Description

Thesis

GMXR Resources (GMXR) is an overleveraged e&p company (debt/ebitda of 23.7x) with a history of massive shareholder value destruction and an immediate need for roughly $100MM in new drilling capital to hold acreage. We believe a bankruptcy filing is imminent as the company failed in its attempt to raise new debt or equity capital earlier this year, hired Jefferies to pursue a balance sheet restructuring, and recently skipped an interest payment on its 2018 bonds.  We recommend a short of both the common stock and the preferred stock (GMXR-P) as both are likely to be wiped out in the upcoming bankruptcy which we expect to be filed in the next 3 weeks. There appears to be a significant disconnect between the debt and equity markets, as GMXR’s mezzanine debt tranches trade at significant discounts to par yet the company’s preferred equity still has $21MM of market value, and the company’s common equity still has a $24MM market cap.

Capital Structure

The preferred stock trades at $6.60/share (26.4% of par) implying an enterprise value through the preferred stock at market of $447MM. 

The 4.5% Convertible bonds trade at 35% of par and the 9% bonds trade at 55% of par.

The company is expected to generate $18MM in EBITDA in 2013 and is therefore levered 23.7x through the bonds and 28.1x through the preferred stock.

On Feb 19th, 2013 GMXR put out an 8-K stating that their "available cash" at year end 2012 was $46.0M and includes $16.8M for payments and reserves for the Feb 2013 5.00% convertible senior notes which were paid off at par in early February.  This would imply pro forma year end cash of $29.2MM.

The company had $10.2MM of accounts payable and $21.5MM of accrued expenses versus only $9.4MM of accounts receivable as of the Q3 balance sheet. These trade claimants would likely also have claims senior to the preferred stock and the common equity in a bankruptcy filing.

Company Overview

GMX Resources is an independent oil and gas exploration and production company. Historically the company focused on gas drilling in the Cotton Valley and Haynesville Shale in East Texas. As gas prices collapsed, in 2011 the company purchased land in the Niobrara and Bakken. The company’s drilling efforts in the Niobrara have been unsuccessful and the company’s Bakken drilling has underperformed expectations.  As of November 8th, 2012 GMXR was projecting 75,000 barrels of oil from the Bakken in the 4Q:12 after generating ~21,000 in October alone and 37,558 barrels in the entire 3Q:12.  However, they disclosed in their Feb 14, 2013 8-K that Bakken production was only 55,100 barrels in the 4Q.  Implying a decrease in production in November and December from October levels! GMXR’s Bakken results (which can be found on slide 12 of the Capital One Southcoast conference presentation at this link http://gmx.investorroom.com/presentations ) are consistently below those of other Bakken operators.

The company owns 34,918 net acres in the Bakken, 40,082 net acres in the Niobrara, 29.837 net acres in the Haynesville and 13,130 net acres in the Cotton Valley.

In the 4^th quarter of 2012, the company’s production was 600 barrels/day of oil, 142 barrels/day of NGLs and 16mmcf/d of natural gas.

Recent Events

On February 1^st GMXR indicated it would pay its March 2^nd interest payment on its Senior Secured Second-Priority Notes due 2018 in shares of common stock as well as cash if the number of shares to be issued was greater than 604,216 shares. (Note how hideously toxic and dilutive these PIK feature is for the common)

“GMXR's Senior Secured Second-Priority Notes due 2018 have a quarterly interest payment due the second day of March, June, September and December. Interest on the notes accrues at 9.0% per annum. GMXR has an option to pay the interest in cash or in shares of our common stock. GMXR has elected to pay the interest payment due March 2, 2013 in shares of our common stock provided, the number of shares of our common stock issuable shall not exceed 604,216 shares. If the number of shares of common stock issuable as interest would exceed 604,216 shares, we will pay any additional interest amount payable in cash. The record date for this interest payment is February 16, 2013. The number of shares of common stock to be issued will be calculated as the quotient of (a) the difference between the total amount of such interest payment and the amount of such interest payment paid in cash, divided by (b) the product of (x) 0.75 times (y) the per share volume-weighted average price of the common stock for each of the 10 consecutive trading days ending on, and including, the trading day immediately preceding the relevant interest payment date. If we were to pay this interest payment entirely in cash, the aggregate amount of cash would be approximately $2.1 million. If we were to pay this interest payment entirely in shares of common stock, the aggregate fair market value of the shares would be approximately $2.8 million.”

