"Losers always whine about liquidity..."

Lack of liquidity is the constant refrain of the insolvent.

Think about it this way: there is a whole class of entrepreneurs that lend to distressed companies, as long as there is collateral. So, if you can't borrow money in the market, what's the matter? Why don't these entrepreneurs think you are solvent?

Actually, stupid lenders will usually lend well past the point where the company is insolvent.

In restructuring, I never saw a case of "illiquidity" that wasn't just insolvency/business failure.

Terry Pratchett's Men at Arms

The reason that the rich were so rich, Vimes reasoned, was because they managed to spend less money.

Take boots, for example. He earned thirty-eight dollars a month plus allowances. A really good pair of leather boots cost fifty dollars. But an affordable pair of boots, which were sort of OK for a season or two and then leaked like hell when the cardboard gave out, cost about ten dollars. Those were the kind of boots Vimes always bought, and wore until the soles were so thin that he could tell where he was in Ankh-Morpork on a foggy night by the feel of the cobbles.

But the thing was that good boots lasted for years and years. A man who could afford fifty dollars had a pair of boots that'd still be keeping his feet dry in ten years' time, while the poor man who could only afford cheap boots would have spent a hundred dollars on boots in the same time and would still have wet feet.

This was the Captain Samuel Vimes 'Boots' theory of socioeconomic unfairness.

Men at Arms

Saturday Night

"Decline of the West"

"The last man on the moon left in 1972. The tallest building in the united states was finished in 1974. [...] US electricity production was growing exponentially until 1972. After 1972 it grew more slowly. Per capita electricity consumption seems likely to have peaked around 2007 or so."

This is a Prechterish viewpoint, consistent with his idea that economic improvement in the great bull market since 1982 (i.e. a "wave five formation") has not been commensurate with the stock market increase during that time.

Speaking of decline, see this WSJ opinion piece "The Ugly Brutishness of Modern Britain" by Theodore Dalrymple, who is also the author of Life at the Bottom: The Worldview That Makes the Underclass. He has written a number of books about the decline of the West. He points out,

"Incivility in Britain thus has a militant or ideological edge to it. The uncivil British are not uncivilized by default—they actively hate and repudiate civilization."

Why are we talking about this on an investing blog? All of this has profound investing implications, although subtle ones that you can't just act on right away. More than anything, these trends imply investments that you should avoid buying. In many cases they can't be shorted either due to market constraints (real estate) or because of high cost of carry and forced buyers (think single asset-class investors).

But you can come out ahead, in relative terms (which is all that matters), by not buying most types of real estate which will have steadily falling NOI as far as the eye can see. Unless you are bullish on the rents that landlords can extract from the growing share of the chav population in Britain? Or, if you think local government employee pensions will be paid somehow besides higher property taxes? Note that some states are poised to dramatically increase taxes already. That could start exciting positive feedback loops.

"JEFF GUNDLACH: If I Were A Young Hedge Fund Manager, This Is The Insane Contrarian Trade I Would Make Right Now"

"If I were one of the nutty hedge fund guys, I would go short Apple, long natural gas, and leverage it 100x."

Notes From the Peter Thiel Startup Class 7

Blake Masters posted more of his notes from the Peter Thiel startup class. I thought that this comment was very interesting:

Roelof Botha: People don’t always appreciate or understand rapid increases in value when businesses take off. They underestimate the massive asymmetry of returns. They hear that a company has joined the billion-dollar club and are perplexed because only 6 months ago, it was worth $200m. The alternative to understanding the exponential growth is believing that Silicon Valley VCs have gone crazy.

Right... but in many of these cases we are talking about companies with no operating profit and even no revenues to speak of. It seems like a rationalization for the new bubble mentality. It's especially funny because he goes on to admit that many of these companies "can be built very quickly, often seemingly overnight" which implies an absence of barriers to entry.

In some cases, these companies have intellectual property barriers or network effects that reward firstcomers, but I don't think that is true as a rule. The Zuck paid $1B for instagram despite revenues of $0. I saw someone who suggested monetizing this app by

• Buying different filters (I really hope they don't go this route, it would be extremely lame and would open the doors for competitors to step right past them).
• Tagging parts of images and placing links to companies/advertisers and shared revenue [...] Maybe even identifying company logos in images and smartly placing the tags on there.
  [...]
• Create a backup and syncing service for those that want to have their computer, tablet, and mobile pictures uploaded to the cloud (also allowing for easy sharing), this would have a small fee depending on amount of storage needed.

Ugh. So, they can't actually charge for their product because it would "open the doors for competitors to step right past them". Who doesn't want lots of obnoxious logos and advertisements all over their photos? Why do I need instagram to back up my photos when I have XX GB on my phone and itunes/the cloud back it up for free?

FT: Chinese Copper Hoarding?

Check out this story, pictures too:

"On a routine trip to examine copper inventories in the bonded area in eastern Shanghai last week, we were astounded by how much copper is being stored in warehouses [...] The covered warehouses were full. The staff car park was used to store copper. The driveway between warehouses was blocked by copper. The warehouse operator told us that it cannot accept additional inventory until existing inventory is shipped out."

Wouldn't you rather own something else? Like nickels?

GMX Resources (GMXR) Does Another Stock for Debt Swap

The company announced this morning,

"as consideration for the surrender by the holders of $4,700,000 aggregate principal amount of the 2013 Convertible Notes, GMXR will issue to the holders an aggregate of 2,714,084 shares of GMXR common stock"

Good for the long bonds/short stock trade. This is a one-day, 3.9% increase in shares outstanding. Reduces unsecured debt by 3.2%, thereby helping recoveries for remaining unsecureds.

The shares were worth $3.75 million at today's price, so the tendering bondholders received roughly 80 cents on the dollar for their bonds. To get rid of the rest of the 2013 maturity, assuming that the stock price would not decline after more new issuance (which it probably would), would require issuing 32 million new shares at this rate, or a almost 50% increase in shares outstanding.

WSJ: "Joel Kotkin: The Great California Exodus"

"California is turning into a two-and-a-half-class society. On top are the 'entrenched incumbents' who inherited their wealth or came to California early and made their money. Then there's a shrunken middle class of public employees and, miles below, a permanent welfare class. As it stands today, about 40% of Californians don't pay any income tax and a quarter are on Medicaid.

It's "a very scary political dynamic," he says. "One day somebody's going to put on the ballot, let's take every penny over $100,000 a year, and you'll get it through because there's no real restraint."

The Bernanke Strategy

"Bernanke tries to escape criticism by three methods when he speaks publicly: (1) reviewing recent financial history at great length even though everyone in the audience already knows this history; (2) adding footnotes to bog down his critics in academic bilge; (3) mildly blaming Congress for its deficits, on the assumption that Congress will do nothing to balance the budget, and therefore the FED (and Bernanke) will escape blame when the house of credit cards finally collapses."

Whopper Investments on "Dirt Cheap Japanese Stocks"

"The fact is with Japanese companies I’m so unaware of the culture, politics, regulations, etc., and have such little grasp on their financials and where all the “bodies are buried” that I’m simply unable to do that with these Japanese companies. Instead, I’m relying on one simple thing- a business that is consistently profitable is almost always worth more than NCAV and certainly not worth less than net cash per share, especially given the company is willing to consistently pay out dividends..."

I think this is a legitimate approach. Not with your whole portfolio, but to allocate a small piece to a large number of companies that are statistically very cheap will probably go well.

I am interested in Japan. I just ordered Investing in Japan: There is no stock market as undervalued and as misunderstood as Japan. And here is another piece of Japan that I enjoyed:

 

Gary North: "How Not to Change America's Politics"

"The number-one thing that we can do [in preparation] is to survive financially locally, and to be in a position to warn other voters in our communities or in our circle of contacts that the government at the federal level must not be allowed to impose an income tax, just as it was under the Constitution until 1913. We have to shrink the federal government. If it is possible, we have to get rid of the Federal Reserve System. This will be easier after a collapse, or after the Great Default, than it is today."

