Our firm previously held a position in GASFRAC Energy Services (GSFVF.PK), the innovative well-fracturing company which has developed a patented waterless Liquid Petroleum Gas gel. We had sold our position earlier in the year but we had reevaluated our thesis on GASFRAC in June. We took a second look at GASFRAC when the share price had declined from $5.32 to $3.60 in the 60 days after it released its Q1 EPS warning. We concluded that it was a worthy company to invest our time in additional research, analysis and evaluation but it was not worthy of reentering a long equity position at that time. We followed up our June research report by analyzing and evaluating GASFRAC's second quarter results. We concluded that although there were positive takeaways from the period, we were concerned about the poor financial management and operational execution during the period. While we were glad to see the stock price get cheaper in order for us to reconsider reentering the company, we had no immediate plans to reenter as we saw that there was significant operational risk in the company during the period. Based on the recently announced management shake-up, we believe that investors should not have an equity interest in the company until the company straightens itself out.
On September 11th, GASFRAC announced that the Chief Executive Officer Zeke Zeringue and the Chief Operating Officer Steve Batchelor would be leaving the company immediately. This was a major curveball out of left field for us as Zeke and Steve were only in the job since November 2011. Furthermore, the only executives of GASFRAC that had predated Zeke and Steve were the CFO James Hill and Robert Lestz, the Chief Technology Officer of GASFRAC's US Subsidiary. We were especially surprised to see the departure of Messrs. Zeringue and Batchelor since under their leadership, GASFRAC had started to rationalize its capital expenditures program. In Q4 2011 GASFRAC spent $36.2M on capital expenditures. In Q2 2012 GASFRAC only spent $15.4M. While we are aware of seasonality variations in GASFRAC's business that may make quarter-on-quarter comparisons less comparable, we have noted that year-over-year CapEx spending for GASFRAC declined by 43% in Q1 2012 and by 31% in Q2 2012.
Source: GASFRAC Financial Statements
There could be a number of reasons why Zeringue and Batchelor were let go. We have noticed that GASFRAC's founder Dwight Loree is still on the board even though he retired as CEO and maybe he wasn't happy with the fact that Zeke and Steve were there to point out that the company expanded too far too fast. Maybe GASFRAC was looking at terrible results in the Q3 period, especially in relation to its competitors. Maybe GASFRAC was about to have a good quarter and Dwight Loree was playing the part of Pat Riley to Zeke and Dwight's Stan Van Gundy. We were willing to see how the company responded to its terrible Q2 2012 earnings miss before determining if there needed to be a management change.
GASFRAC also announced that it was undertaking an operational review to ensure that its current infrastructure was appropriate to support operational efficiency while ensuring long term profitability, sustainably and the continued growth of the Company's proprietary LPG Fracturing technology. We couldn't help but laugh at this language in the press release. Talk about an understatement! That's kind of like saying that the Grand Canyon is a big hole in the ground. Considering the rapid level of growth in annual CapEx from $3M in 2006 to $125M last year and an estimate of $90M in 2012, we can plainly see that the company's growth was unsustainable relative to the level of cash flows generated. We thought that Zeringue and company were coming to that conclusion as CapEx has declined by 39% in H1 2012 versus H1 2011 levels in light of GASFRAC's light utilization rate levels. Andrew Bradford of Raymond James believes that the company may sell some of its underutilized assets.
In conclusion, we believe investors should keep GASFRAC on their watch list. However we believe that investors should also steer clear of a long equity position until the company manages to straighten itself out. We believe that the company has great potential due to the drought in North America offering potential for waterless fracking products and solutions to step in to fill the void for oil companies who are not necessarily able to obtain the water needed to perform fracking operations to drill for oil and gas. However we are seeing a number of operational and management execution issues that make us pause at actually reentering a position, even as a speculative bet for well-diversified accredited investors ($200K annual income and $1M in liquid net worth). Even former GASFRAC Bull Nawar Alsaadi has registered criticism of the company recently. We will be watching the company because we have an interest in the natural gas markets in relation to utility stocks we cover but we believe that unless investors can get Warren Buffett-like special terms on their investment in GASFRAC, they should steer clear of the company as we believe that the management and operational issues more than offset the growth potential of the company over the near-term time period.
Disclosure: This article was written by an analyst at Saibus Research. Saibus Research has not received compensation directly or indirectly for expressing the recommendation in this article. We have no business relationship with any company whose stock is mentioned in this article. Under no circumstances must this report be considered an offer to buy, sell, subscribe for or trade securities or other instruments.