In the February 19^th 8-k the company confirmed that its attempts to raise new debt or equity capital had failed and that the company was looking at a potential restructuring of its balance sheet:

“The Company has recently sought indications of interest for certain debt and equity liquidity alternatives, but not received sufficient support for all of its liquidity needs or plans. The

Company is continuing to explore and evaluate options for its capital needs, as well as continuing to evaluate and finalize its 2013 budget for capital expenditures based on its available liquidity. In connection with its evaluation, the Company plans to retain a financial advisor to assist the Board and senior management in its ongoing exploration of a variety of financing alternatives, including a potential restructuring of the Company’s balance sheet in light of its current liquidity and cash needs.”

On February 25^th, the company issued a press release announcing that they had hired Jefferies to explore a potential balance sheet restructuring:

"In connection with its evaluation, the Company has retained Jefferies & Company Inc., a financial advisor, to assist the Board and senior management in its ongoing exploration of a variety of financing alternatives, including a potential restructuring of the Company's balance sheet in light of its current liquidity and cash needs.”

On March 2^nd the company decided to skip the interest payment on its 2018 bonds even though most of the interest was to be paid in common stock. We believe this is because the share price was too low, and so they would have had to issue 604,216 shares and make a cash interest payment of ~$0.8M in cash and the company’s cash balances are critically low.  The calculation of the ~$0.8M in cash interest is based our analysis of the text from the 8-K and the indenture agreement for the 2018 Senior Secured Second Priority Notes.  We calculate that the 10 day VWAP that ended on March 1st (the last business day prior to or on March 2nd) of $2.83, multiplied by 0.75 and the 604,216 shares.  The interest payment has a 30 day grace period, so GMXR will not technically be in default until April 1^st.

On March 4, 2013 in an 8-K filing the company indicated that it would file for chapter 11 if the company is unable to come to a consensual restructuring of its balance sheet:

“As previously disclosed by us, we have engaged Jefferies & Company, Inc. as financial advisor to assist the Board and senior management in its ongoing exploration of financing alternatives, including a potential restructuring of the Company’s balance sheet in light of its current liquidity and cash needs. If we are not able to successfully implement a consensual alternative for restructuring our balance sheet, or in order for us to implement a financial alternative, we may voluntarily seek protection under the U.S. Bankruptcy Code.” 

Liquidity Issue

GMXR has a history of massive free cash burn. Year to date through Q3, Free cash flow was negative $81MM with 2011 FCF of negative $219MM, 2010 FCF of negative $114MM and 2009 FCF of negative $113MM.

As of year-end 2012, GMXR estimated that they had $46M "available cash" of which $16.8M was earmarked to redeem the remainder of the 2013 February 5.00% Convertible Notes. 

From the press release on February 8^th:

“The Company’s available cash at year-end 2012 was $46.0 million and includes $16.8 million reserved for the maturity of the Company’s 5% Convertible Senior Notes due 2013. The Company has recently sought indications of interest for certain debt and equity liquidity alternatives, but not yet received sufficient support for all of its liquidity needs or plans. The Company is continuing to explore and evaluate options for its capital needs, as well as continuing to evaluate and finalize its 2013 budget for capital expenditures based on its available liquidity.”

Thus the company ended 2012 with approximately $29.2M of "available cash" pro forma for the February 1^st redemption of the remaining 2013 bonds.  While this is an improvement over the $15.5M of cash that they ended the 3Q:12 with, they raised $66.7M from asset sales in the 4Q, and $30M from issuance of new Senior Secured notes to retire the 2013 convertible notes.  Thus despite under-investing in capital expenditures (in page 35 their 3Q:12 10-Q they estimated they would spend $110M in capital expenditures for 2012, they ended up only spending $96M for 2012 according to the 8-K filing on Feb 14, 2013), and $66.7MM in asset sales, they only had a ~$15M QoQ increase in cash.

According to FactSet consensus estimates GMXR having EBITDA of $18MM in 2013 with only $6M generated in the 1H:13. In contrast, their interest payments for 2013 are $42.7M.  Even using PIK where possible, their minimal cash interest payments are still $31.6M. These interest payments are before the $7.3MM in annual preferred dividend payments.  

Notwithstanding the lack of operating cash flow, GMXR’s biggest issue is its need to drill Bakken wells to hold the Bakken acreage. Each Bakken well costs roughly $10-$11MM to drill and we estimate GMXR would need to drill roughly 55 net wells (35k acres, 640 acre sections, 1 well per section) to hold its entire Bakken acreage position. So far GMXR, has drilled or started drilling on 10.7 net wells. Therefore to hold the rest of the Bakken acreage, GMXR would likely need to spend an additional $450-$500MM in capital by lease expiration in early 2016 (ie they need to spend roughly $150MM a year in capex to hold all the Bakken land.)

