I have been thinking about Brigham Exploration Co. (Nasdaq: BEXP) off and on since last August, when U.S. Energy Corp (Nasdaq: USEG) entered a drilling participation agreement with Brigham in Brigham's Bakken oil properties. Today I shorted BEXP at $13.11. Because BEXP was in financially dicey straights back then (it had an Altman Z"-Score1 in the distress zone. ), and was coming up on a drilling deadline, cash-rich, prudently-managed USEG was able to enter this deal on favorable terms. As I have mentioned on my previous blog, USEG has a number of other irons in the fire besides its drilling participation deal with BEXP (e.g., its geothermal investment, its molybdenum property, its uranium properties), but it's been the BEXP deal that has largely driven USEG's stock price since the deal was announced. See how USEG's stock price starts moving at the end of last August:
[caption id="attachment_50" align="aligncenter" width="512" caption="USEG versus BEXP"]
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Since I shorted a dollar amount of BEXP equivalent to my long position in USEG, and since both stocks have been moving in recent months mainly on news of their shared Bakken deal, this is essentially a pairs trade (USEG was trading at $5.07 when I shorted BEXP today, but my average cost on USEG is about $2.80). Currently, USEG has an Altman Z"-score of about 12.4 and BEXP has an Altman Z"-score of about -2.6. Scores above 2.6 are considered to be in the safe zone, and scores below 1.1 are in the distress zone. Short Screen's Altman screener currently lists BEXP as one of the 50 most-distressed companies among those with a price per share at or above $12.
1Recall that Professor Edward Altman created his original Altman Z-score model to predict the default risk of manufacturing companies. In its initial test, the Altman Z-Score was found to be 72% accurate in predicting bankruptcy two years prior to the event, with a Type II error (false positives) of 6% (Altman, 1968). In a series of subsequent tests covering three different time periods over the next 31 years (up until 1999), the model was found to be approximately 80-90% accurate in predicting bankruptcy one year prior to the event, with a Type II error (classifying the firm as bankrupt when it does not go bankrupt) of approximately 15-20% (Altman, 2000). The Altman Z"-Score is Professor Altman's modified formula designed for application to non-manufacturing firms. For more on the Altman Z"-Score, including an example of it in action, please see Applying the Altman Z"-Score Model to a Non-Manufacturing Company.
[caption id="attachment_50" align="aligncenter" width="512" caption="USEG versus BEXP"]
[/caption]Since I shorted a dollar amount of BEXP equivalent to my long position in USEG, and since both stocks have been moving in recent months mainly on news of their shared Bakken deal, this is essentially a pairs trade (USEG was trading at $5.07 when I shorted BEXP today, but my average cost on USEG is about $2.80). Currently, USEG has an Altman Z"-score of about 12.4 and BEXP has an Altman Z"-score of about -2.6. Scores above 2.6 are considered to be in the safe zone, and scores below 1.1 are in the distress zone. Short Screen's Altman screener currently lists BEXP as one of the 50 most-distressed companies among those with a price per share at or above $12.
1Recall that Professor Edward Altman created his original Altman Z-score model to predict the default risk of manufacturing companies. In its initial test, the Altman Z-Score was found to be 72% accurate in predicting bankruptcy two years prior to the event, with a Type II error (false positives) of 6% (Altman, 1968). In a series of subsequent tests covering three different time periods over the next 31 years (up until 1999), the model was found to be approximately 80-90% accurate in predicting bankruptcy one year prior to the event, with a Type II error (classifying the firm as bankrupt when it does not go bankrupt) of approximately 15-20% (Altman, 2000). The Altman Z"-Score is Professor Altman's modified formula designed for application to non-manufacturing firms. For more on the Altman Z"-Score, including an example of it in action, please see Applying the Altman Z"-Score Model to a Non-Manufacturing Company.
