FINANCE

Bankruptcy 101: a primer for U.S. coal markets

The bankruptcy filing by Alpha Natural Resources Inc. last week was the coal industry's biggest yet. It won't likely be the last.

The many maladies of the U.S. coal industry have forced dozens of coal firms into business purgatory: Chapter 11 of the bankruptcy code. Alpha, the United States' second-largest publicly listed coal business, followed in the footsteps of Walter Energy Inc., Patriot Coal Corp., James River Coal Co. and dozens of smaller players that have filed in the last two years.

Two of Alpha's rivals, Peabody Energy Corp. and Arch Coal Inc., are still standing, but their financial fragility means bankruptcy can't be ruled out.

Companies that go through a Chapter 11 "restructuring" will have to take a hard look -- with their investors, and in front of a judge -- at what their businesses can be in the future. It will not be an easy question to answer.

"It's very hard for people to produce a reliable forecast that says, 'Here's where the bottom is,'" said Stephen Arbogast, a finance professor at the University of North Carolina Kenan-Flagler Business School. "So it's an extraordinarily open and painful restructuring that's going to be a combination of consolidation through Chapter 11 and outright liquidation. Because nobody can see any growth and nobody knows where the bottom is."

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The goal is to produce a plan that shows the business can be sustainable. If it's approved by the judge, the firm can re-emerge from bankruptcy. If no plan is approved, the firm may be sold or just go extinct.

EnergyWire lays out the milestones to watch.

1. To file, or not to file

Bankruptcy is a choice. It is a company's acceptance that, under current conditions, it will not have enough money to keep the business going.

Why is that? There could be many reasons. The business likely isn't generating enough revenue due to low prices, for instance. Bonds may be due soon, in the amounts of hundreds of millions, even billions, of dollars.

Historically, coal companies could turn to capital markets to raise cash. But in the current environment, Wall Street isn't interested in issuing stock or debt.

At the start of this decade, coal companies borrowed billions to expand their businesses. Now, they're struggling to pay for that debt -- in some cases, so much that they go bankrupt.

By filing for Chapter 11, a coal company concedes that it can't continue to operate with existing financial pressures. It elects to stand before a court, with its business on standby, to see if a path forward -- with less debt, or a smaller company -- can be envisioned.

Not everyone makes this choice. If a company has enough cash stored away, its strategy might be to wait out the coal downturn.

2. The financial pecking order

Technically, a bankrupt coal company doesn't own its business. Its lenders -- its senior bondholders -- do. They're the first ones to sit down with a company's management and discuss a restructuring plan. That gives them the best chance at what they were promised: their money back.

But they're not the only ones with a chance. There's a pecking order: junior bondholders, suppliers and anyone else who can claim the company owes them money. Everyone has hired a lawyer, because that's how they can vie for a piece of the company -- whether it's being repaired or dismantled.

There may not be enough to go around. The lower you are in the pecking order, the more likely you'll be left with crumbs.

"The main thing is that the investors that own the bonds are in a situation where they may get no or partial recovery on their investment," said Chiza Vitta, a credit analyst with Standard & Poor's.

For example, S&P estimates that if Peabody were to default on one of its "senior unsecured" bonds, the recovery would be a "modest" 10 to 30 percent.

Those who hold stock in the company are lowest in the pecking order. Often, in a restructuring, they are wiped out, receiving nothing for their shares.

3. Existential questions

Consider Walter Energy, which filed for Chapter 11 last month and whose chief business is mining metallurgical coal, the fuel used for steelmaking.

"Is there a reason for Walter Energy to exist a year from now?" said Spencer Cutter, a senior credit analyst with Bloomberg Intelligence. "Is there going to be a market in this world for metallurgical coal? And what are the prices for coal in that market, and what are Walter's costs to produce that coal?"

Bankruptcy forces existential questions for all companies. But given the current state of energy markets, the questions for coal companies are difficult ones to answer.

In the United States, climate regulations may permanently constrain the coal market. Abroad, Chinese demand is slowing, and Indian demand may not make up for it. The price of natural gas and the advance of renewable energy remain major unknowns.

Against that backdrop, coal firms must decide how to downsize their businesses. They may sell mines to raise cash -- if they can find buyers. They will likely rebuild around lower-cost mines in the Powder River and Illinois basins, at the expense of Appalachia.

In Appalachia especially, they will try to put pressure on union and pension interests in order to cut costs.

And if the money doesn't work out, a company may find it has to sell its entire business, lock, stock and barrel.

"There are bankruptcy processes where they just sell the assets. They liquidate," Cutter said.

Some coal analysts argue that U.S. coal companies have profitable businesses, if only they can get rid of their debt. The question is, how do they restructure that debt? And what should the business look like in the future?

4. Make a new plan, Stan

Some restructurings can go quickly, ending in a matter of months, if the company's management and bondholders are on the same page. Other Chapter 11 cases can be long, scorched-earth affairs, if the various parties end up competing for pieces of the pie.

In Alpha's case, it arranged for 18 months of cash to see it through the bankruptcy process. The company said it had the blessing of its major lenders.

In any event, the bankruptcy court ultimately wants to see a proposed plan of reorganization -- whether from management or someone else. The plan can't be temporary, experts told EnergyWire; it can't set the company up to return to bankruptcy in a few short months.

But if there's a plan that sets the company on more sustainable footing, and the court believes it maximizes the value of the company, the judge will approve it. That would allow a company to re-emerge from bankruptcy.

How many companies will make it that far? And how many will fold?

Even longtime coal watchers are unsure if they are witnessing the death of the coal industry, or a gruesome resurrection.

"I don't think there is a consensus view or a popular view about what happens here," said Kristoffer Inton, an equity analyst with Morningstar. "The miners seem optimistic this will turn around. ... [A]s additional bankruptcies come, I don't know what it turns the market into, what happens."

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