August 29, 2012 / 9:40 PM / 7 years ago

TEXT-S&P cuts Venoco's corp credit rating to 'B-'

Overview
     -- Denver-based oil and gas exploration and production company Venoco 
Inc. disclosed plans for the management buyout of the company's public 
stockholders in a take-private transaction.
     -- We have lowered our corporate credit rating on Venoco to 'B-' from 'B' 
to reflect the level of debt assumed with the financing, the new capital 
structure of the company, and our expectations of leverage for the next two 
years.
     -- At the same time, we have removed the rating from CreditWatch with 
negative implications and assigned a stable outlook, which primarily reflects 
our belief that the company possesses adequate sources of liquidity to fund 
its projected uses of cash for the next two years.
     -- The '5' recovery rating for the existing unsecured notes remains 
unchanged, indicating our expectation of modest (10%-30%) recovery on the 
notes in the event of a payment default. In connection, we lowered our ratings 
on the notes to 'CCC+' from 'B-' to maintain the existing one-notch separation 
below the corporate credit rating.
     -- In the proposed financing package, Venoco intends to enter a $175 
million second lien secured term loan. We have assigned a '1' recovery rating 
to the new term loan, indicating our expectation of very high (90%-100%) 
recovery for term loan lenders in the event of a payment default. We are 
assigning a 'B+' rating to the term loan to reflect the two-notch uplift from 
the corporate credit rating as prescribed by the recovery rating.

Rating Action
On Aug. 29, 2012, Standard & Poor's Ratings Services lowered its long-term 
corporate credit rating on Denver-based Venoco Inc. to 'B-' from 'B'. At the 
same time, we removed the rating from CreditWatch, where we placed it with 
negative implications on Jan. 18, 2012. The outlook is stable. We assigned a 
'B+' rating and a '1' recovery rating to a proposed new second lien $175 
million term loan. We lowered our rating on the unsecured notes to 'CCC+' from 
'B-' and the '5' recovery rating remains unchanged. 

Rationale
The downgrade follows Venoco's disclosure that the company's Executive 
Chairman expects  to fund the management-led buyout of public stockholders in 
a manner that results in forecasted debt leverage that is materially higher 
than our threshold for similar 'B' rated peers. The new financing consists of 
proceeds from a $210 million volumetric production payment and $30 million of 
convertible notes issued by the newly formed Denver Parent Corp. which will be 
Venoco's sole owner, plus a $175 million second lien secured term loan and a 
$21.5 million draw on a new revolving credit facility at Venoco, the operating 
subsidiary. Venoco's existing revolving credit facility with a borrowing base 
of $200 million will be paid down at the close of the transaction. In the 
event that the transaction does not close, we will revise our analysis of the 
company. 

While there are no explicit guarantees of operating or parent company debt by 
either Venoco or Denver Parent Corp., we analyze the entity on a consolidated 
basis for rating purposes, consistent with our methodology related to 
strategic control by the parent.

The ratings on Venoco reflect a "vulnerable" business risk and a "highly 
leveraged" financial risk. The business risk reflect the company's relatively 
small consolidated reserve base of 90.3 million barrels of oil equivalent 
(boe) of proved reserves concentrated in California, ability to benefit from 
strong oil prices with production that is evenly split between oil and gas, 
and high cost structure. The company has limited geographic diversity but 
extensive lease holdings in the emerging Monterey Shale of Southern 
California, existing coastal and offshore Southern California liquids 
production, Sacramento Basin natural gas production, and a 22.3% reversionary 
interest in a Denbury-operated carbon dioxide Enhanced Oil Recovery project at 
the Hastings Field in Texas. Altogether, we expect Venoco to reduce capital 
spending significantly to a level that approximates cash from operations and 
to focus on increasing liquids production. 

The company's production is relatively well hedged if hydrocarbon prices 
decline. Not including put options that are ineffectual at our price 
assumptions, approximately 55% of daily production is hedged in 2012 at volume 
weighted average floor prices of $3 per million British thermal units of 
natural gas and $80 per barrel of crude oil. In 2013 and at our prices, just 
less than 50% of daily production is hedged at average floor prices of 
$3.47/mmBTU of gas and $90/bbl of crude oil.

