Drilling Down on Strategic Alternatives

in the Current Energy Crisis

Part III: Finding Hidden Value in Financial DistressWednesday, May 13, 2015

12:00-1:00 pm Central

WEBINAR SERIES

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Housekeeping Items

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webinar. We will also have the recording on our website (www.burlesonllp.com)

� We Welcome Questions� Enter questions into the Questions Pane and we will

respond in the Q&A session at the end

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DISCLAIMER: The viewing of online seminars and the use of the Internet for communications with Burleson LLP, Gibson, Dunn & Crutcher LLP, M1 Energy Capital, and OFSCap will not establish an attorney-client or other relationship and messages containing confidential or time-sensitive information should not be sent. In order to protect past, present or potential clients, we cannot treat unsolicited e-mails as confidences or secrets. Nothing contained herein shall constitute legal or other professional advice from, or to create an attorney-client or other relationship with, any of Burleson LLP, Gibson, Dunn & Crutcher LLP, M1 Energy Capital, or OFSCap. Parties are urged to consult their own advisors for such advice.

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Speakers

Trent Rosenthal (moderator) | Restructuring & Reorganization Partner – Burleson LLP● Board Certified in Business Bankruptcy Law by the Texas Board of Legal Specialization● Over 3 decades of experience in restructuring and bankruptcy law● Handled numerous oil & gas restructurings and workouts

James (“Jim”) C. Row, CFA | Managing Director & Founder – OFSCap, LLC● Background in energy investment banking (international/domestic)● Securities and valuation expert● Former E&P operator and former CFO

Michael Rosenthal | Co-Head, Restructuring & Reorganization Practice – Gibson Dunn ● Represents debtors/creditors in complex, high profile national & cross-border restructurings and Chapter 11 cases● Provides insolvency-related board advice to large public and privately held companies● Experience with corporate separateness and successor strategies and defenses

Rich Bernardy | Managing Director – M1 Energy Capital● Over 25 years of banking and finance, management and entrepreneurial experience ● Experience includes project and structured finance, private equity, debt securities, sponsorship of equity

investments, financial risk management, accounting, forecasting and capital budgeting

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Agenda

• Overview of Distressed Investments• Out of Court Acquisitions• Section 363 Acquisitions• Acquisitions Through Chapter 11 Plans• Investing in Distressed Debt• Risks of Distressed Investments

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Goals

• Give you a better understanding of options for acquiring distressed assets

• Highlight specific action items and concerns• Provide practical advice on investing in distressed

debt and risks of distressed investments

Acquisitions of Distressed Assets and Businesses

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Major Capital in The Marketplace

Overleveraged Capital Structures

Record Leveraged Loan and High Yield Issuance

Not So Smart Money Chased Return in

Historic Low Interest Rate Setting

Expected Increase in Corporate Default Rates

Weak Oil and Gas Pricing Pressures on

E&P and Service Companies

Significant Distressed Investment

Opportunities

Reasons Distressed Investing Presents Opportunities

WHO ARE TODAY’S ASSET BUYERS?

• Out of Court Distressed Asset Purchases• Asset Purchases (within Chapter 11)

o Acquisition of a distressed company’s assets or businesses through section 363 sale or through plan

o Purchase subject to auction processo Purchase at fair market value; days of bargain basement prices are long gone

• Debt Purchaseso Debt for return - Acquiring debt of distressed company with goal to exert

control over refinancing/restructuring/right-sizing of the company and realize appreciation

o Loan to own - Acquiring debt of distressed company with goal of leveraging the rights of that debt into ownership of the company

o Debt can be purchased for less than 100%o Analysis of capital structure, applicable documents and company-side leverage

is critical8

General Overview of Acquisition Alternatives

Chapter 11 Distressed Investment Methods

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§363 SALE PLAN SALE CLAIMS PURCHASE/LOAN TO

OWN PLAN FUNDING May be quicker than a

plan sale Transaction can be

consummated over creditor objections

Assets can be acquired free and clear of claims, liens and encumbrances

More flexibility in terms of form and timing of consideration

No need to register securities issued in the transaction

Assets can be acquired free and clear of claims, liens and encumbrances

Capitalize on discount between fair market value and trading price of claims

Ability to block competing plans

Ability to drive plan structure from fulcrum position

May be appealing to existing equity depending on valuation

May be appealing to banks if cash is used to reduce leverage

Subject to higher and

better offers (buyer may be used as a stalking horse)

