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."
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