MISSION POSSIBLE

The summer of 2002 brought trouble to the crimson leather-covered floors of Mission Resources Corp. The Houston-based E&P company's stock was continuing on a downward spiral, the resignation of a director was followed by that of the chairman and chief executive officer, attempts to sell the company had proven unsuccessful and half its cash flow was going toward servicing $265 million of debt. Mission seemed doomed. Formed by a merger of Bargo Energy and Bellwether Exploration in May 2001, the deal had yet to click. The company began to suffer distress almost immediately with a failed drilling program, followed by September 11 and Enron, and the resulting fall of the capital markets. During the summer of 2002, one of Mission's directors began talking to Bob Cavnar, an old friend who had a background of success with start-ups and restructurings and who was leaving his job as chief financial officer with El Paso Production Co. By August 2002, Cavnar was on board as chief executive of what seemed to be a rapidly sinking ship. "This company was perceived to be a lost cause, but I didn't think it was," Cavnar recalls. "It needed a strategic repositioning, but it had enough inherent strength where I felt like we could fix it." With half of the cash flow Mission was generating going toward its debt service, the money available for capital expenditures wasn't enough to fund an adequate drilling program. The company's stock price had dipped well below $1 per share and commodity prices were also down. Cavnar made two phone calls: the first to long-time business associate Rick Piacenti, who would become Mission's new chief financial officer, and the second to investment bank Petrie Parkman & Co., which would become the company's advisor. A review of Mission's assets revealed the need for a restructuring. "I thought there was enough value in the reserves and there was enough cash flow to keep the company going. Rick and I both felt the commodity-price environment over the next few years or so was going to be pretty strong," Cavnar says. "We decided to do a restructuring, essentially an organic one, without Chapter 11." What did Cavnar and Piacenti have to work with? At the time, the company's reserves were approximately 60% oil, concentrated in East Texas and in the Permian Basin, and the balance offshore the Gulf Coast. Much of the asset base consisted of mature properties that were high-cost and low-margin. The company also had some producing assets in California, left over from a legacy deal, that were price-capped at $9 per barrel, thus draining resources. "One of the first things we decided to do was to turn over the asset portfolio to get rid of the high-cost assets, work on the balance sheet and get the exploration drilling program started-all of those things were essentially stopped when we got here," Cavnar says. The company was in such a mess that selling the company wasn't even an option. "The assets were not in any kind of condition where they could be sold for what I would think would be an advantageous value, so that wasn't even discussed," Cavnar says. "Our first goals were to get a recovery started and get the balance sheet fixed. We're all capitalists, so everything's for sale at a price; that's just the nature of our business-but early on, the focus was on recovery. We had organizational issues, we had governance issues, and we had strategic and tactical issues. This recovery was a 24/7 situation for us." Once the company's many problems were identified, Cavnar and Piacenti developed a multi-pronged approach to fixing Mission. It included reducing the company's debt, lowering the cost structure, gaining more gas assets and balancing long-life reserves with an exploration program that would have high-rate wells with good returns. The company desperately needed a refinancing to reduce debt and allow funding of a meaningful drilling program. Hedge-fund capital With a company that was not even considered fit to sell and a stock price that had been below a dollar long enough for Nasdaq to begin the delisting process, Cavnar and Piacenti found a shortage of financial institutions eager to invest in them. That is until they were introduced to Farallon Capital through Jon Hughes, head of M&A at Petrie Parkman. Farallon, based in San Francisco, is a hedge fund. "We met with Farallon around Christmas of 2002. Basically we just sat down, provided publicly available information and talked about our backgrounds, our philosophy and our strategy. It was a very good conversation, but we weren't talking any kind of deal," Piacenti says. "After the meeting, Farallon went out to the open market and bought almost $100 million of our bonds. Then they came to us and we negotiated to purchase the bonds from them at 73.5 cents on the dollar, which Farallon financed." Hughes says, "The company was in such trouble, the bonds were trading at about 60% of their face value, so Farallon went in and bought these bonds at a discount and took the risk of not having a deal." Through the Farallon transaction, which closed on March 28, 2003, Mission was able to wipe out approximately $17 million of debt and add $5 million in cash, which helped jump-start its drilling program. After this deal, Cavnar and Piacenti still had to tackle the Nasdaq delisting issue. Right after the Farallon deal closed, they flew to