Auction procedures will be imposed

Can not influence structure of POR

More costly and time-consuming

Buyer may become embroiled in plan conflicts

Ability to consummate sale depends on creditor acceptance

May be subject to higher and better offers

Attempt to convert to equity may be thwarted

Management has right to exclusivity and can lock-up major parties-in-interest

Investment may be illiquid

Purchases of equity could destroy certain tax benefits

Investment will likely be subject to market tests

Success may depend on debtor’s need for an equity infusion

Advantages

Disadvantages

Out of Court Acquisitions

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Overview of Out of Court Distressed Acquisitions

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• Many acquisitions occur without the filing of a Chapter 11 case• When the seller is in financial distress, however, the value of

the business makes it risky and unwise to buy equity of the seller

• Purchasing assets of a company in financial distress pose issues and risks for the purchaser.

� First, seller may not be able, with certainty, to convey title to assets free and clear.

� Second, purchaser will have risk of successor liability and risk that transaction will be avoided as a fraudulent conveyance

• The avoid these risks, many purchasers of distressed assets require that the sale be consummated through a Section 363 sale or Chapter 11 plan

Section 363 Acquisitions

Section 363 Purchase of Assets Free and Clear of Liabilities

• Chapter 11 allows a company to reorganize and continue operations as a going concern

• If distressed company cannot restructure or refinance, the only recourse may be a sale of the business

• Section 363 of the Bankruptcy Code authorizes a trustee or debtor in possession to sell property of the bankruptcy estate

• Assets may be sold as a going concern, or in a piecemeal break-up of the company

• The debtor must obtain the “highest and best” value for the assets

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Benefits of 363 Sale

Buyer• Allows Buyer to acquire

business or assets free of liabilities and adverse claims

• Eliminates fraudulent transfer risk

• Reduces successor liability risk

• Potential stalking horse protections

• Court blesses the purchase14

Seller• No need for stockholder

approval of sale• Provides protection to directors

and officers of Seller against “good faith” based claims

• Reduced stress in dealing with remaining liabilities and adverse claims

• Court blesses the sale

Negatives to 363 Sale

Buyer• 363 sale requires bankruptcy

auction process in most cases (even if auction was conducted pre-bankruptcy)

� Gives Buyer reduced assurance of successful acquisition and may have to negotiate deal twice

� Lengthens sale process

• Break-up fees, expense reimbursement, overbid protections and agreed sale procedures may be altered by the Bankruptcy Court

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Seller• Requires chapter 11

filing which may adversely affect the business

• Employee defections, shortening of vendor terms, customer fears

• Bankruptcy option is expensive

• Company actions are under microscope

Limitation of Section 363 Sale Option

• Sale must not be a sub rosa plan that circumvents the Chapter 11 plan process; limits ability to impact how purchase price consideration is distributed

• Assets can only be sold free and clear if one of the following apply:

� Applicable law allows the sale free and clear� Property is to be sold for more than the aggregate value of all liens on the property

� If sold for less than value of liens, the lien holder consents or the lien is in bona fide dispute

� The lien holder could be compelled to accept a money satisfaction

• Lien holders and DIP lender are key players and may, in fact, be the buyer

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Credit Bidding Limitations

• In re Fisker Automotive Holdings, Inc.o Court in Delaware capped credit bid amount to amount holder paid

for the debt, and not face value, to encourage competitive bids. o See also In re Free Lance-Star Publishing

• In re Momentive (upheld on appeal on 5/4/2015)o The Court held that the lenders were not entitled to a “make

whole” and other prepayment penalties upon acceleration of the debt caused by a bankruptcy filling, unless the agreement expressly provides for same upon acceleration. Moreover, the lenders were crammed down to an interest rate using a formula approach (e.g. T-Bill rate plus small risk premium) and not a market rate interest

