Penn Virginia (PVA), headquartered in Pennsylvania, has been in business since 1882. Usually, companies with that kind of staying power rarely go into bankruptcy unless there is a severe economic crisis in the country. But it seems that it merely took a decline in the price of oil to the $50 range to push this company to the brink of insolvency.
The problem with the company is a long series of mismanagement that has led the company to purchase low-quality exploratory wells in Pennsylvania's Marcellus Shale, and absolutely terrible natural gas interests in the Haynesville Shale and Cotton Valley Sands of East Texas that hemorrhage cash. The company bandies about the assets it owns-115 million barrels of oil equivalent, 738 productive wells, and 224,000 acres of leasehold and royalty interests-but the company repeatedly fails to mention that these assets generate losses even in good times.
People who look at Penn Virginia's losses of $400 million over the past twelve months might conclude that is the price you must pay for exploring and producing natural gas during a downturn in the commodities cycle. But that kind of logic ignores the fact that the company's ownership interests in the Marcellus Shale, Haynesville Shale, and Cotton Valley Sands are so inferior that they cannot even generate profits in the good times.
The Brent oil average in 2011 was a tad bit over $111 per barrel. You would think that this would be an environment where every oil exploration company would be profitable. But no, that was not the case with Penn Virginia. This company still managed to lose $2.54 per share, or a little over $100 million. With a company like Conoco (COP), we only need to see oil rise to above $75 or so per barrel for the E&P firm to start making profits again. Conoco shareholders have reason to be optimistic for the long-term future.
But that is not the case for Penn Virginia. Even if the price of oil were to double, it would still be losing money. That is not the kind of asset you want to own, because it requires an exceptionally strong commodities market for Penn Virginia to even generate satisfactory returns.
The company's balance sheet looks atrocious. It carries $1.2 billion in debt, and hasn't generated a profit since the top of the energy market in 2008. Worst of all, as the price of the stock has plummeted from a high of $81 per share in 2008 to the current price that approaches $1, the company has engaged in massive dilution that precludes the possibility of any meaningful recovery.
During the last moment of profitability in 2008, Penn Virginia had 41 million shares outstanding. Now the company has more than 70 million shares outstanding. Even if prices were to recover, the permanent capital impairment that results from a near doubling of the share count is so severe that any kind of potential recovery is unlikely.
The problem with struggling companies is that they often have to make desperate decisions during the downturns in the economic cycle that ensure eventual ruin. If you ever have a moment, check out page 43 and 44 of the company's annual report (and if not, I'll just summarize it for you). You will see the company mention that, of its $1.2 billion debt load, it has $300 million in senior notes that are due in 2019 and $775 million in senior notes that are due in 2020.
These notes are the reasons why the owners of the common stock are almost assured of getting nothing when the company goes bankrupt. On the 2019 notes, Penn Virginia must pay an interest rate of 7.25% on the $300 million in debt. And on the 2020 notes, the company must pay 8.5% interest on the $775 million notes. The reason why I feel confident that this company will go bankrupt is because it is paying between 7.25% and 8.5% in interest on a billion dollars while simultaneously losing $400 million per year so that it will have to borrow even more, at presumably higher rates given the company's deteriorating condition, just to make the payments on its exorbitant debts.
And once Penn Virginia does go bankrupt, the shareholders will find themselves in trouble. In typical bankruptcy cases, companies are able to realize about 45% of their current assets when they sell their goods. With $2.2 billion in assets, Penn Virginia stands to realize about $990 million when it actually sells the goods. It has $245 million in current liabilities, so the figure will decline to $745 million available. When I mentioned earlier that the notes are classified as "senior", the consequence is that those creditors will stand to collect the $1 billion they are owed before we even reach the common stock holders.
And none of these figures take into account the expected cost of legal fees to execute the bankruptcy, which will be substantial. When you only have $745 million net of sales being fought over by creditors that are owed $1 billion, it is a perfect recipe for common stockholders to receive a total wipeout coming out of the bankruptcy. Remember, the entire $1 billion would need to be paid to the 2019 and 2020 senior debt holders before any of the common stock holders would get a crack at claiming ownership from the asset sales.
On Thursday's conference call, the Penn Virginia management team mentioned that the company had considered selling the company but couldn't find any "credible" buyers. I call this the "Countrywide" principle. Just as Bank of America learned that buying an asset for pennies on the dollar can end up costing you billions, no one wants to acquire Penn Virginia now that it is cheap because the assets are low-quality and the current debt burdens are an extraordinary liability.
I suppose there is always the possibility of a greater fool theory in which the company is purchased at a premium, but that is gambling instead of making an investment decision based on probabilities. Penn Virginia loses $400+ million per year, and hasn't turned a profit since 2008. Oil prices could double, and the company still wouldn't be profitable. There has been massive share dilution, and the debt payments to the 2019 and 2020 senior debt holders are serviced at high interest rates. There is nothing in the fundamentals to suggest that this company is not marching towards bankruptcy.
Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.
This article was written by
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.