both the PSEG Entities and certain of the Pass-Through Certificate Holders seeking to consensually restructure their obligations under the Lease Documents. These discussions ultimately proved unsuccessful. During those discussions, the Debtors indicated that, absent a consensual resolution, a bankruptcy filing by the Debtors was likely and that, in such case, rejection of the Lease Documents was probable. Upon information and belief, representatives of both the Pass-Through Certificate Holders and the
PSEG Entities have analyzed and prepared substantially for the relief requested in the Motion to Reject. In fact, the Owner Lessors have had several months’ notice of the Debtors’ precarious financial situation and the likelihood that the Debtors would be forced to seek the relief sought herein if an acceptable out-of-court restructuring could not be accomplished. Public filings issued by the Debtors’ affiliates were clear on this point."
According to the filing, there is $550.4M of the 7.67% Pass Throughs outstanding (Series B). In fact, on November 8th (i.e. today), there was a ~$82.5M lease payment due for the two facilities.
This pass through relates to a sale-lease back transaction on the Roseton-Danskhammer plants in May 2001. The plants were sold to Public Service Enterprise Group, where PSEG contributed $138M of equity to fund the purchase with the balance secured from the two series of pass through notes. To note, these are old plants, and specifically on the Danskhammer side, the declaration notes that the facility will require $375M of capex by 2014 to meet EPA regulation.

As a rejected lease claims, Dynegy expects the maximum claim from these leases to be $300M as governed by section 502(b)(6). This stipulates that the maximum lease rejection claims can be the greater of 1 year's rent or 15% of the remaining term (not to exceed 3 years). With that said, holders of the Pass-Throughs as well as PSEG has commenced litigation a number of times over the aforementioned restructuring transactions:
The litigation commenced by the Indenture Trustee is currently pending in the New York Supreme Court. The PSEG Entities sought injunctive relief in a lawsuit filed in the Delaware Chancery Court in July. The Delaware court denied plaintiffs’ request and both the Chancery court and the Delaware Supreme Court denied plaintiffs’ requests for interlocutory appeal. Plaintiffs' then voluntarily dismissed the Delaware action in August, 2011. The same PSEG entities filed another lawsuit in New York Supreme Court on November 4, 2011 asserting many of the same claims which the Delaware court found unlikely to succeed. That lawsuit remains pending. The Pass-Through Certificate Holders’ case was voluntarily dismissed in favor of the Delaware action.
Moving on, from the DYN 8K today: "It is a condition precedent to the consummation of the Restructuring that the rejection damage claims arising therefrom do not exceed $300 million." with Dynegy being able to waive this is rejection claims come in between $300-$400M (and needing approval if more than this).

Throughout the day today, there were many many markets being made on both the cash bonds and the triggered CDS of Dynegy. It felt like the 8.375% senior unsecured notes due May 1, 2016 were the most liquid cash bonds of the day which went out 75.75-76.25 Here is a chart:

Quick note: This bond will trade slightly higher than the rest of the complex due to the larger claim as a result of accrued interest.

As you can see, bond prices rallied very hard today and over the past two-three weeks.

The question then becomes: What is this thing worth. It really hinges on three things:
  1. What you believe the price of the new 11% Secured Notes will trade to
  2. What you believe the price of the new Convert notes will trade to
  3. And to a lesser extent - the probability / chance that Roseton-Danskhammer rejection claims are significantly more than $300M and the whole plan has to be re-worked
Stepping back a bit: There is $3,570M face value of bonds outstanding at Dynegy including the aforementioned sub notes. I then gross up this value based on accrued pre-petition interest. For instance, the 8.375% notes have $1,046,834,000 outstanding. Each bond has about 4.4 points of accrued interest meaning the total claim is $1,046,834,000 * 1.044 ~ $1,093,000,000.

Each bond is grossed up by the accrued interest. Then I adjust the sub notes to 25% of claim as discussed in the restructuring support plan agreement. I then assume $300M of rejection claims from Roseton-Danskhammer.

