Original Counterarguments and Updates
Ownership: As mentioned in Part One, Howard Mark’s Oaktree Capital Management held a (very small) long position in GNK, which was concerning as he is a top-notch operator. We now know that Oaktree has sold off its entire stake in the company. Chuck Royce has a position as of his last filing, but it accounts for only 0.01% of his fund.
Update: GNK’s largest shareholder, Nevada Capital Corporation, had accumulated 7 million shares in 2011. As of its most recent third quarter filings, Nevada has reduced its stake from 7 million shares to now only 2 million shares, realizing a huge loss. Likewise, Vermillion Asset Management, another large shareholder, trimmed its ownership by roughly a third back in the second quarter, from 3 million to 2 million shares. Presumably, these are among the most informed shareholders and they have backed out.
Price to Book Value Metric: No change. GNK’s P/B ratio continues to hover around 0.1.
Lender Forbearance: No news directly on this topic. As noted in Part Two, however, the company’s third quarter conference call covered the debt situation in a painfully circumspect way. It was nevertheless clear that the company’s debt was changing hands, namely from banks to “non-traditional lenders.”
Update: Since the publication of Part Two, news of an additional large scale sale of debt has emerged, namely from DNB, a Norwegian Bank, to an unnamed third party. It is unlikely that non-traditional lenders will continue to be as patient as the banks when it comes to not getting paid. Furthermore, on the topic of publicly traded debt, the company’s 2015 5% notes had been trading at 45 as noted in Part One. As of yesterday, that debt has slid to 35.5, providing a phenomenal yield to maturity of 39%. Here too, it seems clear that this debt is being dumped by GNK’s creditors.
Additional Updates and Corrections
Tilson: In Part Two, we noted that Whitney Tilson had a short position in GNK, namely in put options (the same type of position we had recommended).
Update: After corresponding with Mr. Tilson, we note that the position in question is held not by Tilson himself, but by his former partner Glenn Tongue. We have also informed GuruFocus of the misattribution.
Short Interest: The short interest in GNK rose between Oct. 15 and Nov. 15 from 6.4 million shares sold short to 9 million shares. This is not in itself a meaningful reason in support of the short thesis, but does point to likely high future volatility (up or down!).
Insider Selling: Perhaps the most important update, after news of Oaktree’s exit, is the news that both the president and CFO have sold shares of GNK on Nov. 15. Insider selling is not necessarily a good indication in a typical situation of an impending share price decline. However, in this situation, it is quite telling because of the extreme valuation. During the company’s conference call, we were told of GNK’s bright future with respect to improving fundamentals in the dry bulk environment (or, to be more exact, the company’s assertions that the dry bulk industry had forthcoming improvements based on projections).
The company’s stock is selling at one-tenth of book value and, if it survives, should be worth substantially more. So, if you are the CFO holding stock whose restrictions on sale have just been lifted, and if you believe the negotiations with lenders are going well, why in the world would you sell your stock at one-third or one-fifth or even possibly one-tenth of its value when you could just hold on for a while?
We have all heard about reasons why executives might sell or would be forced to sell (taxes, personal cash needs, etc.). But to sell at such fire-sale prices in the face of the company’s own proclamation that GNK is about to exit the doldrums defies reason.
Continuing the research into the short thesis has not led very far into reasons to take a bullish position. Two possible reasons have been circulating of note: the value of GNK’s holdings in (1) BALT and (2) JIN:NO.
The easier of the two to examine is Jinhui Shipping and Transportation Limited ( JIN:NO) . GNK had previously acquired 16 million shares in Jinhui, which manages Supramax dry bulk vessels and is traded on the Oslo stock exchange. Jinhui has had quite a run-up recently in stock price, providing a substantial paper gain to GNK. There are two major issues, however, with viewing Jinhui as a salvation to GNK’s immediate financial dilemma.
First, Jinhui Shipping is majority owned and controlled by a tightly held holding company called Jinhui Holdings Company Limited. So, while GNK owns a large stake in Jinhui Shipping, a “strategic buyer” interested in control would not be interested in GNK’s position.
Secondly, Jinhui’ s trading volume is extremely low with only an average of 128,000 shares trading daily on the Oslo exchange. To put this in perspective, GNK’s stake of 16 million shares is the equivalent to the entire volume in 125 days of trading. So, GNK could not just dribble out the shares without affecting the price in a very real way. This leaves institutional investors (@StratCap) as the only exit. Since the exit would involve transferring a block of shares that are non-control, minority and illiquid, it may be difficult for GNK to achieve the transaction at a good price, if at all. GNK would be immediately labeled as a “motivated seller” and may have to sell at a discount. And GNK does not have much time to shop this around.The picture with GNK’s ownership in BALT is more complex. As mentioned in Part One and Part Two, GNK has voting control over BALT through its ownership of a super-voting class of shares. GNK’s economic interest in BALT is, however, only about 12%. Using round numbers, the economic interest equates to about $34 million in value at the current market capitalization of BALT as of the writing of this article. To a strategic buyer, the control block may be worth substantially more. A generous 50% premium over the economic interest equates to $51 million, which is just about the amount of GNK’s debt amortization payment due in March 2014. So, a lucky sales to a control investor might provide breathing room to GNK.
But, would it really?
In addition to GNK’s immediate cash needs for the amortization payment, GNK is also in violation of two loan covenants – its maximum leverage and minimum interest coverage covenants. Those covenants were breached in May of 2013, whereby GNK was forced to reclassify its long-term debt as a current liability. Time has not been kind to GNK and it is doubtful that its ratios have improved. Most likely, given the negative cash flow and negative earnings, they have gotten worse (this is entirely guesswork, but not a hard guess!). In addition, a $48 million amortization payment is peanuts compared to total liabilities of $1.8 billion as per third quarter financials, meaning GNK would likely (again, guesswork only) continue to be in violation of its covenants even if it sold BALT shares to raise cash. Once again, the conclusion is that GNK exists and will exist only by the grace and patience afforded it by its creditors.
A further twist has to do with price: Why buy BALT control from GNK at a premium now, when a potential control investor could pick it up even cheaper in a bankruptcy proceeding?
As disclosed in Part I & II, I held a very small position against GNK using put option contracts. Since that time, I have sold a portion of that position that moved into the money at a nice profit and have rolled that and some additional funds into a new put position, extending somewhat the time horizon and lowering the strike price (effectively levering up the position). The positions in the aggregate now account for about 1.5% of my investable funds, which is much higher that I might otherwise feel is prudent for a short position with puts. But, the payout seems really quite attractive.
By way of illustration, April 2014 puts with a strike price of $1.00 could be acquired (as of yesterday) at the price of $0.15. Should GNK slide into bankruptcy, the puts should pay out at, say, $0.95 or a gain of 6x on the initial investment in the put premium. Even if the likelihood were only one in three of this outcome (i.e. if we assign a two-thirds chance that the puts will expire worthless), the value of the puts are roughly 30 cents but are selling at 15 cents. And that does not account for other outcomes other than bankruptcy – should the company’s current equity owners be heavily diluted, the stock may trade at, say, 50 cents, meaning the puts in that scenario would be worth 50 cents at expiration for a return of 3x.
The future is unknowable. I would love it if I had ten short positions of equal conviction, allowing me to spread the risk of an unfavorable outcome over more positions. But, I do not. Good luck to you. Feedback most welcome.