First things first: I don't know where the price of oil is headed, nor do I know how well the jack-up rig market -- Paragon Offshore's (OTCQX:PGNPQ) bread and butter -- will do over the next couple of years. Both of these uncertainties will have a significant impact on the viability of Paragon Offshore over the long term. None of the uncertainties, however, are important to my thesis over the short term (three to six months).
Here's a bit of background first: Paragon Offshore has filed for bankruptcy, and while most people expected the equity holders to be wiped out, management was able to reach a deal with its creditors while preserving 65% of the company for the equity holders. Some of the term loan holders had expressed discontent with the deal. However, the bankruptcy judge has given the green light for the creditors to vote on the bankruptcy plan.
At this time, only two questions matter:
First, what is the likelihood that the bankruptcy will be voted in favor of by the creditors and subsequently approved by the bankruptcy judge? Second, how much is Paragon Offshore equity worth should the company emerge from bankruptcy as planned?
As for the first question, the judge has approved the bankruptcy plan and 77% of senior unsecured notes holders and 96% of the unsecured holders have already agreed to the deal. Since the term loan holders are unimpaired and thus not allowed to vote, the bankruptcy has a high likelihood of proceeding as expected. I'll assume the probability to be 80%.
As for the second question, Paragon Offshore currently has a negligible market cap of $24M, which equates to roughly $1.5B in enterprise value post-restructuring. This is comparable to the enterprise value of Hercules Offshore (NASDAQ:HERO) of $1.6B. However, Paragon Offshore is a much larger operation than Hercules Offshore; Paragon generated $1.5B in 2015 revenue while Hercules generated $335M. Thus, it seems as if Paragon should trade much higher should the company emerge from bankruptcy. Every $100M increase in enterprise value equates to 4x return for current Paragon shareholders.
In summary, investing in Paragon Offshore could result in permanent loss of capital should the bankruptcy process get protracted. However, the likelihood of the bankruptcy proceeding as expected is extremely high, since the majority of impaired lenders are supportive of the reorganization and the bankruptcy judge has approved the plan. Thus, I'd expect that Paragon Offshore has at least an 80% chance of emerging from bankruptcy. Should it emerge from bankruptcy, shareholders should enjoy a 3x-5x return.
Investors should note that Paragon Offshore operates in a severely competitive industry with a very poor outlook, given the decline in oil prices and increase in the supply of oil rigs. Given the uncertainty in the industry, I would not suggest betting on this company (long or short) over the long term. Over the short term, though, the odds are in the current shareholders' favor. With these odds, I would be comfortable allocating small percentage of my portfolio to Paragon Offshore. I may lose it all -- but if I win, I'll win big. I also believe that I have a high probability of winning.
Disclosure: I am/we are long PGNPQ.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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