Washington. "Our stock price was 85 cents when we went to the delisting hearing. We explained to the Nasdaq committee how the Farallon deal was a catalyst, this was the start, how our drilling program was starting to be successful, and before they could get to their ruling, we hit the dollar mark," Piacenti says. "Once we hit the dollar mark, we never went below it, so in their rules, if you stay at or above a dollar for 10 days or more, that's the criteria to stay listed. "So Nasdaq closed the file and didn't have to rule. We really have never come close to being at that dollar level since." At press time, shares of Mission were trading at $5.55. The divestments of various assets through the cleaning-up process of 2002 generated approximately $22 million, which was added to the company's existing cash flow to form a healthy capital program for 2003. That year, Mission spent $33 million and drilled 48 wells. "We stayed inside of the cash that we had available and we stuck by our philosophy of not borrowing money to do drilling," Piacenti says. "In the beginning, there weren't very many internal projects to do-there was really one internal exploration prospect, and the rest were street deals-because we had not yet put our team together. "It was awful hard to entice people to come here when our stock was trading under a dollar and Mission had a reputation of people wondering if we were going to survive as a company." Debt-for-equity swaps The Farallon deal gave the company momentum, and it also allowed Mission to get out from under a 10-bank credit facility group that was difficult to work with and, according to Cavnar, "verging on hostile." But the Farallon deal was only a 21-month financing. Immediately, Piacenti had to begin work on how Mission was going to refinance that deal. After getting rid of the bank group, he didn't have a bank to work with, although Wells Fargo referred Mission to Foothills Capital Corp., a Wells Fargo affiliate and asset-based lender. "It was very important for us to get things stable as quickly as we could, and that's what we focused on during the first year or so. Then the second part was to begin to develop that track record to give those constituents confidence that we really did know what we were doing," Cavnar says. A key component of Mission's financial restructuring was a series of three debt-for-equity swaps, the first of which was with Franklin Advisors Inc. on behalf of Franklin Templeton Funds in December 2003 for $10 million. Franklin Templeton is a financial institution based in San Mateo, California. "The Franklin debt-for-equity swap was done at $2.22 when the stock was trading at $1.94, so that was a particularly good deal and showed Franklin's belief in the company," Piacenti explains. "They basically did it for what the bonds were trading at, and Franklin was a larger bondholder, roughly at around $50 million worth of bonds. Shortly after that, the stock moved up to trading at $2.25 and the bonds went up to trading close to par. So it was a very good event for everyone." In the midst of fixing the company's balance sheet, Cavnar and Piacenti were forced to turn their attention toward acquisitions. The company's East Texas oil properties had been among those divested in 2003, and under the company's lending scheme with Farallon, management had only 90 days to reinvest the proceeds. Otherwise, the money would have to be used to pay down debt. "We made contact with the owners of a group of properties in the Jalamat Field in southeast New Mexico. We did a negotiated deal to acquire the properties. This field is all gas and gas liquids; it was perfect," Cavnar says. "It was operated and had lots of development opportunities; it was exactly what we needed. We closed that deal the last week of January 2004, then later rolled up the rest of the operating interests to where we now have a 95% working interest in that particular area. That's a model for the way we like to do deals. We try to do negotiated deals if we can, try to get deals we understand that have development and upside potential." Piacenti says, "It helped us on all fronts because it brought our reserves to more than 60% gas, when we started at 40% gas. It also lowered our average cost structure. It gave us more reserves that are of longer-life. All of the things Bob wanted to do were accomplished in this transaction, though it actually took 91 days, so I had to get a one-day waiver from Farallon." Mission followed the Franklin deal with a similar transaction with Guggenheim Capital in a $15-million debt-for-equity swap, which was done at $2.40 per share when the company's stock was trading at $2.30. The deal closed in February 2004. This was followed by another $15-million debt-for-equity swap, this time with Harbert Management Corp., at $2.50 when the company's stock was trading at $2.35. "We did three debt-for-equity swaps at a premium and when we did that, all of a sudden the banks would talk to us," says Piacenti. "We went to Wells Fargo and they said they would do a $50-million revolver, of which $20 million would be dedicated solely to acquisitions. "Our goal was-as fast as we could-to get this company to a 50/50 debt-to-equity ratio. So instead of doing a $200-million bond deal basically out there for seven years, we did only $130 million of high-yield bonds, plus a $25-million second-lien secured