Another GMX Resources (GMXR) Well Comparison: The Eleanore 1-5

I wrote a detailed earlier post about the new GMXR well the Lange and its "offset" well, the Taboo, which was drilled by Slawson. The Taboo data implies that the decline rate of the Lange will be quite steep.

Looking for a comparison for the Wock well, I found that Continental Resources drilled a well 2 miles east of the Wock in 2004, the Eleanore 1-5. (If you look at this map, the Eleanore is the green dot to the east.)

It looks like the Eleanore was drilled with a 6200' lateral. In seven-and-a-half years, the cumulative production of oil has been only 31,000 barrels. It is currently producing about 5 barrels of oil per day. The initial production rate was 125bbl/d but this had fallen to 12bbl/d by the end of the first year.

"Auction date extended for ECD's sale of solar panel firm"

I had stopped paying attention to ENER, but saw this in the Detroit News:

"[E]nergy Conversion Devices Inc. said Monday it has extended by two weeks the auction date for the sale of United Solar Ovonic LLC, its manufacturer of thin-film photovoltaic solar panels."

Apparently, a company called Salamon Group wants to buy ENER for its net operating loss carryforwards:

"This offer is for up to 100% of all issued and outstanding shares of the Company. The offer is in exchange for up to 5 million shares of Salamon Group, Inc. (SLMU). Energy Conversion loss-carry forwards are over $1 billion USD."

It's not clear to me that this transaction would work. The IRS rules on NOLs impose significant limits on the ability to use them to offset taxable income in the event of an ownership change.

Lee Kuan Yew Writes About Demographic Collapse in Forbes

"During the 21st century the U.S. could become the slowly aging leader of a rapidly aging world. Singapore’s experience is no different from that of these countries. Our birth rates have been steadily declining. The fertility rate of the Chinese segment of our population is the lowest, 1.08 (2011), with the rate for Indians 1.09 and for Malays 1.64. In other words, the size of each successive generation of Chinese Singaporeans will halve in the next 18 to 20 years."

That is amazing. How will they respond to this? Import a new population? Slowly shutter the country? It is amazingly difficult to encourage populations to have more children, something Singapore is finding out with the slow failure of its financial incentives to have an effect.

Prechter Paper: "Social Mood, Stock Market Performance and U.S. Presidential Elections: A Socionomic Perspective on Voting Results"

Their paper, "Social Mood, Stock Market Performance and U.S. Presidential Elections: A Socionomic Perspective on Voting Results", just came out.

"We analyze all U.S. presidential re-election bids and find a positive, significant relationship between the incumbent’s vote margin and the prior net percentage change in the stock market. This relationship does not extend to the incumbent’s party when the incumbent does not run for re-election. We find no significant relationships between the incumbent’s vote margin and inflation or unemployment. GDP is a significant predictor of incumbents’ popular vote margin in simple regression but is rendered insignificant when combined with the stock market in multiple regression. Egotropic and sociotropic voting hypotheses fail to account for the findings. The results are consistent with socionomic voting theory, which includes the hypotheses that (1) social mood as reflected by the stock market is a more powerful regulator of re-election outcomes than economic variables such as GDP, inflation and unemployment and (2) voters unconsciously credit or blame the leader for their mood."

Their methods were pretty thorough. Evidence in support of social mood theory.

I write about Prechter fairly often and my review of his most famous book, Conquer the Crash, led to a theoretical breakthrough for me about investor genotypes in an investing ecosystem. Lots of Prechter's ideas stand on their own whether or not Elliot Wave Theory is true.

[I think that EWT is probably trivially true, or, as David Aronson writes in Evidence-Based Technical Analysis, its ability to "fit any segment of market history down to its most minute fluctuations" is because of its "loosely defined rules and the ability to postulate a large number of nested waves of varying magnitude."]

Good Quarterly Letter from Grantham, on Career Risk

"The central truth of the investment business is that investment behavior is driven by career risk. In the professional investment business we are all agents, managing other peoples’ money. The prime directive, as Keynes knew so well, is first and last to keep your job. To do this, he explained that you must never, ever be wrong on your own. To prevent this calamity, professional investors pay ruthless attention to what other investors in general are doing. The great majority “go with the flow,” either completely or partially. This creates herding, or momentum, which drives prices far above or far below fair price. There are many other inefficiencies in market pricing, but this is by far the largest."

More About State Income-Tax Repeal

My post on Saturday about the states with high and rising taxes - that are about to enter a death spiral - also mentioned the no state income tax movement. Oklahoma may win the race to be the tenth state with no income tax.

"[T]here are nine states, including Paul’s home state of Texas, that don’t levy income taxes. Those states have far outperformed high-income-tax states on every measure of economic success. Now Oklahoma is poised to fully repeal its income tax and join the ranks of non-income-tax states."

Oklahoma is proposing to phase out the income tax [pdf] over a period of years; beginning with a cut in half next year. The Phil Kerpen piece concludes by saying:

"Wouldn’t it be great if all of our state governments competed with each other with pro-growth tax, spending, and regulatory policies to attract as much investment and create as much economic growth as possible?"

Yes.

Tonight's Hussman

"I can't emphasize enough how badly standard P/E metrics are being distorted by record (but reliably cyclical) profit margins, which remain about 50-70% above historical norms. Our attention to profit margins and the use of normalized valuation measures is nothing new, nor is our view that record profit margins have corrupted many widely-followed valuation measures."

Recent Hussman Columns

Apr 9:

"Quantitative easing simply does not relieve any constraint that is binding on the economy. Rather, QE is a method by which the Fed hoards longer-duration, higher-yielding securities like U.S. Treasury bonds and replaces them with cash that bears zero interest. At every moment in time, somebody has to hold that paper. The only way for the holder to seek a higher return is to trade it for a more speculative asset, in which case whoever sells the speculative asset then has to hold the cash. The process stops when all speculative assets are finally priced so richly and precariously that the people holding the cash have no further incentive to chase the speculative assets, and are simply willing to hold idle, zero-interest cash balances."

Apr 16:

"I'm quite aware that the investing world has ruled out any possibility of extended market losses thanks to the confident certainty that the Fed is capable of preventing both market declines and economic downturns indefinitely. But even in recent years, the best that these massive interventions have done is to provoke about 6 months of speculative advances and a brief burst of pent-up demand - each time only after the market has suffered reasonably significant losses."

Paper: "Managing the Risk of Momentum"

As you know, I think that momentum investing is totally idiotic. Reading a paper called "Managing the Risk of Momentum," which acknowledges the fatal flaw of the method but purports to be able to avoid the big drawdowns.

"[T]he remarkable performance of momentum comes with occasional large crashes. In 1932, the winners-minus-losers strategy delivered a -91.59 percent return in just two months. In 2009 momentum experienced another signi…ficant crash of -73.42 percent over three months. Even the large returns of momentum do not compensate an investor with reasonable risk version for these sudden crashes that take decades to recover from."

These guys use "the realized variance in the previous 6 months to scale the exposure to momentum." In other words, they think that they can predict crashes. However, the "auto-regression of monthly realized variances yields an out-of-sample (OOS) R-square of 57.82 percent."

I've written about this before - momentum investing doesn't really make economic sense. It's especially funny when the jokers running the momentum funds don't talk about full cycle returns.

Only 2% Bullish on Treasuries in Barron's Poll

"[C]an you imagine any other asset that was in the midst of a 30-year bull market, that had just 2% of the investing population saying they were bullish?"

