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Vanguard Natural Resources (NASDAQ: VNR) issued a stern warning to investors in its third-quarter press release last fall that it might not survive much longer. That is after its banks had reduced the borrowing base under its credit facility for the second time that year resulting in another deficiency. This situation caused the upstream MLP to caution that:
[It] anticipates that its forecasted excess cash flow will not be sufficient to pay the remaining borrowing base deficiency. Refinancing or restructuring our debt, selling assets, reducing or delaying our drilling program or seeking to raise additional capital through non-traditional lending or other private sources of capital will be necessary to satisfy this requirement in order to be back in compliance under the Credit Agreement.
Given that dire outlook, the company must prove that it can find the money needed to get back on a more sustainable path so that it can survive.
The clock is ticking
Vanguard Natural Resources is in a race against the clock because it must pay its banks $37.5 million per month over the first five months of 2017. As of November, it had just $30 million in cash left after pre-paying its December deficiency payment and a $15.1 million semi-annual interest payment on its senior notes. Given where oil and gas prices are these days, the company will not generate enough excess cash flow to meet this obligation.
Because of that, the company has two options. It either must find a way to get the money it needs to pay back its banks or declare bankruptcy, which is what most other upstream MLPs have done. While the company has been reviewing a variety of alternative financing solutions, it has yet to find one that will get the job done. That is partially due to its dire financial situation, which likely scared off many outside investors that could have provided it with capital. Meanwhile, many asset buyers are not going to bid full price for its oil and gas properties because they know full well that Vanguard is in trouble and that there's the potential to buy these assets cheaper should creditors take over and unload them in a fire sale. However, while the company's deeply troubling financial situation has likely reduced the number of potential partners that could provide a solution, it still might have some options.
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Private equity to the rescue?
One possible option that might be available to Vanguard Natural Resources is a rescue package from a private equity fund. That is because firms like Blackstone Group (NYSE: BX), Oaktree Capital (NYSE: OAK), and Ares Management (ARES 1.92%) have provided capital to higher-risk energy companies over the past year in search of higher rewards.
Ares Management, for example, provided a deeply troubled Clayton Williams Energy (NYSE: CWEI) with a $350 million loan last March to replace an equivalent one with its bank group. However, the Ares financing came at a steep cost, with the interest rate triple what Clayton Williams had been paying while also giving Ares warrants that allowed it to buy up to 18.5% of the company at $22 per share. Furthermore, it gave Ares control over Clayton Williams assets if it declared bankruptcy in what analysts dubbed a "loan-to-own" strategy.
That said, the deal would go on to work out well for both sides. It firmed up Clayton Williams' financial foundation, enabling the company to complete several other moves to shore up its finances and get back to drilling. These moves ultimately positioned it to sell out to Noble Energy (NBL) in a $3.2 billion deal earlier this year. Meanwhile, Ares not only collected interest on the loan, but it will make quite a hefty profit from the warrants and a subsequent equity purchase after Noble agreed to pay $139 per share for Clayton William's stock.
A similar deal from a private equity fund could stabilize Vanguard Natural Resources' financial situation, buying it time to find a more permanent solution. For example, it could follow Clayton Williams' blueprint and use its additional time to find buyers for some of its assets and then potentially take advantage of a rising unit price to issue equity and start chipping away at its debt. Those moves could put the company back on the path to long-term sustainability.
Investor takeaway
As things currently stand, Vanguard Natural Resources will not survive this year and could declare bankruptcy within the next few months. The only way to prove it can survive is if it secures an external solution that will buy it more time, such as obtaining a rescue package from private equity. As the Ares-Clayton Williams deal shows, these transactions can work out quite well. The only question that remains is if Vanguard has waited too long and is now too far gone for even private equity to be interested in coming to its rescue.