note, with the $50-million revolver. With that and by paying off the rest of the debt, we could see getting to a 50/50 debt-to-equity ratio." On April 8, 2004, Mission issued $130 million of senior notes, closed on a $25-million second-lien note with Guggenheim Capital and closed a revolving facility with Wells Fargo Bank. The notes issue marked the first public bond deal for Guggenheim, which had recently acquired an independent bond group. "At that point, we had totally recapitalized and saved about $9 million per year in interest expense. We had more liquidity to do acquisitions and we took our maturities from an average of two years to an average of six years," Piacenti says. "Overall, on April 8, we fixed the balance sheet enough to where I no longer worried at night about whether we were going to make it." Cash flow growth After the company's balance sheet was repaired, Cavnar and Piacenti were able to consider their options for growth-through drilling, acquisitions and larger transactions. Before making further decisions, a strategic review was deemed necessary. Cavnar says, "I was kind of hoping to shake loose a deal of some type, and I really wanted to focus on what the internal resources were that we had. I know that 'strategic review' is kind of code for 'the company is for sale,' but this really was a strategic review of the alternatives that we had. "Did we want to sell, did we want to buy, did we want to expand geographically, change our capital expenditure program, sell other assets? Did we have access to markets or capital? At that time we weren't sure." Mission asked Petrie Parkman to advise on this process. "We just tore the company apart property by property to see where the value was, where some alternatives were and what opportunities were out there for sale and for purchasing, and to develop some ideas about where we wanted to go," Cavnar says. "It became apparent very quickly that we had been so focused on just getting the company stable that we had not really had a good, deep review of the assets we already owned." Through that review, Mission identified a lot of opportunities within its existing asset bases, and a good environment to raise equity and debt capital as needed. "In September 2004, we announced the result of the review: We've got an abundance of internal opportunities here, we've got plenty of capital available, we've got lots of things to do, so we're going to accelerate the capital program and aggressively pursue acquisitions," says Cavnar. "A lot of people were surprised that we didn't just come up with some kind of sale, but I felt like I could build more value for the shareholders-and Rick and I are two big shareholders-by continuing in the direction in which we started and accelerating it." The new Mission Today, the new Mission Resources has a very different look: Its reserves and production are now 60% gas, and Cavnar would ultimately like to bring that up to 70%, as he prefers gas because it is more domestically demand-driven than oil and is less expensive to find and produce. The new company's core areas are onshore the Gulf Coast from South Texas to Mississippi, and the Permian Basin, including New Mexico. Cavnar says the company will look for an eventual exit from offshore the Gulf Coast and redeployment of that capital onshore. Now that Mission's stock price is finally rising and the restructuring is complete, don't expect Cavnar and Piacenti to put the company on autopilot. "We never have been those who just sort of rock along, show up for work every day, get the daily reports, that kind of thing; we're always looking for where can we get that additive opportunity that gives us exponential value to what we already have," Cavnar says. "That was the reason for the review and that is the reason for the direction we're taking. We are looking to grow this company as aggressively as we can. We're not going to do anything stupid, but we're going to look at the market and we're going to be aggressive." Piacenti says, "We're looking to create value, and if creating value ends up in a sale, well that's great. But if it means we grow this company and we add value for shareholders that way, what's good for them is good for us. We are here to bring the most value to shareholders that we can." Restructuring is viewed as a difficult process that often results in the sale of the company; Petrie Parkman's Hughes says the reason this restructuring turned out differently was because Cavnar and Piacenti believed they could succeed and were persuasive. "It was their vision of how to get out of the hole they were in and their ability to articulate that with conviction. That was a critical aspect to people gaining confidence in them," Hughes says. "This was not a one-step process; this was a multi-step process that was executed on different levels. It helped that commodity prices went up, but that alone would not have saved this company. From an investment banker's perspective, I was impressed with their ability to conceive this vision and their willingness to take the risk that was involved. Joining a company with a 40-cent stock price was a real risk." For 2005, Mission has increased its drilling budget to $71 million and expects to spend more than 20% on exploration. It lives another day because Cavnar and Piacenti came in and created value where there seemingly was none.