Wow. Amazingly, long term interest rates probably haven't bottomed yet.

SA: "Opportunity In Low Natural Gas Prices With Bonds"

"This Chicken Little attitude in the bond market is unnerving, but it creates excellent short-term buying opportunities. Right now there are numerous gas company bonds at good discounts that are paying huge returns on very short maturities."

Another Great WSJ Opinion Piece - On the Central Bank and Inflation!

Boy! The Fed is living on borrowed time. When we start to get Jim Grant on CNBC plus well-reasoned, Austrian opinion pieces in the WSJ about the unfairness and evil of central banking, you know the day is getting close.

"The Fed, having gone on an unprecedented credit expansion spree, has benefited the recipients who were first in line at the trough: banks (imagine borrowing for free and then buying up assets that you know the Fed is aggressively buying with you) and those favored entities and individuals deemed most creditworthy. Flush with capital, these recipients have proceeded to bid up the prices of assets and resources, while everyone else has watched their purchasing power decline."

Don't forget about well-organized veterans marching in formation, either. I hope Ron Paul can be there to cut the ribbon when they turn the Federal Reserve bank buildings into private offices.

Molybdenum

I posted a while back about Fermi's Paradox and Geoffrey Miller's excellent hypothesis; that it is caused by "computer games not atomic weapons". Another hypothesis is that intelligent life from elsewhere "seeded" Earth with life. There is at least one little data point in support of this theory:

Crick and Orgel further suggested that directed panspermia might help resolve one or two anomalies in the biochemistry of life-forms on Earth. One of these was the puzzling dependence of biological systems on molybdenum. Many enzymes, for example, require this metal to act as a cofactor. Such a situation would be easier to understand if molybdenum were relatively abundant on Earth. However, its abundance is only 0.02% compared with 0.2% and 3.16%, respectively, for the metals chromium and nickel, which are chemically similar to molybdenum. Crick and Orgel commented: If it could be shown that the elements represented in terrestrial living organisms correlate with those abundant in some types of star-molybdenum stars, for example-we might look more sympathetically on "infective" theories.

I was reading a paper about The distribution of elements in cells:

"With the advent of dioxygen the role of selenium has changed to that of a catalyst for the removal of peroxides and of iodine. Once again the special switches in chemistry of several elements with the coming of dioxygen suggest that evolution does not depend upon random mutation but that it operates following stress due to the environmental changes organisms suffer, see Section 9.1."

The availability of individual elements in the biosphere, especially in biologically accessible forms, has varied throughout the Earth's history; especially in response to increasing oxygen levels. In response to this, organisms have shifted the mix of the elements that they use to build themselves and mediate chemical reactions.

Key WSJ Article: "Laffer and Moore: A 50-State Tax Lesson for the President"

Important editorial in today's WSJ with implications about where to live, and own immovable assets:

"Barack Obama is asking Americans to gamble that the U.S. economy can be taxed into prosperity. That's the message of his campaign for the Buffett Rule, which raises income-tax rates on millionaires to a minimum of 30%, and for the expiration of the Bush tax cuts. He wants to raise the highest income tax rate by 20%, double the rate on capital gains, add a new 3.8% tax on all capital earnings, and nearly triple the dividend tax rate."

Also points out that California and Illinois are planning to increase the top marginal rates even more, to 13% and 11% respectively! Meanwhile, "Georgia, Kansas, Missouri and Oklahoma are now racing to become America's 10th state without an income tax."

There's nothing stopping Illinois from entering the same positive-feedback death spiral that killed Detroit, if it makes bad enough decisions. If it does, so much better for the states that are lowering taxes and encouraging productive enterprise. Imagine having other states, besides Alaska, that pay dividends to residents?

Tonight's thought: consider a division of the country into zero income tax states with stingy welfare regimes that productive people flee to, and ultra high income tax (double-digit %) states with crippling regulation that productive people flee from, in the context of Bill Bishop's Big Sort.

Which states' muni bonds do you want to own? Which states do you want to own property in? What if a group of these productive states issued a currency?

New York is a wildcard. New York will do fine so long as it can skim a vig off of the world's investments. However, if the no-tax states were to set up, say, a 100 sq-mile, zero-tax, zero-regulation, caveat emptor enclave for startups, that would be it for foreign ibanks.

Sell your Manhattan apartment at the earliest of serious startups being funded on Kickstarter without VCs, or a major Texas or OKC-based energy company creating an internal ibank that lends and finances new energy companies directly without passing through Wall Street. Imagine if they spent the vig on scientific and feasibility research instead of marketing.

Hovnanian ($HOV) in Barron's Again

“Hovnanian is in trouble,” writes Gimme Credit’s Vicki Bryan. “Profitability is so weak that even with improving sales it hasn’t slowed the acceleration in cash consumption in operations, which has pushed cash to severe lows. Distressed debt transactions and even stock offerings have not staunched the bleeding.”

Vicki is a really good credit analyst.

I've been doing some posts about Hovnanian. Conclusion: the bonds are cheap relative to the stock. 

-- Side note: The CHK long is now the 2nd most contentious thing that has ever been posted here; second only to my thesis that silver should be sold at $40/ounce last spring.

Kodak's First Day Affidavit Mentions Silver Prices

Even though Kodak had projected [Film, Photofinishing and Entertainment Group] (“FPEG”)to generate less cash as film was replaced by digital imaging, the FPEG business was still anticipated to generate substantial cash flow. The rate of the decline of the market for film between 2008 and 2010, however, was significantly steeper than anticipated by nearly all observers: the industry projected a 10% decline, Kodak forecasted a 20% decline and the actual decline was approximately 40%.

In addition to demand impairment, increasing commodity prices negatively impacted FPEG’s cash flow. FPEG purchased approximately $300 million of silver in 2011. Silver prices have ranged between 199% and 294% higher than 2008 prices. Because of the lingering effects of the economic crisis, Kodak cannot pass through all of these price increases to its customers.

The first day affidavit [pdf], which the Bankruptcy Litigation blog did a post about.

It was about a year ago that I mentioned rising silver prices were causing industrial users to substitute other, cheaper, and less price-volatile materials. 

After Declines, Cheseapeake Equity ($CHK) Now a Screaming Buy

"With projected asset monetization of $10bn - $12bn, the implication is that combined cash and asset sales in 2012 exceed the current fully diluted market capitalization of the company."

I am almost never bullish on equities; buyers of stock are usually chumps. But I have never seen a case where the bears were so wrong.

More on this later.

The EIA's Natural Gas Projections

The geniuses at the EIA have released their short term energy outlook for 2012. This is the natural gas section. Their opinion is basically that they have no idea what the natural gas price will be going forward, but it will probably be low.

It's amusing to look at the EIA's past natural gas price projections. Here is a thoughtful critique of the track record of natural gas price forecasts:

From 2002-2009, there are no AEO forecasts that come remotely close to predicting the actual price movements during the same period.

The actual gas price in 2009 was best predicted by the 2004 forecast and worst predicted by the 2008 forecast. A forecasting tool that gets more accurate as one goes farther back in time is hardly one that we ought to rely on to provide us with a reliable view of the future based on near-term fundamentals.

EIA also publishes a retrospective on their past projections.

I can't predict what the natural gas price will be, either. But I can predict that people will eventually stop exploring for and producing a resource that sells for less than marginal cost. I can also predict that people will substitute natural gas for other more expensive sources of energy.

Barron's Article on Hovnanian: "Hammered and Nailed" ($HOV)

This was a great Barron's article on Hovnanian that I meant to post earlier.

Vicki Bryan, an analyst at research outfit Gimme Credit, points out that the company hasn't generated enough cash to cover interest costs since 2006, the result of weak demand and stepped-up land acquisitions considered vital for its future.

