Weatherford (WFT) has attracted a bit of attention recently due to buying pressure from hedge funds such as Orbis Investment, SAC Capital, T Boone and even George Soros. Whether these are speculative or fundamental plays is yet to be discovered. Nevertheless, there certainly are reasons both for buying and for staying away from this highly volatile stock.
Staying Away From It
Reasons for staying away from this stock or even shorting it are vast. First of all, the company is not currently profitable, period. Considering the last four quarters, two have shown positive income and two haven't. Tax losses, severance payments, high professional fees (due to major accounting problems), etc, have become a constant rather than one-time items.
As mentioned before, accounting issues have been a headache for the shareholder, since management has had to restate SEC fillings once and again, not to mention that several income statements from the last few years will probably be restated yet. Income restatements add a deep layer of uncertainty to any investment, especially if shareholders don't believe that management can turn things over. Whether management can indeed turn things over or not is the big question. Debt is a huge concern as well. As of 2012-09-30, total debt was $8.9 billion, versus a total equity of less than $9 billion. For every dollar of equity, the company owes another buck to its creditors.
Total debt to assets sits at 36%, also very high in comparison to its peers. Weatherford's ROA is the worst among its competitors, standing at roughly 1.50%. Divestment at this point is not a strategic option, rather a means to survive. In other words, Weatherford has a bunch of nonperforming assets in its balance sheet and needs to get rid of a whole lot of them. It remains to be seen if these low return assets will be sold at, above or below their book value. Increasing its return on assets is a must, not to mention that - when sold - many of these assets will add some much needed cash to the enterprise's already battered cash position. The cash position is an issue, standing at $365 million, against short term debt of more than $ 1.2 billion. Things have changed a bit from September '12, but this will be discussed later on. Let's just say that free cash flow remains a problem (mainly due to incredibly high capital expenditure) and it may become more difficult to finance the enterprise's operations if not resolved.
Capital expenditure has soared in the last few years, but the problem here is - all over again - that these new assets perform astonishingly low. Weatherford hits record revenues every quarter - partly due to high capex in the most diverse areas - but still doesn't turn revenue into income. Furthermore, there are other issues at hand that have affected the company's image with its stakeholders, for instance, investigations from the DOJ on FCPA violations, such as conducting business with sanctioned countries, plus an investigation from the SEC regarding inconsistencies in its income tax reporting, as mentioned before.
Going Long WFT
However bad the picture above seems, there are reasons for purchasing a piece of this company. All in all, the business is great. Its product and service portfolio is as good as, if not better than, most of its competitors (SLB, HAL, BHI). Revenue has skyrocketed in the last few years and keeps beating estimates every quarter. WFT has growing international exposure, something that has helped offset a rather hindered North American market. Even if the company does have a large exposure to the Canadian and US markets, business in Latin America and all over the world has grown in recent years. It is true that margins have declined almost everywhere, but that fluctuation is also part of this business, as we can see when we compare margins with its peers.
On the bright side, we can acknowledge the effort that management is bringing on to fixing its tax and financial reporting weaknesses. Professional fees will hopefully decrease substantially from Q2 2013 onwards. Capital expenditures are being targeted and will hopefully decline from 14% of revenue (2012) to 10% of revenue (expected 2013). A better working capital handling is needed and management is compelled to work towards reaching this goal. Other metrics that have improved last quarter are net debt (-$207 million), DSI and DSO. All of these efforts have to do with improving working capital efficiency or, in other words, using its debt and cash wisely. The CFO and CEO have made a commitment to get rid of low performing assets in the next few quarters, and this is great news. Not only the cash is much needed but, overall, all these widespread assets do not allow the company to focus on businesses that are indeed profitable.
Tax, accounting and treasury operations are, by and large, the most troublesome of all matters. Weatherford's stock price will depend, most certainly, on how fast and well these material weaknesses can be resolved. Work is in progress, and the company seems to have come far from the early days of income restating, SEC charges, late filing, etc. However, as this trigger may be positive for the stock, it may be awful as well. On the other side, the uncertainty seems to be priced in the stock, given it is trading at less than 1x book value and about 9x forward 2014 earnings, according to analyst expectations and research from the author of this article. This doesn't mean that the company is undervalued; on the contrary, the market is correctly pricing its risk. Weatherford is fairly priced right now, but it might well be potentially undervalued. If, and only if, management is able to turn things the right way, the upside most certainly compensates for the potential risks. Still, there is no clear margin of safety here. Supposing that management does turn things around, we can be expecting the stock to be trading at 15x earnings (and that is already less than its peers, who range between 16x and 20x). We would then have an approximate target price of $ 19.00 / $ 20.00. That is a huge upside of approximately 65%. The time frame depends on how fast can management correct all these issues and whether the market as a whole performs, but it wouldn't be reckless to say that the target price could be reached in 18-24 months.
With all its weaknesses and lack of safety margin, we still believe that WFT is an attractive investment for a risk-seeking investor. However, this opportunity seems to carry a premium reward, since we are talking about a good company struck by poor market conditions and problematic management. Since we discussed WFT's great products and services, it would be interesting to point out that, considering that management continues on its track of letting its shareholders down, the company may be ripe for a takeover. Trading at less than 1x book value, having a 9x forward PE, a broad range of customers in almost every country, and being well positioned in the energy business, make it an attractive takeover target. There are talks about GE buying WFT, but anything is not even remotely official yet. Nevertheless, one shall not say that that wouldn't be a smart play. If that really does happen, then the stock could soar rapidly, even if it would take months or even years for a large conglomerate to absorb WFT and make it as profitable as we shareholders would want it to be.
Disclosure: I am long WFT.
Additional disclosure: I am a former employee (2007/2012), and have no business relationship with the company other than being long its stock. All the information, opinions and point of views were pulled and/or interpreted from public records, such as the company's website, investor presentations, conference call transcripts, SEC filings and other sources as quoted in the article.