Incorporating these hedges, our near-medium term price assumptions for oil and 
natural gas ($85 per barrel of West Texas Intermediate {WTI} crude oil in 2012 
and $80 in 2013; $2.50 per mmBtu of Henry Hub natural gas in 2012 and $3.00 in 
2013) and production of about 18,000 boe per day, we expect Venoco to generate 
EBITDA of approximately $21 million in 2012and $220 million in 2013on a 
consolidated basis. With consolidated debt plus adjustments for volumetric 
production payments, operating leases, and asset retirement obligations 
forecasted to total approximately $1.2 billion, we believe Venoco's adjusted 
debt-to-EBITDA ratio will approach 5.7x in 2012 and 5.6x in 2013. This level 
of leverage is above our expectations for 'B' rated exploration and production 
companies and is more closely aligned with a "highly leveraged" financial risk 
profile and 'B-'corporate credit rating.

Liquidity
Liquidity is adequate. We believe Venoco will source over 1.2x projected uses 
of cash in 2013 and 2014.

After the close of the transaction, we estimate sources of liquidity over the 
next 12 months of at least $230 million, comprising:
     -- $100 million available on its new revolving credit facility with a 
borrowing base of $125 million that matures in 2016; and
     -- $130 million of funds from operations.
 
On the same date, we estimate liquidity needs over the next 12 months to be 
between $180 million and $190 million, comprising capital expenditures and 
minimal working capital outflows.

The new credit facility possesses financial covenants that may restrict 
certain capital expenditures if covenant defined leverage is greater than 4x. 
In addition, there is an absolute maximum defined leverage covenant of 5x 
through June 30, 2013, 4.75x through Sept. 30, 2013, 4.5x through March 31, 
2014, 4.25x through June 30, 2014, and 4x thereafter. The new term loan 
possesses financial covenants governing leverage that are 0.5x looser than 
corresponding financial covenants in the revolving credit facility. We expect 
Venoco to remain in compliance with its covenants.

Recovery analysis
We lowered our rating on the company's $650 million of senior unsecured notes 
to 'CCC+' to reflect the take-private transaction, our '5' recovery rating 
that indicates our expectation of modest (10%-30%) recovery in the event of a 
payment default, and the one-notch downward separation of the notes relative 
to the corporate credit rating that the recovery rating prescribes.

We rate the proposed $175 million second lien secured term loan 'B+', 
reflecting the two-notch uplift from the corporate credit rating prescribed by 
the '1' recovery rating on the term loan which indicates our expectations of 
very high (90%-100%) recovery of principal and interest on the term loan.

For a more detailed recovery analysis, see the recovery report on Venoco that 
immediately follows this release.


Outlook
The outlook is stable. The stable outlook reflects the company's adequate 
liquidity position. We would consider an upgrade if we believe Venoco can 
improve consolidated debt leverage to EBITDA to under 4.5x. We would most 
likely consider a downgrade if Venoco increases its capital expenditures to a 
level that we believe will pressure the company's ability to generate sources 
of cash in excess of its uses by 1.2x or if we believe Venoco is on pace to 
breach one of its bank covenants, which is increasingly likely if oil prices 
fall below $75 for a sustained period.

Related Criteria And Research
     -- Key Credit Factors: Global Criteria For Rating The Oil And Gas 
Exploration And Production Industry, Jan. 20, 2012
     -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 
     -- Criteria Guidelines For Recovery Ratings, Aug. 10, 2009 
     -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 
     -- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, 
May 27, 2009 
 
Ratings List
Downgraded; CreditWatch/Outlook Action

                             To                 From
Venoco Inc.

 Corporate Credit Rating     B-/Stable/--       B/Watch Neg/--
 Senior Unsecured            CCC+               B- /Watch Neg
 Recovery Rating             5                  5

New Rating

Venoco Inc.

 Senior Secured
  US$175 mil 2nd lien 
  bank ln due                B+                 
  12/31/2017                            
  Recovery Rating            1


Complete ratings information is available to subscribers of RatingsDirect on 
the Global Credit Portal at www.globalcreditportal.com. All ratings affected 
by this rating action can be found on Standard & Poor's public Web site at 
www.standardandpoors.com. Use the Ratings search box located in the left 
column.
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