I am a long time holder of GeoMet (OTCQB:GMET) yet first wrote about the stock on April 2, 2013. That article highlighted the challenging predicament GMET was in but that if the company could address its bank debt issues via a successful asset sale, could be a very interesting and deeply undervalued opportunity. Readers can go back to the article to get a sense of the various dynamics impacting GMET but the overall focus was GMET's sale of its Black Warrior Basin (BWB) assets. I anticipated GMET would sell those assets for about $55MM, using comparables from the Constellation Energy Partners (CEP) sale. However, the actual sale came in at $63.2MM, a very robust valuation and very material in alleviating GMET's solvency issues. GMET will receive $63.2MM in proceeds of which at least $52MM will be used to pay down debt, including the elimination of the $21MM borrowing base deficiency which was the largest issue facing GMET.
Following the sale, GMET's proved reserves will total 94 Bcf while the company's borrowing base will be the lesser of $82MM or actual borrowings. I expect that GMET will pay down as much debt as possible while also using some of the proceeds to retire existing hedges. In either case, GMET's capital structure will have improved markedly which should allow the stock to be valued as a viable business as opposed to one on the brink of bankruptcy. The valuation of the BWB assets also provides a glimpse of where GMET's equity could be valued once the market digests the implications of this transaction.
The table below highlights GMET's cash and debt balances adjusted for the sale announcement. The data in 3/31/13 is an estimate based on 12/31/2012 data and adjusted for the data we have from press releases regarding its 3/31/2013 debt balances. The main difference is that GMET paid down roughly $3MM of debt in Q1 2013 as its borrowing base deficiency shrank from $24MM to $21MM from 12/31/2012 to 3/31/2013. What is clear is that the BWB sale dramatically improves GMET's debt balance and credit statistics, as the company is levered at just 4.5x Net Debt/pro forma EBITDA, a full turn lower, post the asset sale.
The transaction also provides insight into what GMET can be valued at post sale due to the attractive price paid for GMET's BWB assets. The $1.465 metric ($63MM/43 Bcf of BWB assets) is an interesting price. Post sale, GMET will have 94Bcf for its remaining assets. The charts below provide a sensitivity analysis based on the valuation the BWB assets sold for to ascertain a range of value for GMET's equity assuming full conversion of the company's preferred stock or no conversion.
GMET's preferred stock is essentially debt so unsurprisingly, there's a greater penalty to shareholders as the value on a per Bcf basis declines and more upside to the common shareholders as the valuation range improves under the non conversion scenario. The interesting thing to note is that price parity between conversion and non conversion of preferred shares is at the valuation the BWB assets were sold for, which would translate into a share price of $0.88, or nearly 400% greater than current prices.
The question to ask is how good are GMET's remaining assets in the Appalachian region and I think the data shows that these assets are attractive. The table below presents the per Mcf production breakdown of GMET's various assets. The Gurnee field and BWB fields were sold for $63.2MM. What is clear is that the Cahaba basin fields were GMET's highest cost fields yet in conjunction with the BWB assets commanded a very attractive sale price. The BWB assets have far lower costs because they are structured as royalty interests as opposed to operating and thus command a higher valuation. Nonetheless, the higher cost Cahaba fields contributed 43% of total daily production of the assets that were sold so the higher cost, operating aspect of the Cahaba fields in relation to the BWB assets were not a significant deterrent.
What this means is that the company's Pond Creek and Pinnate wells should not be significantly discounted from the assets that were sold. Recall that CEP sold its 49Bcf in Black Warrior Operating assets, similar to the remaining GMET assets, for $63MM ($1.29/mcf). Using this metric suggests an equity value of $0.47 - $0.67 for GMET's common under no preferred stock conversion or full conversion of GMET preferred stock. In either case, the value is substantially higher than where shares are currently valued.
A share price in the $0.50 area would imply an enterprise value of $110MM - $123MM depending on the treatment of preferred shares. This would equate to an EV/EBITDA value of 7.3x - 8.2x pro forma for the transaction. This may not look cheap but I think it is given that the EBITDA is depressed due to the implosion of natural gas over the past five years. While natural gas and related futures are rebounding they are still quite low. Cyclical stocks typically exhibit high valuation multiples when operating earnings are depressed yet GMET would be valued at just 8.0x or so trough EBITDA. This valuation would also be consistent with where CEP is valued (8.5x EV/EBITDA).
GMET stock could languish for some time given the lack of a number of investors able to participate in the name. However, individual investors that can focus on the fundamentals and improved outlook should be able to capitalize on what seems to be a very attractive risk/reward given the alleviation of solvency issues and validation of the value of GMET's overall assets. As the market evaluates this transaction and focuses on Q1 2013 results, I think GMET should start to be valued like an ongoing company as opposed to a bankruptcy candidate. If the market starts to agree with this, the stock could be poised for a steep run up.