Awash in $100 oil prices after the Financial Crisis of 2008, Weatherford International (WFT) spent billions on capex to help clients drill for oil. It also splurged on a string of acquisitions to expand operations. The Fed's quantitative easing ("QE") program came to an end in Q2 2014. Oil prices then diverged to the downside, taking Weatherford's business prospects with it. When principal payments came due on Weatherford's $8 billion debt load in Q1 2016, it created a strain on the company's liquidity. Bernie Madoff, Chairman and head of Madoff Investment Securities LLC ("BMIS"), faced a similar problem in December 2008.

Madoff's Ponzi Scheme Defined The Financial Crisis

In many ways Madoff's $50 billion Ponzi Scheme defined the Financial Crisis of 2008/2009. To attract investors Madoff pitched guaranteed returns of 13.5% to 20.0%. However, the broker, his investment background or the investment strategy were not disclosed. When regulators performed due diligence on the funds they discovered the assets existed and the money manager -- Bernie Madoff -- was exceeding promised return horizons. He reportedly employed a "market neutral" strategy -- buying securities in the S&P 500 and hedging the downside with stock options.

Madoff delivered double-digit returns even when the general market was negative for an extended period. Rumors on the Street were that Madoff was subsidizing his hedge fund returns with his brokerage business. According to Shock Exchange: How Inner-City Kids From Brooklyn Predicted The Great Recession And The Pain Ahead, the "scheme" unraveled when Madoff's fund was hit with $7 billion in redemptions: 

During the first week of December 2008 Madoff told his sons, Andrew and Mark, that clients had requested approximately $7 billion in redemptions, creating a strain on the firm's liquidity. Madoff later met with his family at his Manhattan apartment and admitted that the investment advisory business was a fraud. He also stated that he was finished, had absolutely nothing, and that "it's all a big lie ... and a Ponzi scheme." Madoff admitted that the business had been insolvent for years ... he had $200 - $300 million left.

Total losses from the Ponzi scheme amounted to about $50 billion.

Is Weatherford The "Oil Industry's Bernie Madoff?"

A Ponzi scheme connotes when a company attracts new investors to repay current investors. The scheme usually ends when either the company cannot attract new investors or is hit with rapid, sizeable redemptions. Weatherford might be the "Oil Industry's Bernie Madoff" for the following reasons:

Weatherford Has Suffered Liquidity Strain Since Q1 2015

In Q1 2015 the company had free cash flow of -$263 million. What gave me pause was that revenue was in decline, so the company should have been a cash generating machine. It should have collected on receivables, sold inventory, reduced payables and pocketed the difference. Instead, Weatherford experienced cash burn from operating activities. Cash out flow from the change in operating assets and liabilities - a subset of the $42 million cash burn from total operating activities - was $334 million. In particular, the change in inventory was -$32 million; this implied inventory was slow-moving or stale. As a result the company had to borrow $307 million in short-term debt to help fund itself.

Weatherford Is Thirsty For New Investors

At Q1 2015 the company had $7.8 billion in debt at 5.0x run-rate EBITDA. A $395 million principal payment was due in Q1 2016 and a total of $1.5 billion due from 2016 - 2018. Given its cash burn it could not have made those payments without attracting new investors. 

In Q3 2015 -- about six months before the $395 million principal payment was due, Weatherford attempted to raise $1.0 billion via a mix of normal shares and subordinated notes. Analysts opined that the funding would be used to acquire divested assets pursuant to the pending merger between Halliburton and Baker Hughes. Weatherford's stock fell 17% to $8.41 on the news. After-hours management perplexed the market by canceling the capital raise due to concerns over pricing. The Financial Times described the 17% sell-off as a shareholder revolt, and "aversion to growth."However, I saw through the ruse. Weatherford was thirsty for capital , but not for an acquisition.

First of all, an acquisition would have been counter to Weatherford's prior strategy of asset divestitures. Its wanton acquisitions had led to its $7.8 billion debt load in the first place. Weatherford decided to shutter assets in order to pare debt, yet the market for oil and gas assets had all but dried up after oil prices fell. Secondly, Halliburton's proposed divested businesses mainly operated in North America where Weatherford had a large presence. The deal likely would not have passed regulatory scrutiny anyway. Lastly, I suspected Weatherford would suffer a goodwill impairment charge when its Q3 earnings were reported. Such a charge would have [i] reduced its equity and [ii] likely breached debt covenants with JP Morgan and other short-term lenders. I suspected the company wanted to raise more capital to meet a potential acceleration of its short-term debt.

Since its failed capital raise in Q3 2015 the company raised [i] $630 million in equity in Q1 2016 and [ii] $2.7 billion of normal debt and convertible debt in Q2 2016. The equity raise cured a $395 million principal payment due in the first half of the year, and the bond offerings all but eliminated principal payments from 2017 to 2019.

Weatherford Is Insolvent By $3.1 Billion

The $3.3 billion from new investors alleviated near term bankruptcy risk, yet Weatherford's operations have worsened. In Q1 2015 -- when it first experienced liquidity strain -- it had $120 million of quarterly interest expense and $425 million of EBITDA. In Q2 2016 it had $119 of interest expense and about $108 million of EBITDA. Q2 results were overstated due to a windfall from the cancellation of a contract in Zubair; its true EBITDA could be half that. Nonetheless, EBITDA does not cover interest expense and through the first half of 2016 Weatherford had free cash flow of -$400 million.

At this pace it will likely have to keep its "scheme" going; it will have to attract new investors to help pay interest on its $7.2 billion debt now at nearly 15x EBITDA. And yes, just like Madoff's BMIS, Weatherford is insolvent. It listed $14.1 billion in assets at Q2 2016. I estimate that over $8 billion -- $5.2 billion in PP&E and $3.2 billion in goodwill -- is practically worthless. I also estimate Weatherford is insolvent by $3.1 billion. Otherwise, why wouldn't it simply sell assets to fund itself? In my opinion, it could be the "Oil Industry's Bernie Madoff" and define the era of Fed-induced stock market gains like Madoff defined the Financial Crisis of 2008/2009.