• In re R.L. Adkins Corporationo The Fifth Circuit held that a creditor/prospective purchaser failed to

timely exercise its credit bid rights and therefore would lose the right

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363 Process – Stages

• Pre-petition marketing and negotiation with potential buyers

• Indications of interest and letters of intent

• Formal executed agreement with lead bidder (the “Stalking Horse”); debtor’s obligation is subject to court approval

• Chapter 11 Filing

• Lock up Debtor in Possession Financing� Evaluate DIP lending options� Great way to lock up the case and deadlines, etc. and excellent interest rate

and fees� Advantages to provide DIP loan by pre-petition lender, i.e. rollover

• Court establishment of bid procedures

• Post-petition marketing or auction

• Sale hearing

• Closing18

Considerations for Stalking Horse

Considerations for Stalking Horse

• Advantages to the Stalking Horse• Control of the initial terms of the transaction to “set the standard”• Ability to influence the pacing of the transaction• Generally has a head-start on due diligence and a longer period of

negotiation with the Seller• Regulatory issues

» In a regulated industry, Stalking Horse has opportunity to work with regulators to develop plan to obtain approval of acquisition

» Ability to begin seeking approvals and start waiting periods running prior to the auction process

• Opportunity to develop the confidence of the Seller, estate representatives and other constituents, and to develop relationships with management

• Stalking Horse has opportunity to obtain break-up fee or expense reimbursement

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Considerations for Stalking Horse

• Risks and concerns for the Stalking Horseo Tethered Goat and Illusory Purchaseo Investment of Stalking Horse will ultimately be used for the

benefit of the debtor (including by making some material discovered or developed by the Stalking Horse available to other bidders)

o Stalking Horse creates a clear target that other bidders know they need to beat

o Court may refuse to approve agreement with Stalking Horse due to factors such as break-up fees, no-shops, overbid protections and lock-ups If court refuses to approve, proposed Buyer is faced with modifying agreement or losing deal

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Acquisitions through Pre-Packaged Plans

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Types of Purchases through Plans• (Buying assets) or (providing planned funding) in exchange for

ownership of reorganized entity• Purchases may be structured during the Chapter 11 process or in

connection with a more streamlined pre-negotiated or pre-packaged Chapter 11 filing

• Pre-packaged and pre-negotiated bankruptcies:o Plan is negotiated with key constituencies prior to filing

• Pre-packaged bankruptcy:o Solicitation and vote occur prior to the filingo Company can typically emerge within six months of filing

• Pre-negotiated bankruptcy:o Solicitation and vote occur during the caseo “lock-up” agreements generally require certain constituencies to vote in

favor of Plano Typically longer in duration than a pre-packaged bankruptcy, but

significantly shorter than a “free-fall” bankruptcy

Acquiring Assets Through a Plan in Contrast to a 363 Sale

• 363 Purchaseso Occurs during the case and often well before plan confirmationo Not dependent on meeting requirements of plan confirmation;

however, sale must not be a sub rosa plano Since creditor constituencies have no vote, must conduct as an

open or public sale• Purchases through a Plan

o Occur as part of the Plan confirmation processo Creditors must vote to confirm the plano Confirmation of plan equals approval of the purchaseo Much lengthier, more expensive and complicated processo Structure is often far more flexible

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Benefits of Purchasing Assets Under a Plan

• Despite stringent confirmation process, purchasing assets through a Plan allows purchaser more flexibility than a purchase of assets through 363 saleo Can purchase assets or acquire equity in reorganized entityo 363 sale purchaser can only offer dollars (or a credit bid) and cannot

dictate which creditors obtain what portion of purchase price nor can it reorganize capital structure

o Greater ability to obtain protection from successor liabilityo Greater ability to avoid competitive biddingo Ability to obtain protection from future asbestos and other tort liability

» Appointment of future claimants’ representative» Section 524(g) statutory trusts

• Competitive bidding not generally required in plan context if creditors vote to confirm the plano Different rule for new value contributions from equity owners

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Investing in Distressed Debt

Comparison of Distressed Investment Approaches

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PURCHASE OUTSTANDING DEBT NEW MONEY INVESTMENT

Purchase large portion of outstanding debt securities at levels below par

Anticipate recapitalization transaction that converts “fulcrum” debt issue into equity (at face value)

