GulfMark Offshore: Insolvency Ahead? – Seeking Alpha

This might be the last chance to sell or short GulfMark Offshore (NYSE:GLF).

GulfMark's Highland Knight. Source: Adrian SPye, Creative Commons.

Cash Running Low

The company's last financial statements are from Q3 2016. GLF shareholder equity fell from about $1 billion in 2014 to $518M last quarter, a decrease of almost 50% since the beginning of the market downturn. The company operates 71 vessels that provide support to offshore operations of the oil and gas industry, and fixed assets' carrying value has been impaired in the last months. The cash position is $10 million, and working capital is $23 million. But cash flow last quarter was -$12 million.

The cash from financing is mostly from increasing debt. At this burn rate the company should have already run out of cash by Q4 2016, and all working capital will be gone in by Q2 2017. Also, the company disclosed in their last 10-Q a cash commitment of $24 million:

We have a vessel under construction in Norway that was scheduled to be completed and delivered during the first quarter of 2016; however, in the fourth quarter of 2015, we amended our contract with the shipbuilder to delay delivery of the vessel until January 2017. Concurrently, in order to delay the payment of a substantial portion of the construction costs, we agreed to pay monthly installments through May 2016 totaling 92.2 million NOK (or approximately $11.0 million) and to pay a final installment on delivery in January 2017 of 195.0 million NOK (or approximately $24.4 million at September 30, 2016)

The company's access to the revolvers is subject to the valuation of the collateral (vessels) that could be further impaired in quarters to come, and many other inconvenient covenants that:

This latter point might ultimately prove to be a killer because the company is operating at a negative EBIT.

What's Next?

According to Stein's Law: "If something cannot go on forever, then eventually it must stop." Sooner rather than later, GLF will be unable to pay the interest on its debt (carried at about $473 million). GLF debt has been trading at deep discounts, between $30 and $65. The current prices around $60 represent a 100% rally from historic lows.

As previously mentioned on Seeking Alpha, a group of hedge funds has acquired a significant portion of the debt. Based on the table above, I believe their cost basis for the debt could be between $140 and $310 million. In other words, after a hypothetical bankruptcy, they will have acquired the company and its 71 offshore vessels at about $2 to $4.5 million each.

Market price of GLF debt. Source: Borse Berlin.

Worse Than Insider Selling

On March 7, the company disclosed the resignation of William Martin as a director. Martin is the CIO of Raging Capital Management, an investment fund that as of Dec. 31, 2016, was GulfMark's largest shareholder. This development might reflect differing interests between Raging Capital as a shareholder and as a bond holder.

Competitive Position

One of the main markets for GulfMark is the North Sea. In this region, the industry has begun to see consolidation through a three-way merger between Solstad Offshore (the aqcuirer), Farstad Offshore, and Deep Sea Supply. This deal is illustrative of what can happen to a distressed OSV (offshore support vessel) operator. After heavy losses, Farstad had an unsustainable capital structure:

Source: Created by author with data taken from Farstad's financial statements.

The company reached a restructuring deal with their debt holders that includes:

After the deal, old shareholders would keep 0.8% of the company:

Source: Created by author with data taken from Farstad's restructuring press release.

Immediately after this restructuring, Farstad and Solstad will merge through a stock-for-stock transaction. The ratio will be 0.35 shares of Solstad for every 12.5 shares of Farstad. Immediately afterward, Deep Sea Supply will merge into the new "Solstad Farstad." This new company will be a major global player in the industry, with a fleet numbering 155 vessels. The share of vessels provided by each predecessor is as follows:

Source: Created by author with data take from the companies' websites.

There are many differences among vessels in design, deadweight tons, etc., but this provides some insight about the merger. The actual ownership of the resulting entity will be split in such a manner that Farstad post-restructuring shareholders will own 59% of the company.

Solstad Farstad ownership will be as follows:

Source: Created by author with data from Farstad's restructuring press release.

There is, certainly, some important dilution for continuing Solstad shareholders: Now, they collectively own just 31% of the resulting company. But this could prove highly beneficial for them since they have received an almost debt-free Farstad, and the total debt/equity ratio is going down.

Contrast and Compare

One of the approaches I learned from Benjamin Graham is to compare the financial information of several companies to try and find which one has a better relative valuation. For example, I've taken the main, public American OSV companies:

Note: Income figures are in thousands. Source: Created by author with data taken from the companies' financial statements (GLF Q3 2016, TDW and HOS Q4 2016).

Only Hornbeck Offshore Services (NYSE:HOS) has positive cash flow, and their CEO announced plans to position the company as an acquirer in the industry.

Highway to Liquidation

Debtholders in the OSV industry face three scenarios:

1. The company is strong and there's little fear of a default under any circumstances.

2. The company is near insolvency, so it can be readily taken over and liquidated, merged, etc.

3. The company is in trouble but insolvency could happen a few years from now. By then, demand for secondhand vessels is going to be close to zero. This situation offers the least chance of recovering the principal.

It is in the best interests of debtholders to sell the underlying assets as fast as possible. Time works against them: As months go by, more cash is burnt by the companies and other foreclosures satisfy the secondhand vessel demand. I believe that intelligent debtholders will try to accelerate the realization of the company's assets, as long as they keep some resale value. The urgency will decline as the fleet approaches scrap value.

Catalyst

Tidewater (NYSE:TDW), the industry leader, is expected to announce either a restructuring or a bankruptcy on Monday, March 13. This could have contagious effects on the rest of the industry. Currently, the company does not comply with the debt covenants, and debtholders have been granting temporary waivers in order to avoid a default situation. Management has already warned that "it is likely that the shareholders' ownership interests will, at a minimum, be significantly diluted." It isn't pleasant for shareholders to be at the mercy of vulture funds.

The Effects of Consolidation

The OSV market is grossly oversupplied, and it is almost impossible to sell a fleet one vessel at a time. In many countries, cabotage laws restrict the operation of foreign-owned or foreign-flagged vessels, notably in the American Gulf of Mexico. Finding buyers will be harder as time goes by. Therefore, debtholders who want to maximize the probability of recovering their principal need to dispose of their fleets in the most value-adding manner. In the North Sea, Farstad's debtholders essentially wiped out the equity and traded the company as a whole. In return, they get shares of a promising industry leader that they can sell immediately in the stock market.

Now, consolidation is very bad news for the acquired companies (Farstad shareholders essentially got wiped out). There are many other Farstads out there and their shareholders face permanent capital losses. There is still a lot of pain coming for the equity in this industry.

Key Takeaways

Disclosure: I am/we are long HOS.

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.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

More:

GulfMark Offshore: Insolvency Ahead? - Seeking Alpha