💥Frac Sand = Quicksand💥

Emerge Energy Services, Houston & CMBS & More


We sent the first edition of PETITION in October, 2016. Here’s what it looked like:

We were so new that the reading time was simply 5.35 minutes — not 5.35 “a$$-kicking” minutes. Clearly, we hadn’t yet found our voice. 😜

A year later, prompted by a NeimanLab article about the launch of Substack Inc., a startup seeking to help newsletter writers get paid, we cold-contacted Hamish McKenzie, one of the company’s co-founders. We introduced PETITION to him and, in the first instance, he practically laughed us off the phone. Here we were, an anonymously written newsletter talking about “disruption from the vantage point of the disrupted (and bankrupted?).” Bankruptcy and restructuring probably weren’t areas that immediately came to mind to he and his co-founders when they launched Substack. But then we told him we had thousands of investors, bankers, lawyers, consultants and others already reading us. And we thought there was a lot of room to grow. Suddenly a newsletter geared towards restructuring wonks didn’t seem so crazy.

Over the next several months, we strategized with Hamish and the Substack team about toggling over to a paid product. Over this time, word of mouth grew strong and we bolstered our subscribership considerably. Yet we were nervous about whether our readers would actually pay for what we had to say. The Substack guys were sure they would. We offered unadulterated edgy content that couldn’t be found elsewhere. Fast forward another year and they couldn’t have been more correct.

We have thousands more subscribers now. We have converted a meaningful percentage of them to paid Members. We are honored to have a significant number of the country’s major law firms, investment banks, restructuring advisors, and PE firms as group Members. We are currently the third largest newsletter by revenue on Substack’s platform. We are SO thankful for all of you.

And then yesterday Substack announced that it raised $15.3mm of venture capital from Andreessen Horowitz and Y Combinator, two of the top venture capital firms in the country. They will use the proceeds to expand their team of three — yes, they’ve been lean AF up to this point — and bolster their product. That funding will juice Substack’s capabilities and, in turn, weaponize PETITION with new features and Member benefits. The more they grow, the more we grow and the more we grow, the more they grow. Our incentives are totally aligned — a relatively new construct in media. It seems that, serendipitously, the VC-backed tech world and the restructuring world have, in fact, converged.

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⛽️New Chapter 11 Filing - Emerge Energy Services LP⛽️

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On Tuesday, a day when these bozos are writing that America really ought to avail itself of increased offshore drilling, a company correlated to the onshore oil and gas market — Emerge Energy Services LP ($EMESZ) — found itself in bankruptcy court. This, ladies and gentlemen, is a story about commodities, cyclical markets, logistics, and the power of the bankruptcy code. And the story starts with sand. Yes, sand. Emerge Energy Services is the second company dealing with proppant — or sand — to file for bankruptcy in the last week (see, e.g., Shale Support Global Holdings). 

Simply put, exploration and production companies infuse proppant into water and then inject that water or other fluid into wells at extremely high pressures to keep fissures open and stimulate the release and extraction of hydrocarbons. It wouldn’t be overstating the case to say that sans sand, the fracking revolution enjoyed by the United States over the last decade would not have been possible. It is that key to the process.

Emerge Energy Services LP is a publicly-traded (pink sheets now) miner and processor of silica sand; its operations are conducted at facilities located in Wisconsin and Texas. Generally speaking, logistics out of the Emerge’s 4 Texas plants are easy: because orders of “in-basin sand” from these plants are transported 200 miles or less, customers can pick them up. Emerge’s Wisconsin plants, on the other hand, are generally in excess of 200 miles away from customers and therefore Wisconsin’s “northern white sand” requires rail transport — a significantly more expensive proposition. Indeed, “transportation costs typically represent[] more than 50% of customers’ overall cost for delivered sand.” Once taken by rail, the sand is dropped at a transload and storage location where customers can then pick up their orders by truck. Emerge provides an end-to-end user experience; it “build a significant fleet of company-leased and customer-committed railcars, assembled a network of leased transload and terminal storage sites located near major shale plays, and designed a supply chain management system.” To make this work, Emerge entered into a number of long-term contracts with railcar lessors and transload facilities. That’s right: all of this for SAND! Ain’t America beautiful? 

