In November 2012, I wrote an article on SeekingAlpha describing a preferred stock I had bought more of recently. I said I was "thankful" for it because it was paying me a very high yield (yield to par of ~25%) and, despite its small size and illiquid market trading, it appeared safer in many respects than larger and more liquid yield-oriented investments such as Linn Energy (LINE) and Magnum Hunter (MHR) preferred series C. Interestingly, not only has this preferred subsequently paid more than double the yield of those two yield-oriented investments, but it has also almost doubled, trading up substantially relative to those two securities.
The preferred I am referring to is the preferred stock of GeoMet (OTCQB:GMET), whose preferred shares trade on the NYSE under ticker GMETP. As I mentioned in that first article, GMETP had traded down after concerns regarding its bank group and potentially being overdrawn on its credit facility. This was precipitated by a drop in natural gas (UNG) to decade-low prices in 2012, below $2 per mcf. I pointed out that GeoMet's preferred was trading at a discount to the PDP value of GeoMet's reserves, net of the value of the bank debt, which provided a margin of safety to the investment.
This contrasted substantially with both LINE and MHR-PC. I am not prescient and had no idea that LINE would come under attack by Barrons and HedgeEye. I just knew that it was yielding ~7%, which seemed low to me considering the highly leveraged equity nature of the security, and the potential for interest rates to rise over time. Since then, LINE has traded down to a ~10% yield. With the recent Berry (BRY) acquisition, it has solidified its financial position, but may still be a risky investment.
MHR-PC seemed to have less of a margin of safety as well. It traded at a multiple of PDP value, thus risking principal loss if there were a liquidation. I pointed out that Gary Evans, CEO of Magnum Hunter, is innovative and a capable manager of an E&P company. But MHR-PC had no conversion optionality on the upside, was already trading slightly above par, and had less reserve and cash flow coverage than the GeoMet preferred.
Buying GMETP at $5 (the price the day that article came out) would have generated a total return of ~100% in the subsequent ~13 months, versus a total return of ~-15% for LINE and ~11% for MHR-PC.
GeoMet is currently in liquidation. Considering the substantial influence preferred holders (and Yorktown, the largest holder in particular) have on the company, it seems unlikely the company would have proceeded with liquidation if they were not going to receive sufficient value for the assets to pay off the preferred at par and to generate some recovery for the equity. It will be interesting to see the final value recovered for the preferred and equity, but even if it is slightly below par for the preferred, the investment will still have substantially outperformed the comparables mentioned above. And it is a good example of the potential outperformance from buying a security with a substantial margin of safety.
Additional disclosure: I am also long GMETP and GMET. I may buy or sell any security mentioned at any time with no further notice.