[...]That's why Bryan thinks a bruising recapitalization is inevitable, perhaps within a few months. The maneuver could involve converting outstanding bonds into equity, heavily diluting existing shareholders. Bryan goes so far as to call Hovnanian's stock "worthless."

The article's "bottom line" has been prescient: "Hovnanian may have to ask bondholders to swap debt for equity, diluting stockholders."

I've already written a few posts about Hovnanian. I view the debt as cheap relative to the stock, and you'll notice that they are undergoing a slow motion restructuring.

Notes From Peter Thiel Lecture on Startups

"Startups are important because they are small; if the size and complexity of a business is something like the square of the number of people in it, then startups are in a unique position to lower interpersonal or internal costs and thus to get stuff done."

"Volatility at World's End: Two Decades of Movement in Markets"

How Can Anyone Doubt Austrian Economics?

Great Gary North post:

"Why do so many entrepreneurs make the same mistakes at the same time? [T]here must have been misinformation conveyed to almost all market participants. But how? Because of central bank tampering with the money supply. Money is the common commodity. It conveys information to most participants. To find why people make the same mistakes at the same time, he said, look at monetary policy of the central bank and fractional reserve commercial banks."

Answer to the question in the title: because they are crooks. Keynesian sophistry helps justify a bloated government.

"CNG in a Box"

"Chesapeake Energy and GE have announced plans to deploy GE's 'CNG In A Box' units at service stations and convenience stores. The units would dispense compressed natural gas to vehicles that can burn it. The first of the 250 planned units could be in place by this fall."

GMX Resources (GMXR) Presentation at 2012 Oil and Gas Investment Symposium / IPAA New York

The slides and mp3 of the presentation are available at the company's website. It's worth listening to so you can hear the tone of management. There wasn't any real novel information that wasn't in the press release, so I won't comment any further than that.

Updated GMX Resources (GMXR) Cap Table

Latest estimate; this updates the bond prices and reflects the increase in senior secured debt that will occur as a result of the PIK election for the interest payment due June 1, 2012.

Also, adjusting the interest expense in the table for the secured notes to reflect that they will most likely continue to chose the PIK election, which is at a higher interest rate. (I haven't seen a trade on the secureds recently; but I am estimating them to trade at 80.)

Shares Outstanding	69,272
	Face Amount	Price	Market Value	Interest Exp
Cash, as of 12/31/11	-102,493	1.00	-102,493
4.5% Senior Note due 2015	86,520	0.49	42,395	3,893
5% Senior Note due 2013	59,372	0.77	45,716	2,969
11.375% Senior Note due 2019	1,970	0.50	985	224
11% Senior Secured Note due 2017	288,620	0.80	230,896	40,407
Total Debt	333,989		217,499	47,493
9.25% Series B Cumulative Preferred	79,418	0.52	41,297	7,346
Enterprise Value through Preferreds	413,407		258,797	54,839
Common Stock	99,752	1.44	99,752
Enterprise Value	513,159		358,549

Once again, we see a disparity between the enterprise value implied by the debt and what is implied by the common stock. Buyers of the unsecured debt create the company at a valuation of around $220 million and buyers of the common stock create the company at a valuation of around $510 million.

"GMX Resources (GMXR) Provides an Operational Update"

In a press release today, GMX Resources (GMXR) provides "an operational update, production for Q1, guidance for Q2 and year end 2012 and the Company's election on the semi-annual interest due on its 2017 Senior Secured Notes."

In the "Williston Basin Update", the company repeats the same information about their fourth operated well, the Lange 11-30-1H. This was the well where they announced initial production on April 4, and I pointed out not only could we not determine much without more information, but also there is a well nearby operated by Slawson (with 25% WI to GMX) that seemed to have a ferocious decline rate from initial production.

If they wanted to demonstrate that this well had good economics, they could tell us: how much it cost, what price the produced oil is getting, what the actual time series of production vs time is.

The release mentions that the company's "workover rig arrived in North Dakota on March 23, 2012, and work has been done on the Evoniuk 21-2-1H and the Frank 31-4-1H. The Evoniuk 21-2-1H and the Frank 31-4-1H are both currently on pump and producing oil. The workover rig is next scheduled to work on the Wock 21-2-1H well."

The purpose of the workover rig was to address the actuator balls from the sliding frac sleeve, which had failed to flow back to the surface, and which they said were stuck and restricting production. A competing explanation was that the formation pressure was too low for the balls to flow back, although it was and is unclear what was happening based on the information they gave. Anyway, if the workover had resulted in a substantial increase in production, don't you think they would have announced that in this release?

Their Akovenko 24-34-1H operated well has been drilled and is supposed to be fracked in May. Their Johnston 31-4-1H operated well was just spud. There are a number of other wells where the company is not operating but has varying degrees of working interests: Neil 24-19MBH, with a 4% WI and operated by Burlington; Logan 24-8H, 17% WI, also Burlington; and Pojorlie 21-2-1H, 34% WI, operated by Continental.

Looks like they are still shooting seismic in the Niobrara. It is not clear what ability they would have to develop these even if they found worthwhile targets. They mention a Niobrara well operated by Devon with a 29% WI to GMX; its 30 day rate of production was 10 BBLs/day.

Management's comment (from Michael Rohleder) is that "GMXR and other larger operators have drilled enough wells that our entire acreage footprint has been substantially de-risked," referring to their Bakken acreage.

I don't know about that. What I'm seeing, so far, is some wells that were pretty clearly bad (negative net present value) and one well that is better but which doesn't necessarily have a positive net present value. I'm not sure why they wouldn't publicize the details (actual oil production numbers and well cost) that you would need to estimate the NPV of the wells.

Interestingly, they plan to start gathering the gas being produced by the wells in the Bakken. But, again, it's not clear what the economics of this will be, given the expense of building pipelines for gas that is so cheap. I would like to know what price (basis) they will get for this gas, and what the fixed and variable costs of the gas gathering will be.

The company disclosed some information about the discount between its Bakken oil and the NYMEX price: "basis differential has varied from month to month, ranging from a low of $5.50 in August of 2011 to as high as $25.00 in March of 2012. GMXR's estimated basis differential in April is expected to be $12.00 and is estimated at $10.00 for the remainder of 2012 year."

The company also gave production guidance for 2012, which is estimated to be 354,000 BBLs of oil and 562,000 BBLs of NGLs. That should be about $50 million in total revenue. Meanwhile, they look to have greater than $50 million in preferred coupons and interest expense (assuming they continue to PIK the notes), plus they had projected SG&A expense for 2012 to be $31 million.

There is a glaring omission that they haven't discussed: can they show us a cash flow projection that results in the 2013 notes, currently trading at 77, and the 2015 notes, currently trading at 50, being paid off by maturity? It seems to me that they could better accomplish their goals by deleveraging the capital structure.

Fundamentally, they have not released what I would consider truly useful information about their well performance to date in the Bakken. They also have not addressed the concern about the debt maturities and capital structure. It seems to me that no news is generally bad news in cases like this.

USG Corporation Reports 2012 First Quarter Results

"USG Corporation, a leading building products company, today reported first quarter 2012 net sales of $812 million, up 13 percent from first quarter 2011 net sales of $721 million. USG's first quarter operating profit was $27 million compared to a $58 million operating loss in the first quarter of 2011."

Cognitive Defect Responsible For Optimism Identified

Here is a fascinating paper in Nature Neuroscience, "How unrealistic optimism is maintained in the face of reality". From the abstract:

"Unrealistic optimism is a pervasive human trait that influences domains ranging from personal relationships to politics and finance. How people maintain unrealistic optimism, despite frequently encountering information that challenges those biased beliefs, is unknown. We examined this question and found a marked asymmetry in belief updating. Participants updated their beliefs more in response to information that was better than expected than to information that was worse. This selectivity was mediated by a relative failure to code for errors that should reduce optimism. Distinct regions of the prefrontal cortex tracked estimation errors when those called for positive update, both in individuals who scored high and low on trait optimism. However, highly optimistic individuals exhibited reduced tracking of estimation errors that called for negative update in right inferior prefrontal gyrus. These findings indicate that optimism is tied to a selective update failure and diminished neural coding of undesirable information regarding the future."

