If there was a publicly traded equity security that the market knew was worth $0 -- or even had negative equity value from discounted cash flows or some other valuation methodology -- in theory the security should trade at or near $0. However, if the business has some cash flow to offset debt service costs for few months or so, in reality, the security will trade slightly above $0. That's because investors know that the company can kick the can down the road for the time being, and there is "option value" on the equity. As to how large this option value should be, that's largely a function of how much time the business has until it has to throw in the towel, and how big of an upside the business has when you reach or get past the inflection point.
Many E&P companies are currently in an analogous situation, trading on option value, with perhaps a few months or about a year left before they are forced to default (not covenant breaches that will get waived, but missing interest payments or failing to repay debt). But they potentially possess a large upside in equity if commodity prices rebound during such a time frame. Obviously, these companies have minimal equity value and their bonds are trading at impaired prices to reflect distress and theoretical liquidation values.
While I have monitored many E&P companies' stock prices as they plummet -- and many of them filed for Chapter 11 since mid-2014 -- Chesapeake Energy's (NYSE:CHK) story stands out given its gravitas (along with one of its key peers, Southwestern Energy (NYSE:SWN)). It was a company with a $20 billion market capitalization and an aggregate enterprise value of above $30 billion less than two years ago, and it is still the second largest natural gas producer in the U.S. Only now, its market capitalization is $4 billion, 80% below its peak, and has a corporate rating of Caa2/CCC.Read more by clicking here.
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