Or, refinancing/restructure transaction that results in appreciated debt return

Investor injects new equity and/or debt capital into liquidity-starved situation

Allows investor to capture discount in firm trading value

If situation improves materially and recapitalization does not occur, investor can still realize attractive returns through sale of debt position at improved prices

Provides investor with greater control Able to privately negotiate transaction

terms

May be difficult to acquire large position No inherent control over process/timing/

governance Situation may deteriorate and investor may

no longer hold the fulcrum security

Loan docs/intercreditor may limit options

Debtor’s cards – cram-up and make whole

Risk that new capital ultimately inures directly to the benefit of existing senior lenders if situation deteriorates

Description

Advantages

Disadvantages

Investment for Return – Buying Debt and New Investments

• Distressed companies present opportunity for investors to purchase outstanding debt at steep discounts and participate in upside of that debto Particularly true at the onset of the announcement of financial

distress when traditional lenders may seek to exit their positionso Important to have an in depth knowledge of the assets and capital

structure of the company; knowledge is powero Identifying and purchasing fulcrum security may give more control

over restructuring process and, therefore, the returno Critical to understand key economic and intercreditor provisions of

debt documents

• DIP Financing - DIP financing has little risk and excellent returns

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Taking Control of Companies Through Purchases of Debt

• Chapter 11 plans can provide for the conversion of certain classes of debt into equity

• Identifying the “fulcrum” debt tranche maximizes ability to execute loan to own strategy

• Quantity of debt purchased may create leverage in a Chapter 11 caseo 1/3 control – creates blocking position in a Chapter 11 classo 50.1% control – may provide ability to amend debt documents to allow

certain out of court restructuringso 2/3 control – may provide control of a class of debt in a Chapter 11

restructuring» Will still need to satisfy greater than 50% numerosity requirement

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Taking Control of Companies Through Purchases of Debt or Equity

• Out of court considerationso Purchase of equity of distressed company may impact

change of control provisionso Inability to force minority hold-outs to accept terms of

restructuringo Elimination of equity interests – requires all stockholders to

consent» Potential alternative – significant dilution of existing equity

o Agent as an obstacle – replacing the agento Pro-rata distribution provisions – may be triggered by equity

for debt exchange

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Taking Control of Companies Through Purchases of Debt

• Chapter 11 considerations:o Debtor is in control of plan process and has tools to rein in ability to

convert to equityo Debtor has plan exclusivity for first 120 days, subject to extension for 18

monthso Debtor has right to reinstate or “cram-up” debt

» See Momentive decision in Southern District of New Yorko A Chapter 11 restructuring must be financed through use of cash

collateral and/or DIP financing» Priming fights/DIP lender leverage

o Lenders in fulcrum position have significant leverage, however, 50% control of a debt tranche does not necessarily provide control (as opposed to blocking right) over the Chapter 11 class vote

o Intercreditor disputes and agreements

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Taking Control of Companies Through Purchases of Debt

• Ability to take advantage of tax benefits not otherwise available under Section 363o Acquiring interest in business through ownership in reorganized

debtor under plan, as opposed to outright purchase of assets, may allow use of debtor's NOLso The value of being an old and cold creditor

o Acquiring ownership interest of reorganized debtor under plan may avoid recognition of gain that would have resulted from asset sale

» Thus, identical investment by buyer might be more attractive through plan, both to buyer and to debtor, than through asset sale

o Unlike Section 363 sales, asset transfers pursuant to plans are not subject to transfer taxes

» Florida Dep't of Revenue v. Piccadilly Cafeterias, Inc., 128 S. Ct. 2326 (2008)

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Finance Choices - Pros and Cons

Forms of Capital Available to Acquire Distressed Assets

• Public Equity Markets – IPO’s, Secondary Offerings, SPE’s

• Equity Private Placements – Closed-end Funds, Hedge Funds, Family Offices, Foreign Investment Sources, Institutional Investor Direct Sources

• Mezzanine Debt (Marked by higher pricing through increased interest, and/or equity kickers) – Senior Secured Notes, Junior Secured Notes, Registered High Yield Debt, Bridge Loans, Term Loans

• Bank Debt – Senior Secured Borrowing Base Revolvers, Senior Secured Term Loans, Second Secured Loans (“B” Loans)