This was published in October. Now I can tell the permabulls and people who didn't learn from 2008 that there is something literally wrong with their brain.

EIA: "U.S. rail carloads of coal in first quarter of 2012 lowest since 1994"

"Total U.S. carloads of coal by rail during the first quarter of 2012 fell to 1.55 million carloads, the lowest level for any quarter since the beginning of 1994, as demand for coal by the U.S. electricity sector decreased."

GMX Resources (GMXR) Opts to PIK Its Next Senior Secured Interest Payment

From this afternoon's 8-K:

"GMXR’s 2017 Senior Secured Notes have a semi-annual interest payment due the first day of June and December. GMXR has an option to pay the interest in cash (11.0% per annum) or a PIK election (9.0% per annum in cash and 4.0% per annum payable in the form of additional notes). GMXR has selected the PIK election for the interest payment due June 1, 2012. The record date for this interest payment is May 15, 2012. The PIK election will increase the outstanding principal balance of the 2017 Senior Secured Notes by $5.1 million."

PIK stands for "pay-in-kind"; the SSNs give them the option to pay a higher interest rate in exchange for less cash outlay. So, part of the interest payment is more debt. You can think of this as negative amortization.

Monday Links

"What can be added to the happiness of a man who is in health, out of debt, and has a clear conscience?” -- Adam Smith

Great title; probably true: "The dumbest guys in the room: Is Cheniere Energy a contrarian indicator for natural gas?"

College professor thinks bloated, inefficient college signaling mechanism is immune from competition. "The normativity of conventional education isn't a passing phase. College attendance is a central tenet of our society's secular religion. A student who scoffs at all these expectations probably has a serious problem with authority. Would-be employers treat him accordingly."

NYT on 'Taxmageddon': As a result of income tax increases, "inflation-adjusted, after-tax income for the median household could fall next year to its 1998 level, in spite of the continuing economic recovery."

Selections from an interview with John McPhee, one of the greatest living writers. "I believe that so-called writer’s block is something that any writer is going to experience every day, but in a minor way. You break through some kind of membrane, and then you go into another world. Time really goes fast in there, but it is hard as can be to get there, and it frightens me."

WSJ: "The plunge in natural-gas prices over the past few months has had a surprising side effect: Investors love trading the plummeting commodity."

Important NYT article from 1986: "The directors of the New York Stock Exchange voted yesterday to abandon a decades-old rule that gave all of a public corporation's shareholders equal voting rights. Instead, companies traded on the exchange will have the right to issue classes of common stock with unequal voting rights."

I've been meaning to talk about Kickstarter on the blog. Meanwhile, check out an example project "Launch the Griffin", a project to launch an Irish pub in South Pasadena, CA.

Here's something about the financial literacy of college students. Sadly hilarious - and Tyler Cowen (aka cheap chalupas) thinks that U.S. colleges are the most competitive sector: "seventy percent of American college students have credit cards, five of every six of those students do not know their cards' interest rates [...] It gets worse. Nearly all of the 725 students who took the survey in fall 2009 were business majors"

No kidding: "Investors might be surprised to see how highly correlated their emerging market stocks are to the S&P 500." An interesting paper about correlations. They note that hedge funds provide little diversification benefit in a portfolio. This is true of funds that don't do any original work, or who are so big that they are closet index funds by necessity.

Pair trade idea: "XLU:SPY is very close to as cheap as its ever gotten since 2007. With 2.12% div carry, this is an attractive hedge"

Targeted advertising on Facebook: "if you want to reach the 100 people on Facebook who live in California, are between 18 and 36 years old, like "space" and work at Apple or Google, you can."

Read the Barron's article on student loan debt. "The 30-to-39 age group owes more than any other age decile, with a per-borrower debt load of $28,500." Unbelievable, to still be paying off student loans at that age, and later.

The Ultra-Organized and Elaborate Tactics of Mexican Drug Cartels

Amazing article:

Low, anti-vehicle Normandy barriers, recently installed, ran along the border. Rodriguez said that traffickers use flatbed tow trucks to drop dope-filled vehicles over the barriers. They drive over higher vehicle barriers on portable, custom-built metal bridges. [...]

Cartel surveillance teams generally know how long it will take a law-enforcement unit to get from one point to another — they measure response times. They are familiar with the protocols of Border Patrol shift changes. They know that there are fewer agents in the field on weekends. They have mapped everything — all the forest lanes wavering away from the Lochiel gate, for example, as well as the dead-end spur roads. They know whether the Border Patrol has been using trackers in an area and how much lead time a group will need to outpace them.

If a vehicle crossing the border at Lochiel trips a sensor or is otherwise detected and law enforcement responds, scouts direct it onto a spur road, where its driver covers it with brush and a camouflage tarp. (Scouts may also note the potential presence of a new sensor.) Already provisioned for this eventuality, drivers will wait for minutes or hours or days, until the roads are clear.

Traffickers use decoy groups to walk across the border at known sensor locations. Or they may employ banzais, who simultaneously scale border fences and scatter, vacuuming up manpower. Jim Chilton told me that 12 men with assault rifles once marched across the border and straight at a National Guard surveillance post. The men paused while the alarm rippled through the system and then crossed back. As Border Patrol units and tactical teams and sheriff’s deputies and helicopters descended on the post, smugglers crossed en masse for miles on either side.

"Fine wine investors lose millions as companies go under"

"As the stock market crashed and returns on savings plummeted, she decided to put money from her maturing bonds and her earnings into vintage Bordeaux as well."

Oops! Wine isn't an investment! Neither is art.

GMX RESOURCES INC. Announces First Quarter 2012 Earnings Release Date and Conference Call Information

Date set for Q1 earnings:

"GMX RESOURCES today announces that the Company will release its 2012 first quarter financial and operational results after the close of trading on the New York Stock Exchange on Wednesday, May 2, 2012. The Company has scheduled a conference call for Thursday, May 3, 2012 at 8:00 a.m. CDT to discuss the first quarter 2012 financial and operating results."

They previously announced that they:

"will attend the 2012 Oil and Gas Investment Symposium / IPAA where members of the Company’s management team will be presenting. The 2012 Oil and Gas Investment Symposium / IPAA will be held at the Sheraton New York Hotel & Towers April 16-18, 2012. A copy of our slide presentation will be available on the Company’s website before our scheduled presentation and the event will be webcast live as well as available for replay. Details regarding the Company’s participation in the symposium are as follows: Tuesday April 17, 2012 from 8:45 – 9:05 AM EDT"

Should be interesting!

Capital Structure Table for A123 (AONE) Shows Big Disparity in Market-Implied Enterprise Valuations

This is roughly what the cap table looked like according to the 10-K (for the period ended 12/31/11).

	Face Value	Market Value
Cash	-186,000	-186,000
Revolving Credit Lines	38,000	38,000
EV through Senior Debt	-148,000	-148,000
Convertible Notes	140,000	43,400
EV through Notes	-8,000	-104,600
Common Stock	142,454	142,454
EV through Common	134,454	37,854

Notice the huge disparity between the enterprise value implied by the convertible notes and what is implied by the common stock. Buyers of the notes create the company at a negative valuation and buyers of the stock pay an enterprise valuation that is around $240 million higher.