However, GMXR’s current cash position and 2013 EBITDA is insufficient for them to have a $100MM to $150MM drilling program for 2013 in the Bakken. GMXR has attempted to find additional sources of capital from the markets in the form of debt or equity, but have been unable to do so.  ("The Company has recently sought indications of interest for certain debt and equity liquidity alternatives, but not received sufficient support for all its liquidity needs or plans." - From Feb 19, 2013 8-K filing). Given the company’s massive leverage its not surprising that it couldn’t find new capital providers.

We believe the only way this company is going to be able to raise new capital is if the new capital is in the form of a Debtor in Possession loan and therefore senior to all the existing indebtedness.  The need for new capital gives the company a large incentive to file for bankruptcy in order to access the DIP lending market.

Worth

GMXR’s independent reserve engineers determined the present value of the company's proven reserves at year end 2012 to be $80MM at SEC pricing and $195MM at 5 year average pricing.

SEC Pricing

Proved Reserves – 2012 SEC Pricing(a)

Even at higher, 5 year average prices, they only have $195MM of proven reserves.

NYMEX Natural Gas Strip and SEC Oil Pricing

Proved Reserves – 5 YR Annual Average NYMEX Natural Gas Strip Pricing(a)

With no drilling capital going to the Niobrara, Cotton Valley, or Haynesville, the only other valuable asset of the company is its ~35,000 net acres in the Bakken. The company paid $4,667/acre for this land and similar non-held by production, undeveloped Bakken land has been transacting at between $1,200 and $6,200/acre (see page 31 of Emerald Oil’s pitchbook for a table with land transaction values in the Bakken http://content.stockpr.com/vyog/media/4e6077df4ec9b8e293fed271c4d8c6b4.pdf ) With GMXR’s land so far producing results worse than peers, it is unlikely it would receive a premium valuation in an asset sale. At $5,000 per acre the land would be worth $175MM.

The book value of all the assets of the company was $343MM on the last balance sheet (3Q:12 10-Q), and the year end book value is likely less than that given the collapse in the value of their reserves. Book Equity of the company was negative $125MM as of their last balance sheet.

We view the asset value of the company being the PV10 of the proven reserves plus the value of the Bakken land which would imply an asset value range of $255MM to $370MM which is significantly less than the company’s $426MM in total debt implying no recovery value for the preferreds or the common.

With the company likely needing a $100MM DIP loan in bankruptcy to continue drilling in the Bakken to hold the acreage, the Senior bonds and the Senior Secured Second Priority notes will likely also be significantly impaired if not completely wiped out in the bankruptcy and it wouldn’t surprise us if the Senior Secured Notes end up being fully equitized and significantly impaired.

Catalyst

We believe that GMXR will file for bankruptcy by April 1^st, the date they become in default for nonpayment of the March 2^nd interest payment for their 2018 Senior Secured Second Priority Notes. The preferred stock and common stock would likely trade to close to $0 on the bankruptcy filing as there would be little hope for recovery.

In addition, we expect the company to skip its March 31^st scheduled preferred dividend payment which should cause retail preferred shareholders to sell the preferred.

GMXR is a non-accelerated filer under SEC rules, thus they have 90 days after the end of the year to file their 10-K.  Thus by April 1, they will also need to update the market on their audited financials and outlook for 2013 which we believe will be a negative catalyst for the common and preferred stock as the company is likely to receive a going concern qualification to its audit. 

Risks

The company is able to raise $100M in new common equity and thus able to avoid bankruptcy filing while funding continued development.  This scenario would likely result in a large rally in the preferred stock, while the existing common stock would be massively diluted. We believe this is unlikely as the company has not been able to generate sufficient investor interest previously and has hired a financial advisor to examine balance sheet restructuring. 

Appendix

I’m not sure if this is relevant but Tripp Kenworthy the Accounting Director of GMXR and the son of CEO Ken Kenworthy died at age 31 on February 14^th.

Catalyst

We believe that GMXR will file for bankruptcy by April 1^st, the date they become in default for nonpayment of the March 2^nd interest payment for their 2018 Senior Secured Second Priority Notes. The preferred stock and common stock would likely trade to close to $0 on the bankruptcy filing as there would be little hope for recovery.

In addition, we expect the company to skip its March 31^st scheduled preferred dividend payment which should cause retail preferred shareholders to sell the preferred.

GMXR is a non-accelerated filer under SEC rules, thus they have 90 days after the end of the year to file their 10-K.  Thus by April 1, they will also need to update the market on their audited financials and outlook for 2013 which we believe will be a negative catalyst for the common and preferred stock as the company is likely to receive a going concern qualification to its audit.