Thursday, October 11, 2012

GMX Resources Drops 14% On Heavy Volume

Reading between the lines of the proxy statement the company filed:

The Board believes the increase in available shares for future issuance is appropriate to fund the future operations of the Company and to address the upcoming maturity of the Company's 5% convertible notes due in February 2013 Notes
The company is supposed to be taking in $69 million from the Cotton Valley Sands sale, and this maturity is only $27 million. However, there are some restrictions (from the covenants of the secured notes) on the company's ability to use cash from asset sales.

I imagine that the company fully expects and would even like to use debt/equity exchanges on the 2013 maturity instead of redeeming in cash. Here's how that could look: they pay $10 million in cash and plan to exchange the remaining $17 million for equity. That would mean issuing 30 million new shares (based on current price), and would reduce the current shareholders to owning only 60 percent of the post exchange equity.

The worst part for the company is that there is sort of a positive feedback loop here, because the lower the share price the more shares will be needed for the exchange, the worse the dilution, which means the less the current shares are worth. It's a hard feedback cycle to arrest if you believe (as we do) that the equity doesn't have any value (even if the 2013 notes are fully equitized).


Allan Folz said...

Concerning the positive feedback loop, these type of dilutive type loans were all the rage in the mid/late 90's. Some guys on Silicon Investor (if you remember/heard of that one back in the day) made out like bandits shorting along side the "lenders."

One guy eventually set-up an EDGAR search for the key words the SEC filings would always have. Some private equity outfit would buy some number of convertible bonds that were structured to pay back in shares issued at a discount to the closing price of last N trading days prior to conversion. The lower the shares went, the more shares the bond holders would be issued.

It was obvious the guys buying the bonds would short the heck out of the stock before the bonds even closed. Once they had the bonds in-hand, and the stock started dropping, they could scale up their shorts knowing full well the more shares they shorted, the lower the price the shares traded at, the more shares they'd eventually be issued to cover their shorts. It was incredible. They had some name for it, which I forget, but basically it was a dilutive death spiral.

I was only in my early 20's at the time and lacking serious capital so I was not able to take a seat at the party. Such a shame.

There was one guy from WA who went by the name Bill Wexler. For a while I wondered if you were him. You have similar styles. :-) Hopefully he's sippin' mi tais in Hawaii these days.

CP said...

Thanks, good comment.

The other thing I forgot to mention is that, for the new 2nd lien notes, "at the Company’s option, in lieu of paying interest in cash, the Company may, through the second anniversary of the settlement date, pay interest in the form of freely tradable shares of the Company’s Common Stock, with the number of shares being based on a 10-day volume weighted average price, discounted to yield the equivalent of a 12% interest rate for interest so paid in shares."

There are approximately $51.5 million aggregate principal amount of New Notes outstanding. That's $3.1 million in semiannual interest expense if paid in stock.

That is over 5 million shares for the next interest payment assuming the current price!