Well, it is until it isn’t. America can also be a brutally competitive place. And Emerge started to realize that (a) in 2015 when demand for frac sand decreased as one oil and gas exploration production company after another scaled back (94% of total revenue in ‘18 correlates to oil and gas) and (b) in 2017, when the entire proppant industry began shifting away from northern white sand to in-basin sand. This shift curtailed demand for northern white sand and upended Emerge’s entire supply chain. In a flash, Emerge found itself stuck with an over supply of leased railcars and transload facilities. Worse? The whole supply chain was established pursuant to fixed long-term contracts that are now a massive albatross. Indeed, Emerge leases 4,910 railcars, of which a majority have lease terms expiring during 2020-2022 but many others extending out as far as 2028. To make matters worse, unused rail cars must be stored, adding millions of dollars of storage costs to the mix. 

It’s important to remember that from 2011 to 2014, horizontal drilling and hydraulic fracturing were going gangbusters. Wildcatters everywhere were rolling in dough and America’s drilling in the Bakken Shale, in Texas, and elsewhere, put the country on the map as an oil and gas player. With the rapid rise of fracking came a rapid rise in services companies lending a hand. There is now a ton of competition in the frac sand space. What was, at one time, an under-supplied area is now somewhat commoditized and vastly over-supplied.*

All of this created additional problems due to the company’s capital structure. The company has over $200mm of debt. Due to revenue, cash flow and liquidity shortages, the company tripped certain financial covenants and has been in default since Q4 2018. 

This bankruptcy filing will allow the company to accomplish two main objectives: (i) use the power of bankruptcy code section 365 to reject superfluous uneconomic railcar and transload contracts and (ii) deleverage the balance sheet. To that end, Emerge intends to reject the contracts of all but three railcar lessors. Moreover, it entered into a restructuring support agreement (the “RSA”) that would refinance the revolving credit facility and equitize the second lien position. The second lien noteholders would walk away with at least 95% of the interests in the reorganized partnership and some take-back paper ($150mm minus approximately $66.7mm). The RSA has a nice little “death trap” feature that would, upon acceptance of the proposed plan of reorganization, gift general unsecured creditors (note: unsecured trade debt is approximately $56mm) 5% of the new equity interests in the reorganized partnership, plus new warrants to acquire an additional 15% of such new equity interests. Existing equityholders stand to recover something IF and ONLY IF the general unsecured creditors except the plan. Emerge hopes to have this whole process consummated by Halloween. We’ll see what kind of fight an official committee of unsecured creditors unleashes in the interim. Given the oil and gas macro environment and the impaired nature of the second lien debt, it will be awfully hard for any such committee to argue that they’re entitled to any additional value.

*It doesn’t help that Emerge invested in a San Antonio-based sand mine in 2017 that quickly proved to be a complete and utter trainwreck. Currently, it’s all but mothballed. Emerge followed that blunder up with the acquisition of a (in-basin sand) mine site in Oklahoma and the immediate initiation of construction of a 1.5 million-ton facility. The company stopped work on this project in January 2019. By that point, however, the company had expended $15.2mm, of which nearly half remains unpaid. We’ll give management this: they at least recognized the shift away from northern white sand and tried to do something about it. Unfortunately, it appears they simply made problems worse. Sadly for certain trade vendors, the risk of those decisions has been transferred to them to their significant economic detriment.


