Current price: $21.45
Cash Out Price: $30.00
Upside: $850 (for odd-lots)
Expiration Date: TDB
Over the last few days there has been a lot of publicity regarding the risk free opportunity to make $850 from Parker Drilling reverse stock split. While the spread is definitely attractive, I think the risk of this transaction getting cancelled or terms amended is very high.
I do not have any position at the moment.
Parker Drilling (PKD), drilling and well service provider for O&G industry, has decided to reduce its amount of shareholders to less than 300 in order deregister from SEC and delist. The company intends to commence a 1 for 100 reverse stock split followed by a forward stock split, which will result in all shareholders holding less than 100 shares getting cashed out at $30/share. The offer still has to be approved by the shareholders, but as the two main holders (own almost 62%) have agreed to vote for the split, approval seems to be guaranteed. The real risks lie elsewhere.
- The aim of this transaction is $0.8m in annual savings that could be realized by cutting the expenses related to the public listing. This means that there should definitely be a limit of how much the company is ready to pay to buy-out the minority shareholders, especially at 50%-150% premium to market prices before the announcement.
- The initial number of shares to be cashed out was estimated at 37.5k (0.03% of the total) resulting in aggregate buyback cost of c. $1.1m with additional $0.8m for various professional fees related to this transaction. However, due to apparent large risk free upside for smaller shareholders and high publicity, the eventual number of shares to be repurchased will be multiple times higher than the initial estimate. 20x increase in volume after the announcement clearly shows accumulation by odd-lot accounts – hard to imagine anyone else suddenly becoming interested in soon-to-be-delisted stock at large premium to where it was trading just a few days ago.
- Recent transactions with large odd-lot benefits/priority had 10k+ of odd lot accounts (CBS – 12k and FTV – 10k). On top of that, as this is a reverse split rather than a tender offer investors should be able to participate in the transaction from multiple odd-lot accounts under the same name which will add further upward pressure on the number of shares to be repurchased. And while higher risk and smaller market cap are likely to somewhat offset these effects even with 5k odd lot accounts the cost of transaction would jump to $16m. More than a third of that would simply be spent on paying the premium to the market prices.
- There have been numerous cases where similar transactions (with lower premiums) got cancelled or modified due to the increased odd-lot accounts number. The most recent is BLBD – a tender offer with odd lot priority and $200 potential upside. Transaction has received considerable attention from investors and 3 weeks later the company removed the odd-lot priority. BLBD stock dropped below $23/share (pre-announcement price was $26/share, offer price – $28/share) and stayed under $24/share right till the expiration date. In the end, the offer ended up being oversubscribed by 12x (6.6% proration) and BLDB stock fell down significantly in the following two weeks. Instead of risk-free $200 odd-lot speculators (including me) lost around $300-$600.
- Aside from cancelling the transaction outright PKD might also change the cash-out price or amend the terms that only shareholders of record (rather than beneficial owners) with less than 100 share ownership would get cashed out. Monarch Cement deregistered this way back in 2014 by reducing the count of record holders to less than 300. So it seems that this road should be open for PKD as well.
When PKD announced it’s intentions to deregister and delist shares dropped to $16 and only bounced back to current levels after odd-lot accounts started piling due to high cash-out price. For the whole August after Q2 result announcement PKD shares traded within $12-$17 range. Thus, if the reverse split terms are amended or transaction is cancelled altogether, PKD shares will likely trade significantly lower – at least 25% downside.
I struggle to understand why would PKD announce such transaction terms. I doubt management (together with bankers/lawyers working on this transaction) did not foresee the spike in odd-lot accounts. One of the possibilities (and I am just purely speculating) is that $30 odd-lot cash-out was announced already with intention to cancel/amend later. In this way liquidity is created in the market that allows larger shareholders (who have no willingness/abilities to own delisted stock and who might have objected the transaction) to exit their positions at a premium and at a zero cost to the company.
Additional points on Parker Drilling
PKD management claims that the company is undervalued as it only recently came out of the bankruptcy (March’19). The company trades at 2.3x LTM EBITDA and 2.5x Forward EBITDA which is materially below peers on both metrics.
PKD wend bankrupt in Dec ‘18 and came out of it in Mar ‘19 with debt reduced by two thirds (from $585m to $210m).The company has also raised an additional $95m through rights offering (at $15/share) and currently sits on $139m of cash. Coming out the bankruptcy and rights offering company was/is mostly owned by previous note-holders.
The bankruptcy was caused by the aftermath of to 2014 oil price crash that affected the whole O&G industry. PKD was operating unprofitably ever since 2014 and managed to turn profit only in the recent quarter ($0.31/share).
CEO portrays this recent improvement coupled with far more flexible balance sheet as a sign of successful turnaround. Despite continued challenging environment in the U.S., he is optimistic about operations in foreign markets (58% of revenues):
The strategic changes we made were timely, as there remains a considerable amount of uncertainty in the marketplace, particularly with respect to North America fundamentals. In the U.S., many EMP companies are reducing their CapEx budgets, slowing drilling activity, and demonstrating a greater focus on shareholder returns, all while production continues to rise. Service pricing also remains challenging, due both to falling rig activity as well as excess capacity in the marketplace. By contrast, the international markets appear to be strengthening and will likely continue to do so throughout the rest of the year and into 2020. There has been a good deal of positive EMP sentiment overseas, with tendering and drilling activity increasing. This healthier market environment is evidenced by our year-over-year improvement in revenues and growth margin, both in our international rental and drilling segments.