Oil States International: More Value In Spin-Off?

May. 9.13 | About: Oil States (OIS)

Investors who are comfortable with the record high level of the stock market and a stock at the top of its 52-week range may want to consider Oil States International (NYSE:OIS) as a momentum or financial structure play, or may want to watch it for dips. While its operations as an oilfield supplier, especially in remote worksite housing, have won plaudits, Oil States excited investors with the possibility it may spin off its accommodations unit into a REIT or other structure, leading to a 17% run-up in the stock price in one day. On May 3, 2013, the company filed an 8-K with the Securities and Exchange Commission confirming its evaluation of a potential separation of its accommodations business. Potential investors should note that activist investor JANA Partners LLC, headed by Barry Rosenstein, has purchased 9.1 percent of the company for $340 million and so is a significant force urging the company to spin off its accommodations unit into a structure that will separately showcase its value. JANA has also urged changes at companies such as Marathon Petroleum Corp and Agrium.

Clearly, Oil States is not a stock for value investors at this time. The major uncertainties in the price are the probability investors assign to a spinoff occurring and the results of any other action JANA Partners may take. However, it is worth looking at Oil States' operations via its most recent quarterly earnings conference call to understand why it earned Rosenstein's attention.

Oil States has four business segments: accommodations, offshore products, well site services, and tubular services. The Accommodations segment is the largest of the four.

Oil and Natural Gas

While an oil bubble, like the natural gas one seen in 2012, remains a risk, oil drilling continues at a strong pace. The emphasis is on efficiency and recovery, on down-spacing and cost cutting. And in a move that clears some brambles for natural gas, the EPA has just declared that its original estimates of gas released into the air during fracturing were too high, and thus the industry is properly addressing containment.

Lynn Helms, director of the Department of Mineral Resources for the North Dakota Industrial Commission, has emphasized that drilling the Bakken is a decades-long proposition, requiring 16-18 years just to develop the play.

The new mantra is down-spacing, or putting more wells into each 1280-acre unit, something Ryder Scott considers economic and Seeking Alpha author Richard Zeits has detailed by company. And, technology continues apace with companies like Approach Resources describing the need to recover more than the 3%-10% of original oil in place in formations like the West Texas Permian.

The Potential Gas Committee just increased its estimate of US natural gas reserves by 25% to its highest level ever: 2,384 trillion cubic feet of technically recoverable gas. US utilities are using more natural gas as its price competes with coal. US industrial and petrochemical companies are expanding their domestic operations to take advantage of the cheaper fuel and feed-stocks, both natural gas and natural gas liquids. Cheniere Energy and others have LNG export projects underway, a market that will support further gas drilling.

New hydrocarbon basins continue to be delineated.

Offshore, companies have adopted the requirements for the post-Macondo world. Recent discoveries include Shenandoah-2: a thousand net feet of oil pay in high-quality Lower Tertiary reservoir offshore Gulf of Mexico in Walker Ridge Block 51. Offshore drilling continues around the world, from Israel to Brazil to western Africa.

Supporting it all for now is continued monetary easing, strong oil prices, recovering US gas prices, and other national economies, like those in Germany and Japan, choosing to replace nuclear energy with coal or natural gas.

Accommodations Segment

The company has drawn notice for its ability to provide temporary and permanent on-site housing in Canada, the US, and Australia. Its competitive advantage is its experience in doing so in remote, isolated areas, like the Athabasca Oil Sands in Canada and through its recently acquired MAC subsidiary, Australian metallurgical and thermal coal mining locations. According to Reuters, this segment accounted for a quarter of Oil States' 2012 total revenue of $4.41 billion. Revenue from the business more than doubled since 2010, when Oil States acquired the MAC Services Group in Australia for $638 million.

According to Cindy Taylor, president and chief executive officer of Oil States, "accommodations revenues increased 7% to $297 million, primarily due to contribution from seasonal Canadian mobile camp activity, partially offset by weak activity in the United States. Earnings before interest, taxes, depreciation, and amortization increased 11 percent from the prior quarter to $132 million. The US market was characterized by competitive pricing, and an overcapacity of equipment, particularly impacting our Bakken business."

For reference, the United States Geological Survey just doubled the estimate of oil reserves contained in the Bakken to 7.4 billion barrels of undiscovered, technically recoverable oil, and tripled its estimate of natural gas reserves there to 6.7 trillion cubic feet. Bakken production has rocketed up during the last few years and North Dakota officials put out calls for housing solutions. Dozens of companies responded. So as Oil States indicates, the Bakken became a very competitive market for accommodations.