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Some other news in oil and gas:

1. Fitch Ratings reported that energy will lead U.S. high yield default volume for the third month in a row. Weatherford gets a big assist on this front. The July TTM energy default rate stands at 4.1%. The overall market stands at 1.9%. Energy accounts for 30% ($5.4b) of the year-to-date default volume. Per ABL Advisor:

"We expect to see more energy defaults in the near term and many are legacy E&P or oilfield services names that became distressed from the 2014-2016 oil price collapse and remain troubled even with prices at $60/bbl," said Eric Rosenthal, Senior Director of Leveraged Finance at Fitch Ratings.

Fitch anticipates the energy default rate to be 5% for YE 2019 and 4% for YE 2020, topping the projected 2% overall market rate for both years. Six issuers with total bond debt of $8.7 billion have market bids on the notes below 40 cents, including Sanchez Energy Corp., which has a July 15 interest payment due on its largest unsecured tranche.

2. S&P Global concurs with Fitch’s assessment.

Per S&P:

"After a relatively quiet 2018 for oil and gas defaults, the sector appears to be back in the spotlight this year with 10 rated oil and gas issuers downgraded to 'D' or 'SD' so far in 2019," S&P Ratings said in a July 12 note. "D" and "SD" are ratings for companies that are in default or have chosen not to make a debt payment, resulting in a selective default. "While hydrocarbon price volatility throughout the first half of this year is partially to blame, the lower echelon of rated issuers is also struggling to meet market demands of operating within internally generated cash flow and is experiencing investor fatigue due to disappointing returns."

S&P Ratings said a small group of distressed companies, survivors of the 2015-17 meltdown, may not escape financial trouble in 2019 as debt maturities loom and commodity prices remain low.

A second, larger group of companies went through at least one reorganization through the bankruptcy courts and now may be looking at Chapter 11 again.

"Based on market indicators such as equity capitalization and indicative debt trading levels, there appears to be a possibility that many of these companies could soon end up back in court for Chapter 22 proceedings --a euphemism for a second Chapter 11 bankruptcy filing," S&P Ratings said.

Tell us something we don’t know.


3. Speaking of Chapter 22 proceedings, Vanguard Natural Resources Inc. announced that it has…gulp…”successfully” emerged from chapter 11 with approximately $375 million of funded debt and $47 million of liquidity comprised of more than $7 million in cash and $40 million of unused revolver capacity. Its new board of directors includes a number of gentlemen with significant restructuring experience: it’s as if it’s already gearing up for a 33. Anyway, we cringe now when we see these kinds of announcements:

Here, though, we couldn’t help but also laugh. Is there a better name for a grizzled-veteran-of-two-bankruptcies-in-two-years than “Grizzly Energy”? This is bankruptcy folks.

💩Is Houston Effed? (Short CMBS?).💩

Oil and gas bankruptcy activity has been robust again this year, a mere 3 years after the last bust cycle in (primarily) Texas. News abounds about how drillers are finding ways to cut costs now that the capital markets have chilled considerably and investors are sick of funding money-burning endeavors.

Which brings us to last week’s news in CMBS-land. CMBS delinquencies increased to 2.84% in the month of June, up 18 basis points from May. Aside from May, however, the rate is at the lowest it has been in a year. By way of comparison, the CMBS delinquency rate in June 2018 was 3.95%. So, things are generally looking good for CMBS.

That said, this bit caught our attention and we wonder whether it is a sign of things to come. Per Trepp (by way of Commercial Observer):

Another distressed asset that became newly foreclosed is the $90 million loan behind the 450,154-square-foot Two Westlake Park office complex located in Houston’s Energy Corridor. The loan was transferred to special servicing in July 2018 due to local market weaknesses stemming from the industry-wide contraction in the oil sector. Occupancy had dipped to 68 percent for fiscal year 2018 due to significant downsizing by energy tenants BP and ConocoPhillips. (emphasis added)

Oil supply far outweighs demand these days and prices remain at levels that are unsustainable for a vast majority of companies. Will we be seeing an uptick in special servicing activity in the Houston area? 🤔


We have compiled a list of a$$-kicking resources on the topics of restructuring, tech, finance, investing, and disruption. 💥You can find it here💥.

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