The one hazard of this cap table is that the balance sheet we have is now over three months out of date and does not reflect any subsequent cash burn or equity issuance since the beginning of the year. We know that there was one share issuance:

"In January 2012, we completed a registered direct offering of 12,500,000 units at a negotiated price of $2.034 per unit, with each unit consisting of (i) one share of our common stock and (ii) one warrant to purchase a share of our common stock for net proceeds of approximately $23.5 million."

So I have another cap table that tries to take this transaction into account:

	Face Value	Market Value
Cash	-209,500	-209,500
Revolving Credit Lines	38,000	38,000
EV through Senior Debt	-171,500	-171,500
Convertible Notes	140,000	43,400
EV through Notes	-31,500	-128,100
Common Stock	154,579	154,579
EV through Common	123,079	26,479

So, with the new share issuance, the gap between the note-EV and the stock-EV is a bit higher actually: $250 million!

Hovnanian (HOV) Using Proceeds From Share Issuance to Repurchase Notes

Hovnanian had recently announced that they would be issuing and selling up to 28,750,000 shares - which is almost a 30 percent increase in shares outstanding. Today they announced that the

"net proceeds from the issuance of the Shares, along with cash on hand, will be used to fund the purchase of approximately $15.3 million principal amount of 6 1/4% Senior Notes due 2016, approximately $22.8 million principal amount of 7 1/2% Senior Notes due 2016 and approximately $37.4 million principal amount of 8 5/8% Senior Notes due 2017 in a private transaction."

The 6.25s trade at 72, the 7.5s trade at about 60, and the 8.625s trade at 60 as well. There's actually only about $175 million of the 8.625s remaining, so they are buying back more than 20 percent of that issue. Another slow motion restructuring. The stock appears to be roughly half owned by retail; and most of the institutional holders are index funds.

More About A123 Systems (AONE)

Greentech Media has a good post about the troubles at AONE.

This is an even more extreme enterprise value disparity than what we saw in ENER. The market value of the debt is about $40 million, but the company has ~$200 million in cash, meaning that the bond market implied enterprise value is negative $100 million or even less. Meanwhile the market capitalization is like $130 million! That is a huge disparity!

This is a clear restructuring candidate. It's hard to sell enterprise products when your bonds are trading at 30; people wonder whether you are going to be around, etc. It's hugely distracting. I don't know why they haven't already announced an exchange offer?

Natural Gas Keeps Falling

Amazing - down 50 percent since October.

Wednesday

Great conversation between a physicist and an economist. "At that 2.3% growth rate, we would be using energy at a rate corresponding to the total solar input striking Earth in a little over 400 years. We would consume something comparable to the entire sun in 1400 years from now."

Astonishing and hilarious - Tyler Cowen thinks that U.S. higher education is "perhaps the most competitive and successful sector in the most competitive and successful economy of all time"! Three-quarters of colleges in this country would fold up if employers were allowed to IQ test in hiring.

Economic surprise index is turning back down. And so are high yield bonds.

"Phoenix" Coyotes NHL Team Debacle

Great article on the "Phoenix" Coyotes NHL team debacle in Glendale: "For some weird reason, moving an ice hockey team to the desert with no base of hockey fans and locating it a good 45 minutes from the wealthier parts of town caused the team to go bankrupt."

Glad I don't own any real estate in Glendale! What a mess, and this one is just garden variety stupidity and not because of anything systemic like the aging population.

One of the reasons that professional sports are so loathsome.

Why Propaganda Isn't Working As Well Anymore

"Governments have now realized that all of their propaganda efforts will never succeed as long as the internet remains an anarchic, free environment. So, now in full force begins the war on the internet."

Monday Links

Nassim Taleb: "If schools (colleges) want to resemble real life, they would only care about the subject in which the student has the highest grade and ignore the others, a total drag. In a convex world, the average is of *zero* significance -like an option - since only the upper bound counts. So push the upper bound further."

The End of Retail: "over the course of a year in which the level of economic activity has clearly risen, certain major categories of big box retail have shed jobs."

The USSR's "State Scientific Enterprise on Superdeep Drilling and Complex Investigations in the Earth's Interior" and the Kola Superdeep Borehole.

Hussman: "the Fed has increasingly pursued policies of suppressing interest rates, even driving real interest rates to negative levels after inflation. Combine this with the bursting of two Fed-enabled (if not Fed-induced) bubbles - one in stocks and one in housing, and the over-55 cohort has suffered an assault on its financial security: a difficult trifecta that includes the loss of interest income, the loss of portfolio value, and the loss of home equity. All of these have combined to provoke a delay in retirement plans and a need for these individuals to re-enter the labor force."

Dishwashers and "The Price of Quiet."

Must-Read Article About New Social Dotcom Bubble

Not that anyone who reads this blog would be dumb enough to invest in these, but essential reading

The feeling was palpable. Y Combinator had sixty-five companies present (42Floors was one of them). And we saw 500 eager investors, frenzied almost, excited to invest in entrepreneurs. One investor emailed me four times, texted me three times, called me and sent me a message on LinkedIn -- desperate to get a check in before the round closes.

What I love is the school of thought that, sure, the market is overheated but "who knows" whether these investments will be +ROI or not until a decade from now.

Happy Easter from Credit Bubble Stocks

Good Friday

Credit Bubble Stocks is on holiday in observance of Good Friday. We'll be back soon with more mispriced capital structures!

Hard Working Norwegians and Germans

"The values of the "entrepreneurial self" in a Midwestern farming community in the wake of the farm crisis of the 1980s are discussed, based on ethnographic interviews with Norwegian and German farm residents in Star Prairie county of western Minnesota. [...] Competitive production is a moral obligation in this community, and individuals ... believing that good performance demonstrates that they are worthy of their inheritance from their farming ancestors. [...A] bad farm manager is one who values leisure and conspicuous consumption over responsible management."

Capital Structure Note: A123 Systems ($AONE)

A123 Systems (AONE) designs, develops, manufactures and sells advanced rechargeable lithium-ion batteries and energy storage systems and provides R&D services to government agencies and commercial customers.

The company has a market cap of $120 million. There is also $140 million face amount of convertible notes outstanding, which are trading at 30 cents for a market value of $42 million.

The notes bear interest at 3.75% and mature on April 15, 2016. The initial conversion rate of 138.8889 shares of common stock per $1,000 aggregate principal amount of notes is equivalent to a conversion price of approximately $7.20 per share.

The company has had a negative gross margin each of the past three years. Also, its operating expenses (not including COGS) are nearly 100 percent of sales.

On January 25, the Company raised $23.5 million from an institutional investor in a registered direct offering. They are also taking actions to improve cash flow by reducing manufacturing costs and operating expenses, as well as by managing inventory levels. The company mentioned in its annual report that if it "is unable to raise enough capital and improve operating performance, the Company's growth potential may be adversely affected and the Company will have to modify its growth plans to conserve available cash. Management believes that the available cash and cash equivalents should be sufficient to fund operations for the next twelve months."

Interestingly, the company had close to $200 million cash at the end of 2011. This looks a lot like another ENER situation with a negative enterprise value through the bonds.

Hovnanian (HOV) Prices Share Offering at $2

"Hovnanian Enterprises announced today that it priced its previously announced offering of 25,000,000 shares of its Class A Common Stock at $2.00 per share..."

That was priced 7 percent below today's close. Great for the bonds/stock trade.

Job Polarization

"Job polarization refers to the recent disappearance of employment in occupations in the middle of the skill distribution. To display this phenomenon, the authors decompose employment into occupational groups and then delineate occupations across two dimensions: cognitive vs. manual, and routine vs. non-routine. [...] The figure above shows that across three decades, the share of employment in the middle of the skill distribution appears to be disappearing. Prime suspect: routine biased technological change."

