March 16, 2017 / 11:00 AM / 4 months ago

RPT-Hedge funds to reap big stock gains from bankruptcy of coal miner Peabody

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    By Tracy Rucinski  and Tom Hals
    CHICAGO/WILMINGTON, Del, March 15 (Reuters) - When leading
U.S. coal miner Peabody Energy Corp            emerges from
bankruptcy next month, a group of seven investment funds could
reap hundreds of millions of dollars in gains from an unusual
sale of discounted company stock.
    Six hedge funds and a state investment fund together own
about half of the company's unsecured bonds, according to a
January disclosure statement from Peabody. They used that
leverage to gain access to a private placement of company stock,
which has become surprisingly valuable amid an unexpected coal
resurgence.
    The exclusive offering for institutional investors will be
challenged in bankruptcy hearings starting Thursday by a group
of individual investors who were shut out.
    Those investors - who said in court filings that they own
between 5 and 7 percent of the unsecured bonds - will argue in
U.S. Bankruptcy Court in St. Louis that Peabody's reorganization
plan should be rejected because it violates a bankruptcy statute
requiring equal treatment for owners of the same securities.
    "This is absolutely theft from a small group of people who
are powerless," said Edward Hindelang, 69, a longtime investor
in Peabody's stock who started buying its bonds when clouds
gathered over the coal sector in 2015.
    St. Louis-based Peabody declined to comment, but has argued
in court that its Chapter 11 restructuring plan maximizes value
for all investors and creditors. Extra benefits for major
investors reflect their outsized role in negotiating and
financing the company's bankruptcy exit, the company has said in
court filings.   
    Two of the hedge funds - Elliott Management and Aurelius
Capital Management - played a pivotal role cutting the deal.
Elliott and Aurelius gained negotiating clout by threatening a
protracted legal challenge aimed at using an accounting change
to strip $1 billion in collateral from a loan arranged by
Citibank.
    Elliott, Aurelius and Citibank declined to comment.
    Individual investors are being shut out of a private
placement of $750 million in newly minted Peabody preferred
stock - at a 35 percent discount to the company's estimated
valuation. The sale of stock, which comes with attractive
dividends and other benefits, is only open to institutional
investors who hold Peabody bonds, including the seven funds.
    Individual investors can, however, buy stock at a discount
of at least 45 percent in a separate $750 million common stock
offering, which is also open to major funds. 
    In both stock sales, the number of shares investors are
allowed to buy is based on the amount of Peabody debt they hold.
 
    Individual investors argue they should have access to both
opportunities, which would allow them to buy much more
discounted stock.
    Peabody and the hedge funds have argued in court that the
private stock placement is legal because it will be conducted
separately from the bankruptcy reorganization plan. 
    Individual investors contend that the private stock offering
is integral to Peabody's broader plan to exit Chapter 11
protection and should not be considered as legally separate.
   
    PROFITING ON DEBT
    Elliott and Aurelius first approached Peabody management in
late 2015, announcing themselves as "significant" holders of the
company's increasingly distressed debt, according to testimony
by Peabody's chief financial officer, Amy Schwetz.    
    In the following months, Elliott, Aurelius, and the other
investment funds negotiated the private stock sale with Peabody
executives - who will also get stock bonuses under the
reorganization plan. The stock grants to Peabody's six top
executives, who ran the company before bankruptcy, could be
worth tens of millions of dollars.            
    The stock is coveted because Peabody's bankruptcy exit
coincides with a brightening coal industry outlook, at least in
the short-term, amid increased demand from Asia and expected
deregulation under U.S. President Donald Trump.
    There's no way to determine exactly how much the investment
funds stand to gain because it is not known what each of them
paid for Peabody's bonds or what their newly purchased stock
will be worth on public markets.
    But Elliott and Aurelius - derided as "vulture funds" by
some critics - are known for buying corporate debt at deep
discounts and spending heavily on litigation to try maximize
their returns in bankruptcies.
    The other large holders of Peabody debt include Discovery
Capital Management, PointState Capital, Contrarian Capital
Management, Panning Capital Management and the South Dakota
Investment Council.
    The funds did not respond to requests for comment.
    By buying stock at a 35 percent discount to Peabody's
estimated valuation in the private placement, institutional
investors would receive about $1.2 billion in stock for an
investment of $750 million. The funds could also buy large
portions of the common stock being offered to all investors at a
45 percent discount.
    Opponents of Peabody's plan say the hedge funds' profit may
be much larger because Peabody's estimated market capitalization
of $3.1 billion is unrealistically low, failing to account for
the improved coal outlook. The opponents have projected that
Peabody's market capitalization upon bankruptcy exit will be
$5.4 billion.
    The funds, however, took on big risks in carrying Peabody's
distressed debt through bankruptcy, said David Tawil, president
of the Maglan Capital hedge fund.
    Firms such as Elliott and Aurelius often seek out
investments with the potential for all-or-nothing outcomes, he
said. 
    "You need a tremendous stomach," he said.
    
    PENNIES ON THE DOLLAR
    In late 2015 - when Elliott and Aurelius first disclosed
their Peabody bond holdings - global coal consumption was
plummeting and U.S. power plants were switching to ever-cheaper
natural gas from shale fields. 
    Peabody faced a looming cash crisis. In debt-market trading,
the company's unsecured bonds fell from 30 cents on the dollar
in October 2015 to a low bid price of 2.5 cents in February
2016, according to Reuters data.
    Like the hedge funds, some individual investors saw an
opportunity in the beaten-down bonds.
    Joel Packer - an entrepreneur and hedge fund founder who
invested retirement funds in Peabody bonds - was attracted by
the potential returns. He never imagined that a bankruptcy could
result in a lucrative private stock offering that shut out
individual investors.
    "I was looking for yield. Rates were down, and coal was
really in the garbage pail," said Packer, 73. "It was
inconceivable that they would distinguish between individual
investors and institutions."
    Packer is now among the investors suing Peabody and six of
the seven funds for denying them access to the private stock
placement. A separate trial on the individual investors' lawsuit
is scheduled for May 17 in St. Louis.
    Attorney David Kovel, who represents Hindelang, Packer and
two other investors, argues the hedge funds are stretching the
law at the expense of creditors with less influence.
    "Hedge funds and other powerful stakeholders are testing the
bounds of bankruptcy law," Kovel said. "As the bounds go upward,
they'll be pushing the limit."
    

 (Reporting by Tracy Rucinski in Chicago and Tom Hals in
Wilmington, Delaware; Editing by Noeleen Walder and Brian
Thevenot)
  

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