In the first quarter of 2013, Oil States announced the opening of the Anzac Canadian Lodge in the oil sands region of Alberta, Canada. The Anzac capacity is 338 rooms and is backed by a one-year contract, with the expectation that it will support other in-situ projects in the region.

Oil States also announced a new Australian village to support metallurgical coal projects - the Boggabri Village in New South Wales, with a capacity of 508 rooms. Oil States average available rooms increased by 631 during the first quarter of 2013, to a total of 20,009. The revenue per available room (RevPAR) was $119.

Offshore Products Segment

In offshore products, the company had $201 million of revenue in the first quarter, and $36 million, or a margin of 18%, of EBITDA. Oil States booked $216 million of new orders in the first quarter, ending with a backlog of $564 million, including subsea pipeline orders for Brazil and West Africa. According to the company, pipeline sales revenues are expected to increase in the second quarter by $205 million to $215 million.

Well Site Services Segment

In well site services, Oil States had first quarter 2013 revenues of $178 million and EBITDA of $56 million. Second quarter revenues are estimated to be between $185 million and $200 million, with EBITDA margins of 32-33%.

Tubular Services Segment

According to the company this segment "generated revenues of $394 million in the first quarter of 2013, compared to $455 million in the fourth quarter of 2012, typically our strongest quarter." The company reports considerable pricing and margin pressure because of higher industry inventory, strong import volumes, and increased US mill capacity. Gross margins are expected to be about 5%.

Overall Financials

On a day when the Dow Jones Industrial Average closed at an all-time high of 15,105, Oil States was only marginally off its 52-week high at $95.47/share. At nearly 55 million shares outstanding, this gives Oil States a market capitalization of $5.2 billion. Again note that Barry Rosenstein's JANA Partners owns over nine percent of the stock.

Per Yahoo Finance, Oil States' 52-week stock range is $60.03-$95.84 per share. Yield investors should note that Oil States pays no dividend.

The company's most recent earnings per share was $7.52, giving it a price-earnings ratio of 13. Its 2013 expected earnings per share is $6.90.

Reported by Forbes and others, David Einhorn, the president of $8 billion hedge fund Greenlight Capital, also favors an accommodations unit spinoff and says that the stock is worth $155 per share, and that the accommodations business alone has a value of $6.9 billion.

Competitors

At a recent Permian Basin oil industry conference, it was clear numerous companies compete with OIS in one or more of its business segments. In accommodations, that includes small and large companies like Target Logistics, Signor Group, Legacy Housing, Cotton Logistics, Sodexo, Remote Logistics International, Palomar, and Palm Harbor. Competition to supply accommodations in the Bakken play in North Dakota and the Eagle Ford and Permian plays in Texas is strong. It is less so in prime Oil States operating areas of Canada and Australia.

In products and services, its competitors include several large companies like Schlumberger (NYSE:SLB), Halliburton (NYSE:HAL), National Oilwell Varco (NYSE:NOV), Baker Hughes (NYSE:BHI), Weatherford (NYSE:WFT) and Cameron (NYSE:CAM). Smaller well service companies are Hornbeck Offshore (NYSE:HOS) with market capitalization of $2 billion, Oceaneering International (NYSE:OII) with market capitalization of $8 billion, Superior Energy Services (NYSE:SPN) with market capitalization of $5 billion, and RPC Services (NYSE:RES) with market capitalization of $3 billion.

Other Factors

Oil States counts among its directors Mark Papa, the chief executive officer of oil producer EOG, a company regarded highly for its operations.

Risk Factors

Note that the ownership of a 9.2 stake by a hedge fund, which is urging a REIT spinoff, adds considerable uncertainty to the stock price. The stock, along with the market itself, has reached an all-time high, suggesting investors expect the accommodations spinoff to occur. This will change Oil States' asset base and hence its valuation. Real estate plays retain strong appeal; note the recent $1.5 billion loan to J.C. Penney secured by its real estate assets.

Also, Oil States is a service provider to extraction commodity businesses. Should interest rates rise or other factors cause commodity prices to fall, both oil producers and their suppliers, like Oil States, may experience lower revenues.

Disclosure: I am long OIS. 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.