WSJ: "Shell Considers Building Gas-to-Diesel Plant in Louisiana"

"Royal Dutch Shell is considering building a giant plant in Louisiana that would convert natural gas into diesel fuel..."

"Hovnanian Enterprises, Inc. Announces Proposed Public Offering of Class A Common Stock"

"Hovnanian Enterprises, Inc. announced today the commencement of a registered underwritten public offering of Class A Common Stock. The offering is anticipated to consist of the issuance of 25,000,000 shares of the Company's Class A Common Stock. [...] The Company intends to use the net proceeds of the offering to purchase certain of the Company's senior unsecured notes in a private transaction and for general corporate purposes, including the refinancing, repurchase or repayment of indebtedness, working capital needs, capital expenditures and expansion of the business."

Good for the long bonds short stock trade...

GMX Resources ($GMXR) and the Not Very Informative Press Release

After the market close today, GMXR announced that it had

"successfully drilled and completed its fourth operated horizontal Bakken well, the Lange 11-30-1H, 89% working interest, located in Sections 30&31 Township 147N Range 99W in McKenzie County, North Dakota. The Lange 11-30-1H was drilled to a measured depth of 20,519' with a lateral length of 9,348'. It was completed as a 32 stage frac Middle Bakken producer achieving a peak rate of 2,549 boepd @1,500 psi flowing casing pressure."

What you will often find with E&P companies is that they will announce a production metric on a new well that tells you almost nothing. With production rates, it is important to know over what time period the test took place. This well is still on confidential status in North Dakota and the company isn't saying what time period that rate was over, what the decline rate was, etc.

They are also reporting a "barrel of oil equivalent" number and not giving the breakdown between oil, NGLs, and natural gas. A guy actually called investor relations today and asked for the breakdown: no comment. He also asked whether or not the well is connected to a pipeline so that the natural gas can be sold. Again, no comment. I suspect it is being flared like other North Dakota wells.

Here's why this matters. The chart below is for a well called Taboo 1-25-36H, which is operated by Slawson but where GMXR has a 25% working interest. The well announced today - the Lange #11-30-1H - "is a direct offset and located 3,000 feet east of the Taboo" according to the company. So the Taboo well performance should be useful in thinking about the Lange.

The blue bar is the "initial production" in "barrels of oil equivalent (BOE)" for the Taboo well that GMXR announced in February.

In theory, the initial production of 1436 BOE should equal the initial production of 1197 actual barrels of oil plus one-sixth of 838 actual MCF of gas (which were the numbers reported to the state) in order for the BOE number to be BTU-equivalent. However, the BOE number that you get if you add the state numbers is only 1337 BOE. Where are the missing 100 BOE? It could be that the "initial production" number GMXR reports and the state numbers are calculated over different periods of time. That is why it is nice when companies give details about how they calculate "initial production" numbers.

Moving on from "initial production" to ongoing monthly production is where the story gets interesting. The "actual" IP numbers shown are from the NDIC well production history website. The "average" numbers shown are calculated by dividing BBLS Oil/Days in the NDIC well production history data.

You can see that the average daily bbl production over month one was 73% less than the "initial" daily production number from the state. Precipitous production declines are characteristic of these horizontal frac wells.

So, by month three, the Taboo well seemed to be producing 325 actual barrels of oil per day. Maybe it will produce somewhere between 50,000 to 100,000 barrels during the first year. And that will be almost all of the oil it will ever produce. It is hard to see it producing enough oil, which sells at a discount in the Bakken, to equal the present value of the ~$10 million estimated well cost. In other words, it is hard to see how this well can break even.

The Lange well, announced today, has a higher IP number, although it is not really comparable to the numbers we are using for Taboo. It could be a better or worse well; we haven't been given enough information to know and it is still on "confidential status" with the state. One would think that, if there was clearly good information, the company would have released it in the press release. So, we are probably looking at another well that is borderline breakeven assuming a normal cost of capital. For GMXR, with debt trading at double digit yields, the cost of capital is much, much higher.

Ironically, the worst case for shareholders may be that GMXR drills wells that are borderline breakeven. If they were drilling clear losers (which the early wells appeared to be) they might stop. But if they drill breakeven wells, they will use up their cash right before some major debt maturities coming due. Less cash means less bargaining chips to use with bondholders, which implies a more dilutive restructuring.

Another Geoff Gannon Post on Net Nets

That bigger concept is that a good net-net is really just a decent business. Why would insiders still control 10% to 50% of a company that has been public for 10 to 30 years? Because it’s a decent business. It may not be a great business. I’ve seen insiders happy to hold something earning 6% to 8% on equity for decades. And they think their lives are pretty good. And they’re probably not wrong.

"Meme Mining for Fun and Profit"

S-curves!

Flowing Barrels on ATP Oil & Gas (ATPG)

From my point of view, being long ATP equity is not much more than a bet on oil, and even then it may be a losing bet. All of the company's increased PV-10/standardized cash flow the last 3 yrs is from price revisions, while reserves have stayed flat despite massive spending. Based on the forecasting I've done, there appears to be little FCF to repay debt and indeed significant additional NPIs and ORRIs will be needed to fund cash gaps. Indeed, ATP's deepwater strategy may be 'rolling over.'

Another Blogger Writes About GMXR

"At 90% gas production, 98% gas reserves, a cash cost structure of around $3.00/Mcfe - about even with spot prices pre-basis, and no remaining hedges, GMXR is in a world of pain. I understand it gives them more time to attempt a liquids conversion by doing the exchange, but with the variability of results in the Niobrara, recent cost pressures in the Bakken and my expectations of continued pressure on the gas curve, the company may just be whistling past the graveyard."

GMX Resources (GMXR) - Capital Structure Arbitrage Idea

Summary
GMX Resources (GMXR) is an Oklahoma City-based, independent oil and natural gas exploration and production company. They have interests in the Bakken in North Dakota, the Niobrara in Wyoming, and the Haynesville/Bossier and Cotton Valley Sands in East Texas. You might have noticed that GMXR was on last Friday's list of "Cheap Debt, Upcoming Maturities, and Big Market Caps." Once again, we seem to have an energy company where pieces of capital structure have mutually inconsistent prices.

The market capitalization is almost $100 million, even though the preferred stock trades at 50 cents, the unsecured debt (due 2013 and 2015) trades at similarly deep discounts, and with an inverted yield curve), and the senior secured notes (due 2017) are trading at a YTM of ~17%. The market prices of the debt securities imply that the common stock is out of the money by over $150 million.

Shares Outstanding	69,272
	Face Amount	Price	Market Value	Interest Expense
Cash, as of 12/31/11	-102,493	1.00	-102,493
4.5% Senior Note due 2015	86,520	0.45	38,934	3,893
5% Senior Note due 2013	59,372	0.69	40,967	2,969
11.375% Senior Note due 2019	1,970	0.50	985	224
11% Senior Secured Note due 2017	283,520	0.80	226,816	31,187
Total Debt	328,889		205,209	38,273
9.25% Series B Cumulative Preferred	79,418	0.52	40,948	7,346
Enterprise Value through Preferreds	408,307		246,157	45,619
Common Stock	96,289	1.39	96,289
Enterprise Value	504,596		342,445
Valuation Gap Implied by Debt/Preferred			162,150

Catalysts
One immediate and ongoing catalysts is that the company is actively deleveraging by issuing shares in exchange of its notes due 2013, which are the nearest and most pressing maturity. After three exchanges YTD, shares outstanding have grown by 10 percent and the face amount of 2013 notes has been reduced by $13.4 million.

Even more deleveraging will be necessary. Ongoing interest expense and preferred coupons are $45.6 million annually. Given the ambitious capital spending plans (more about the IRR of those later), our bet is on continued equitization of the capital structure.

