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.