• Joint Ventures – Bring in non-op partner to fund acquisition/development costs, Access a Strong Operator as partner and take a promoted minority interest in acquisition

• Alternative Financing – Volumetric Production Payments, Pre-pays, Sale of Working Interests, Reversionary Interest Sale, Off-Balance Sheet Structured Financing

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Public Vs. Private Capital Choices

Public• Liquidity in Market – Access to large

investor group that continues to invest in upside of energy

• Cost of capital on fully diluted basis is lower than most alternatives

• Multiple qualified investment bank groups hungry for deal flow

• Time to get to market and fund – can take six months or longer for 1st time companies accessing market

• Higher costs for due diligence and meeting SEC regulations

• Risk that Capital Markets will shut down prior to funding – lead to collapse of acquisition and possible lawsuits

Private• Plentiful sources of private capital

currently in market – Alternative industries not as attractive metrics

• Time to execute is much quicker for both debt and equity; existing companies and known teams have advantage to accelerating process

• No regulatory approvals required, but investor committee approvals needed

• More in depth due diligence on assets being acquired

• Higher hurdle for ROI and IRR required by private market

• Private money has more terms and control on management and ops

• Cost of capital always higher

Practical Advice Regarding Distressed Investments

Practical Risks of Distressed Investments

• “You’re either In, or Out”• Seasoned investors seek out mismanaged or financially distressed companies

o Focus as much on opportunities as riskso Maintain your standards, but price the risk accordingly

• Financial issues of distressed companieso Funding constraintso Accounting / reporting issues (reliability is a major issue)o High financial team turnovero Controls are in disarray

• Factors to consider (distressed or post bankruptcy)o Liquidityo Cash burno Supplier relations and termso Working capital managemento Customer relationship, debt covenants and going concern issues, and o Subjective acceleration clauses in credit agreements

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Practical Risks of Distressed Investments

• Risks:� Obvious financial and contractual landmines� Buyer beware (warranties/indemnities) are of little value� Tax – a key area of risk � Non-core assets thought to be liquid or easy flips are not� Assessing “risks only” � Liens and title imperfections� Manage by the month� Bidding – private equity or hedge fund players usually win over

strategic players� Cheap money has pushed down expected returns� Failing to track and maintain due diligence checklists� False expectations – most 2 years+

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Practical Risks of Distressed Investments

• Hidden Liabilities (bankruptcy specific)� Analysis of cure payments� Stretched payables� Rejected contracts

• Acquirers need� Turnaround talent� Strong process experience� Infrastructure to evaluate, plan and manage an investment

• Avoid Litigation� The “J” Factor� Venue

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Take Aways

• Purchasing assets from a distressed business is complex, but there are many options, and it can be very rewarding

• Seek advice from financial advisors, investment bankers and attorneys that are familiar with the process to maximize your chance of success

• Buying debt of a distressed company in an attempt to obtain control of the distressed assets is an available option, but the risks should be considered carefully.

• The current market environment is perfect for some major activity in the purchase and sale of distressed assets

• Experienced players succeed

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Q&A Session

• Please Submit Questions via Questions Pane on Your Screen

• Please Be Patient As We Try to Answer All Questions

• Thank You For Attending!

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Join Us For Part IV

• “Chapter 11 in Practice – A Case Study”• Wednesday, June 3, 2015• 12:00-1:00 p.m. Central Time• Registration Link: https

://attendee.gotowebinar.com/register/4721063602303012865

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Contact Information

Trent Rosenthal [Online Bio]Restructuring & Bankruptcy Partner – Burleson LLP Phone: 713.358.1724Email: trosenthal@burlesonllp.com

James (“Jim”) C. Row, CFA [Online Bio]Managing Director & Founder – OFSCap, LLCPhone: 713.823.2900Email: jrow@ofscap.com

Michael Rosenthal [Online Bio]Restructuring & Reorganization Partner – Gibson, Dunn & CrutcherPhone: 212.351.3969Email: mrosenthal@gibsondunn.com

Rich Bernardy [Online Bio]Managing Partner – M1 Energy CapitalPhone: 713.300.1420Email: rbernardy@mecapital.com