The company has no problem issuing stock. Shares outstanding nearly doubled during 2011, as their oil-play acreage in the Bakken and Niobrara were both purchased using some stock as currency.

Another ongoing catalyst is the Bakken well results, which have been disappointing but may improve after workovers (on multiple new wells). Our fingers are crossed.

Capital Structure Mispricing
The senior secured notes with a face amount of $284 million trade at 80 cents for a yield to maturity of ~%17. These have a nominal 11% coupon; it is actually an option for 11% cash or 9% cash and 4% PIK.

The unsecureds are trading with an inverted yield curve: ~60% YTM for the 2013s and ~35% YTM for the 2015s. Total unsecured debt at face is $146 million. There is also a preferred, trading at roughly 50, with face amount of $79 million. Total liabilities through the preferreds are $408 million. [And it is hard to identify any assets that sum to this amount.]

The valuation gap (roughly $160 million) between face value and market value of unsecureds and preferred stock imply that the equity is significantly out of the money. In our view, the real debate is whether the fulcrum security is the senior secured or the unsecureds.

The company seems to need need a distressed debt exchange, which it has already started by way of the periodic debt for equity swaps. (No public exchange offer has been made yet.)

CapEx Plan for 2012 Implies Restructuring this Year
The company has an ambitious plan to drill 7.1 net wells in the Bakken in 2012, which they say will cost $68 million (and not counting other capex). Their interest expense and preferred coupons should be $46 million, and they project SG&A for 2012 to be $31 million.

Their own projection is for 373k bbl oil in 2012 which we guess is roughly $30 million in revenue, and the company had $100 million in cash at the end of 2011. In theory, the company would need to actually be building cash to meet the upcoming unsecured maturities. In reality, it is likely that some kind of deleveraging transaction will take place to clear the unsecured maturities and allow the company to spend more money drilling wells and buying acreage.

Sum of Parts Valuation
Keep in mind that the current enterprise value through the preferreds is $410 million and the total enterprise value is $500 million (and this assumes nothing for working capital). Sell side research that we have seen puts a value of $350 million on the company's assets, which covers the secureds but results in impairment for the unsecureds and leaves the preferred stock and common stock with nothing in a liquidation.

We actually struggle to come up with a value as high as the sell side research. The company has a few key assets: producing wells and acreage in the Haynesville (much of the production has been VPP'd), the Cotton Valley, acreage in the Niobrara, acreage in the Bakken, and a few producing wells in the Bakken.

The company wrote down the Cotton Valley Sands inventory at the beginning of 2011: "Due to the Company's focus on developing the new acreage in the Bakken and Niobrara oil resource plays, and the prolific nature of the Haynesville/Bossier gas resource, we do not currently expect to reactivate a Cotton Valley Sand vertical drilling program within the next five years."

The way that the company came to acquire the Niobrara and Bakken acreage is noteworthy. First of all, most of the purchases were made at the beginning of 2011. This was roughly two to three years into the Bakken play - making them a late arrival. [The EIA has an excellent animation of producing wells in the Bakken. For fun, and something I may do in a followup post, compare the locations of good wells to the location of GMXR acreage.] Anyhow, the company acquired acreage in a series of transactions that involved a large proportion (in some cases, 90%) of consideration paid in common stock of GMXR.

Bakken Acquisitions
From a company filing:
"GMXR's 26,087 total net acre leasehold for these acquisitions is primarily in five distinct areas, all of which are within the Bakken 'thermal maturity window'. The consideration to be paid by us for the three Bakken transactions includes the issuance of shares of the Company's common stock. Two of the transactions, totaling 8,290 net acres (including 1,629 acres under the LOI), reflect an average purchase price of $4,665 per acre, with approximately 67% paid in common stock [...].
"The third transaction, previously announced January 20, 2011, totals 17,797 net acres for a purchase price of $1,000 per acre. Approximately 90% of the consideration will be paid in common stock [...]."

Niobrara Acquisitions
From the previous filing:
"GMXR's entry into the Niobrara involves two transactions for approximately 41,637 net acres in southwestern Goshen, southeastern Platte and north central Laramie Counties in Wyoming, with a 80% net revenue interest. One of the sellers has retained a 90-day option to reacquire a 50% working interest in approximately 16,000 acres, at our initial cost."

Trade Ideas
The stock is optionable so no there is no borrowing concern. You can get negative delta synthetically by buying puts or shorting deep-in-the money calls. There is fairly high implied volatility, which means that you can create the company at a higher price in the options market by selling calls.

The obvious play is to short equity and buy the 2015 notes, which have the lowest dollar price. Another obvious opportunity would be to try to tender the 2013 notes for stock back to the company, at a transaction premium. These transactions, which are already taking place, amount to a slow motion restructuring and help the debt recovery (by reducing amount outstanding), dilute the existing common stock, and most notably decrease expected future volatility and therefore reduce the value of call options, because of the deleveraging.

As always, do your own research, but it seems to me that the bonds are drastically underpriced relative to the stock. 

Major Holders
Insiders own roughly 5 percent and institutions another 36 percent. So the company is 59% owned by retail. It doesn't look like there is much actively managed ownership - mostly index funds.

Weird Behavior
On the most recent quarterly conference call, an analyst asked about the company's Niobrara acreage. One of the company executives said "we'll tell you about it when we've got a - when we have a great story to tell at the site".

The preferred stock is putable back to the company if CEO Ken Kenworthy ever leaves the company, voluntarily or involuntarily. As company filings state,

“We depend to a large extent on the efforts and continued employment of Ken L. Kenworthy, Jr., our [CEO]. The loss of his services could adversely affect our business. In addition, if Mr. Kenworthy resigns or we terminate him as our [CEO], we would be required to offer to repurchase all of our outstanding Series B Preferred Stock. The indenture governing our Senior Secured Notes will restrict our ability to repurchase our outstanding Series B Preferred Stock, and we may be required to issue other preferred or common stock in order to raise cash for such required repurchases.”

Keep in mind that the preferred stock is trading at roughly 50 cents, with a face value of almost $80 million. It would not be good if the company was forced to buy it back at par. What do you think boardroom discussions are like with a CEO whose departure would cause that kind of a liquidity drain?

Partial Conclusion
I'm going to publish this post now and update on the sum of parts analysis, waterfall recovery analysis, well results, and acreage details later. 

Studies in Pessimism, by Arthur Schopenhauer

"If two men who were friends in their youth meet again when they are old, after being separated for a life-time, the chief feeling they will have at the sight of each other will be one of complete disappointment at life as a whole; because their thoughts will be carried back to that earlier time when life seemed so fair as it lay spread out before them in the rosy light of dawn, promised so much — and then performed so little. This feeling will so completely predominate over every other that they will not even consider it necessary to give it words; but on either side it will be silently assumed, and form the ground-work of all they have to talk about."

Other Value Bloggers Write About Conrad Industries (CNRD)

One post is called "A watershed moment for Conrad Industries" and the other is "Conrad Industries... unanswered questions" - where the "unanswered question" is "why is the stock so cheap".

It's funny for me to see people puzzling over the cheapness of the stock now, when it is hitting new highs, as opposed to over a year ago when we first started writing about it. As a longtime CNRD follower, it is also amazing to see three posts and lots of tweets about it in one week.

Hussman on Abnormally High Profit Margins

"The hope for continued high profit margins really comes down to the hope that government and the household sector will both continue along unsustainable spending trajectories indefinitely. Conversely, any deleveraging of presently debt-heavy government and household balance sheets will predictably create a sustained retreat in corporate profit margins. With the ratio of corporate profits to GDP now about 70% above the historical norm, driven by a federal deficit in excess of 8% of GDP and a deeply depressed household saving rate, we view Wall Street's embedded assumption of a permanently high plateau in profit margins as myopic."