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Morningstar | Weatherford International Announces Intent to File for Bankruptcy; We Are Slashing Our FVE

Financially beleaguered Weatherford was sunk by a perfect storm in the first quarter. On May 10 post-market close, the company released disastrous first-quarter results and announced a plan to sign a restructuring support agreement with its creditors and subsequently file for chapter 11 bankruptcy. After reviewing the RSA and revising our forecasts for the company, we are reducing our fair value estimate to $0.15 per share from $1.75 previously.

Under the terms of the RSA, unsecured noteholders will swap about $6 billion in debt for a 99% equity stake in the post-reorganization company. Current Weatherford shareholders will receive 1% of new equity, plus warrants to purchase another 10% of the new common stock (exercisable upon the company meeting certain benchmarks). The full plan details remain under negotiation, but we assume a warrant value per share equal to 10% of the equity value per new share. Altogether, this results in current shareholders getting 2% of the equity value of the post-reorganization company.

We've also lowered our near-term forecasts for Weatherford's revenue and profits to account for financial distress costs. Using our new enterprise value with our estimate for the company's post-reorganization debt levels, we estimate a new equity value of about $7.5 billion, with 2% (about $150 million) going to current Weatherford shareholders. This results in a new fair value estimate per share of about $0.15.

We expect the RSA will be confirmed by noteholders and approved in bankruptcy court. In any case, we don't expect terms to get any better for current Weatherford shareholders. Although, based on our forecasts and equity value, current Weatherford shareholders are getting a very bad deal, we don't think shareholders have a strong chance at gaining by contesting the plan, as a prolonged court fight will only erode the value of the company further. With liquidity drying up for Weatherford, shareholders are in a very weak negotiating position.

How did Weatherford arrive at this point? Despite its high debt load, the company looked in solid shape at the end of the fourth quarter, thanks to very strong profitability improvement throughout 2018 as the company's transformation plan played out. However, the first quarter was disastrous for Weatherford. After generating $100 million in operating cash flow in the fourth quarter, Weatherford saw a $250 million operating cash flow drain in the first quarter (versus our expectations of positive $100 million).

This operating cash flow disappointment came from two primary sources. First, adjusted operating income was negative $3 million versus our expectation of $88 million (and consensus at $74 million). This was caused by headwinds across the company, but in particular Western Hemisphere results were affected as it seems Weatherford was hit belatedly by the U.S. shale activity slowdown (which had begun in the third quarter). Second, working capital caused a $200 million outflow versus our expectation of no net effect. It appears that Weatherford's customers and suppliers panicked in the first quarter, causing a surge in working capital needs.

Theoretically, we believe that Weatherford remains easily solvent, and in the absence of the recent panic, it could've skirted by liquidity issues in 2019 (even taking into account weaker-than-expected operating results in the first half). However, with the company already in a financially vulnerable position, the loss of confidence has become a self-fulfilling prophecy. Weatherford now has no choice but to pursue a chapter 11 plan of reorganization.