Three Candidates for the Next Offshore Energy Deal

Includes: BHI, HAWKQ, TTI
by: James Shell

We could see the logic in the Ensco (NYSE:ESV)/Pride (NYSE:PDE) deal after a little analyisis, but it would be even more interesting to find a couple of acquisition candidates in the area of offshore energy equipment and services before the deal is consummated -- and it turns out there are a couple.

The first thing is, the candidate companies have to be pretty big, otherwise why bother? Anybody that is looking for an acquisition in this business is doing so to increase market share or get themselves into a part of the world where they are not already. Secondly, the candidate company should be underperforming from a net margin standpoint, like PDE was, for whatever reason. The reason might be operational in nature, but could just as easily be some other temporary situation that is uncontrollable or otherwise can be corrected by a little effort. Finally, there can't be an excessive amount of debt or other baggage on the books that might make the deal more risky.

So here are a couple of interesting stories that might fall into this category:

Market Cap ($M) LTD Other Total Gross Marg Net Marg 2008 Revs
Seahawk Industries HAWK 91 0 0 91 n/a n/a 682

I am not going too far out on a limb here; HAWK has engaged Simmons & Company to look for "strategic options," so this one is only a matter of time.

HAWK went from revenues of $681M in 2008 to down around $30M per quarter currently. It operates a fleet of around 20 drilling rigs of various types in the Gulf of Mexico and obviously is struggling with the current drilling/permitting situation down there. According to its most recent investors presentation, out of its 20 rigs, 10 are mothballed semi-permanently; of the remaining 10, a couple are "available," while about half of the remainder are waiting for permitting to happen sometime in February or early March; the other half are completing jobs in roughly the same time frame. Thus there is a bad-case scenario of permit delays that says HAWK could have only one working rig in April.

The bright side for HAWK is that it has no long term debt, and the nominal "loss" that it shows on its books every quarter is due to depreciation expense on the part of the fleet that is still active. As of its last quarterly report, HAWK had $41M in cash on the books, and had negative cash flow of about $6M per quarter, so it can keep the game going for a while longer. HAWK does have some short term debt plus some accounts payable, so it's obviously stringing out its suppliers to preserve some cash.

So here's the thing: The stock has gone from 0.35 to 7.42, and the current market capitalization is $91M, so if you wanted or needed to buy 20 oil rigs that would come to a little under $5M per rig ... and that might be a pretty attractive price. I am not enough of an expert in this type of equipment to tell you exactly how attractive, but it is obviously dependent on the condition and type of rig.

So this one is going to happen, and pretty soon; the speculation is how much a slot-type jackup oil rig costs to build from scratch, or alternately how much scrap steel can be extracted from 20 of them vs. the $91M market capitalization.

Market Cap $MM LTD Other Tran Cost $MM Gross Marg Net Marg 2008 Revs
Tetra Industries TTI 895 300 100 1195 39% 1.40% $1B

Tetra Technologies is more of a longshot, because it does have a little long term debt, but this business had $1B in revenue in 2008, and is down about 10% from itss high point. TTI's peril was a lot of destruction caused by Hurricane Ike, from which there is still $100M or so in dispute with the insurance companies.

TTI's offshore part of the business is less than 1/3 of its revenues, and is not really drilling as much as it is closing down old wells, and a variety of other services that are going to become increasingly important, particularly as this activity is getting more scrutiny.

There are three main businesses; here's a breakdown:

Offshore Fluid Other
Revs 225 200 140
PBT 30 18 26
PE Ratio 15 15 15
Potential Mkt Cap 450 270 390
Total 1110

The offshore business has revenues of $225M, with a PBT of $30M, and at an industry-typical PE ratio of 15; that business alone, spun off, would be worth $450M market cap, probably even more because at a ratio of about 13% PBT to sales. It's not doing as well as some of the others who are in the high 30s, and could have its "value enhanced" by someone else in this business.

It also runs a well-thought-of drilling fluid business which could be worth $270M, and a couple of other smaller businesses, one of which is to service older oil wells to extract the last drop out of them -- an attractive business to be in; that combined segment is its most profitable.

The final kicker is that in addition to this, TTI also owns 7.1 million barrels of crude oil reserves and an additional 33.5 bcf of natural gas reserves.

So you can see that if you were really interested in getting its offshore business for one reason or another, you could just about accomplish the deal by selling the other two businesses plus the reserves.

There is one main barrier to doing this: The debt. You really need about $1.2B to buy the company and get rid of the debt. You can get about $660M by spinning off the other two businesses, you'd need to get about $540M for the reserves, and that all depends on the geologists and engineers, the oil price, and the discount that you'd have to pay because the hydrocarbons are still underwater.

The second barrier, if you want to call it that, is that it had a couple of good quarters, the stock has gone from 7 to 11.42 since September; the higher it gets, the less attractive the deal is. It would have been a much better deal then.

But in its last presentation TTI indicated its desire to exit the hurricane-prone "risky" part of its business. Management feels that its current stock price still does not reflect the value of the business, even at the industry average PE, and you don't know what will happen with either its stock price or the oil price to make the deal potentially more attractive.. Plus, you know that Ensco was willing to pay a pretty big premium for PDE's business, which was performing at about the same level, so someone might come along who is interested enough in the business to do the transaction.

Finally I would mention in passing Baker Hughes (NYSE:BHI). Its market capitalization is $29B; it also had a couple of good quarters; and the stock has gone from 50 to 70 since September. It is too big and doing too good of a job to be bought out by anybody, but it is fanatical about tracking oil rig activity. It predicts that most of the world's expansion in drilling actvitiy in 2011 will be in North America, where there will be a need for roughly 200 more rigs.

So there is going to be demand for rigs. You can probably see the day rates go up, particularly if the oil price goes up, and so there are some prospects. BHI's also big enough, and has deep enough pockets, to be on the other side of either of these transactions.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.