This is somewhat important because according to the restructuring support agreement:
"If the aggregate claims arising from the rejection of the Roseton / Danskammer leases are allowed by the bankruptcy court in an amount that is less than $300 million, the aggregate principal amount of New Secured Notes shall be reduced by an amount to be agreed for every dollar such claims are less than $300 million. If the allowed claims exceed $300 million and the condition to consummation of the chapter 11 plan requiring such claims to be capped at $300 million is waived as set forth below, the aggregate principal amount of New Secured Notes shall be increased by an amount to be agreed for every dollar such claims exceed $300 million. The adjustment amount to be agreed for increases in the New Secured Notes shall be the same as the amount for decreases in the New Secured Notes."
Bringing this all together, I see approximately $3,850M claims. Of this, each bond will have a different percentage of % claim based on the size of the bond and its accrued interest. Our 8.375% notes for instance have 28.3% of the claims.

We must then apply this 28.3% to the value of the package being received:
  • 28.3% * $400M of cash = $113.2M
  • 28.3% * $1 Billion of Notes = $280.3M * Assumed Trading Price of Bonds. I actually am more bullish on this piece of paper than the market given how much equity I think there is at GasCo and CoalCo (which secures the new notes). I assume that they trade at par+ (whereas many people are saying in the low to mid 90s). So $280.3 * 100 = $280.3
  • 28.3% * $2.1 Billion of Convertible PIK Notes = $594.3M * Assumed Trading Price of Bonds. This is where things get real messy, and truly believe the swing factor here given the size and uncertainty of what will happen with this security.
With the market trading price of the existing 8.375% senior note at 76, the market is implying (assuming par on the secured notes), that the convert will trade to ~74 cents on the dollar. (To check math: $113.2 + $280.3 + (74% * $594.3) = $833.3 /$1,093 = ~76.

To me, that feels right (mostly based on the PIK, and subordinated nature of the security), but I think there is upside there for 2.5 reasons:
  1. Aforementioned equity value of GasCo and CoalCo flows through to the Converts after deducting for 11% Notes. I would expect an IPO of one or both entities after litigation is resolved.
  2. The incentive factor here: If the converts are not called prior to 12/31/2015, they are then convertible into 97% of DYN's equity. It is imperative for equity holders to deal with this security prior to that. Of course, when you got Carl Icahn calling the shots, you never know what you are going to get as a bond holder
And reason 2.5 -> If you are bullish on the power market, this is a very (VERY) levered way to play recoveries in the power market (where demand, in theory, eventually should increase in a time when no new supply is coming to the market.

With that said, at today's prices there is not enough pessimism priced into the bonds to get me overly excited. I would play in small size and then wait for some sort of scare on the litigation front or the power markets to add to my position. This will be a fascinating bankruptcy to follow after what happened with Mirant 5 years ago. We will keep you updated as the trial (s) proceed.


Anonymous,  11/09/2011  

Great article. Any thoughts on the equity, Hunter?

Anonymous,  11/10/2011  

In their Voluntary Petition they list their total debt as $6.181B? Shouldn´t you be using this amount?

Anonymous,  11/10/2011  

Shouldnt the $1.25B promissory notes from DHI enter into the calculation?

Anonymous,  12/08/2011  

I think you would leave the 1.25B promissory notes out because they're getting that in exchange for the undertaking payment stream from INC (the consideration for CoalCo) which is being assigned to DHI by DGIN (the original recipient of the undertaking since CoalCo was technically a subsidiary of DGIN). Not to mention DGIN is DHI's immediate subsidiary so it's cash in the same family.

Mark H 1/23/2012  

Any thoughts on why the equity and bonds have been dropping simultaneously? The plan is something of a zero sum equation, so one would expect that either the stockholders benefit at the expense of the bondholders or the bondholders get a greater recovery (pushing down the equity value). Seems odd to me.


hunter [at] distressed-debt-investing [dot] com

About Me

I have spent the majority of my career as a value investor. For the past 8 years, I have worked on the buy side as a distressed debt and high yield investor.