This blog is written in response to the bear case articulated by Christopher Wallace on 11/26/13.
Bear objection 1: High leverage
Bull response 1: The appearance of high leverage is temporary and caused by acts of G-d in 3Q13.
Adjusted EBITDA for 9ME3Q13 was $14.9mm versus $29.2mm during the prior year period. This is because 3Q13 EBITDA was -$8mm versus $6.9mm in 3Q12. It's important to note that nothing fundamental happened to the earnings power of this business, and that the multiple is still extraordinarily low. Accidents do happen, but not often, and it's a mistake to believe that the acceptation is the norm. If it were the norm, SAEX would simply not have made it this far, nor would any of their competitors.
So, I think management will be gunning to hit their 2014 EBITDA target, which links to a compensation bonus. Note that SAEX added a full time IR person in the quarter, so we should not only expect better numbers next year, but enhanced communication about those numbers.
Bear Objection 2: High cost debt
Bull Response 2: Refinance coming in Feb 2014, frees up $5.4mm/yr
The $80mm 13.5% term loan debt is callable in February of 2014 when the company has said it plans to refinance at a lower rate. This term loan was expensive because the company was private at the time it was arranged, and lenders worried about reclaiming the collateral from abroad.
Because SAEX is now public, it can obtain financing from the bond market (or any major bank) at far lower rates. Collateral issues are no longer a problem. If they can refinance the 13.5% debt at say 6.75% (which is still probably too high an interest rate to assume) then that adds $5.4mm pre-tax income each year of your model.
Bear Objection 3: Risks of a fixed contract biz
Bull Response 3: This is not unique to SAEX
The fixed price nature of the contract is in general an asset to SAEX and allows them to plan cost and achieve high margins. In a disaster scenario they will eat some labor costs but as more and more assets are owned over time (which is the trend at SAEX) there is less and less rental expense to absorb in the event of a delay. Note that the work delayed in 3Q13 will still get done in 4Q13 and indeed generate profit, albeit less than if it had been completed timely.
SAEX sometimes wins contracts when it is NOT the lowest bidder because of its sterling reputation.
Bear Objection 4: Customer concentration
Bull Response 4: The concentrated base turns over 100%/year
The top customer pool actually changes and turns over each year, so the top five customers this year are not the same top five customers next year. Each year another combination of major oil companies are ready with a new set of contracts. Recall that this management team has been in the industry forever and that they are very highly regarded by their customers.
Bear Objection 5: Expensive relative to peers
Bull Response 5: The peers have overstated EBITDA because they capitalize speculative library expense.
SAEX has no speculative library expense, if you subtracted the library expense from EBITDA for each of the peer companies your choose the numbers should look very different.
Even with the bad news in 3Q13, backlog actually increased in the quarter, and SAEX will open new offices in Africa and Indonesia in 4Q13.
Bear Objection 6: High growth means high capex
Bull Response 6: No, SAEX has been on a capex binge the past two years as it buys instead of rents equipment when utilization on that equipment reaches 60%.
SAEX's problem was obtaining the cash necessary to spend the capex, so that its profit margins could improve. Imagine if you had to rent your car at a daily or weekly rate instead of making a car payment each month. SAEX was in the position of constantly having to rent the car, instead of just buying it, even though it used the car enough every day to justify owning it.
Part of the reason famed value investor Joel Greenblatt suggested this business for acquisition by the TRIO merger spac (which is how SAEX came public) is that it can grow with minimal capex and minimal working capital requirements. 3D seismic gear looks like a bunch of pain cans, united by a wifi network - not exactly a fleet of drilling rigs.
It's important to emphasize that management wins contracts because of their reputation in the industry for execution. SAEX's backlog actually increased in the quarter, and they are opening new offices in Africa and Indonesia. No one who runs an oil company and who is handing out contracts changed their mind about SAEX because of the extraordinary and unusual events in 3Q13.
So, if you agree with me that the bear case is flawed, be sure to check out some of the recent bullish write ups on this name to learn more.
Disclosure: I am long SAEX.