Geokinetics (GOK) recently filled a pre-pack bankruptcy in Delaware. In this article I will analyze the following information:
1. The submitted liquidation value
2. The valuation analysis submitted in support of restructuring plan
3. The expected outcomes/values relative to the current price
Overview of Bankruptcy Process
There are many paths through the corporate bankruptcy system in the U.S. Broadly speaking, you can either liquidate the assets of the company or attempt to restructure those assets. While there are many factors that determine whether a company will be liquidated or reorganized, two of the key determinants are the liquidation value of the company and the valuation analysis. Again, generally speaking, if the liquidation value is higher than the valuation analysis of the reorganized firm, the company will likely be liquidated. If the valuation analysis is demonstrably higher than the liquidation value, then the company is likely to be reorganized. There are a lot of details surrounding the assumptions of the liquidation analysis and the valuation analysis and those items are vigorously debated and attacked by the different stakeholders in the company which is what brings us to Geokinetics.
The capital structure of Geokinetics is reasonably straightforward and as a result, the company has filled a "pre-pack" petition with the court. This is significant in that a pre-pack requires the written agreement of the creditors PRIOR to filing for bankruptcy protection. One of the biggest risks to a bankruptcy is a long, protracted battle between different classes of creditors and equity holders. A pre-pack filing signals reasonable agreement and cooperation among the parties along with a relative level of sophistication among management and the advisors (pre-packs are difficult and painful to architect but can be highly beneficial if done correctly.)
Every deal has hair on it. In the case of Geokinetics, it is the belief by the holders of the preferred equity that the submitted plan is not adequate (read: too low) and that as a result there position should be improved. From a priority perspective, they have little to stand on and as a result the most likely scenario is that this plan will be approved in a form that is reasonably close to the one that has been submitted to the courts. So, lets look at what is in those filings.
Source: Company's bankruptcy filing
In support of the company's plan of reorganization they have filed the liquidation analysis shown above. The analysis shows "distributable value" of between $122.1MM and $148.8MM after expenses related to the wind-down. Of note is that the recovery to holders of the Senior Secured notes would be between 22.3% and 30.7% which is reasonable in my experience. If the company were going to be liquidated, the bonds would be trading at some discounted value to the expected liquidation proceeds. But, they are not. The bonds are currently trading at approximately 52%. Before we get to why, lets look at the valuation analysis.
In the valuation analysis above, the value available to be "distributed" to stakeholders is $280MM of which $56MM will be held as debt and the balance would be converted to equity. When you compare this value to the value available during liquidation as discussed above, it is clear that a restructuring is the most likely outcome. As I mentioned earlier, I believe that this plan will get approved in some form reasonably close to the submitted plan. If anything, I think that the preferred holders will make the argument that the plan is too conservative and as a result there position should improve. It is this dynamic that sets the stage for a potential short term return.
In the table above, I have taken into account a variety of potential scenarios that might play out and I have assigned a probability based on my experience that is assigned to each scenario. To help with reading the table, I will call your attention to the term "Plan Discount". In the valuation analysis, a 20% margin of error has been assigned to the recommended plan. In each scenario I compare the potential outcome with this margin of error and without it.
Based on the scenarios above and my handicapping of the outcomes, I believe that the bonds should be valued at approximately 65 versus the current 52 and there is a far higher probability that there is upside relative to the potential downside. If anything, I have overstated the downside of a liquidation at a 5% probability. In my view, the chance of a liquidation is effectively zero. If I assigned a value of zero to the two liquidation scenarios, my view is that bonds should be worth 67, again with potential upside to 97.
One thing that I am ignoring in this analysis is time and the reason for this is that I believe this plan will be approved within 45 days of the filing date as management and the advisors have asserted. The filing date was March 10, 2013 so we are already eleven days into a 45 day process.
This is a highly speculative issue and I would not bet the ranch on this one, but I do believe that there is compelling upside in the debt of Geokinetics (CUSIP: 37252CAB6) from the current price for an investor with an appropriate risk tolerance and time horizon.