I just bought some more of T-3 Energy (TTES) at $12.13. The stock, like many other energy plays, has dropped significantly in the last few weeks, pretty much back to where I first bought it in August.
Before getting to this particular pick, I do believe that energy stocks, in general, are good buys here. The stocks have recently sold off dramatically, for no apparent reason, other than that crude oil is down a bit, and speculators in the energy stocks are either booking gains and/or taking losses. As always, though, I'm generally inclined to purchase stocks like TTES over other stocks in these types of declines, since there is a special situation here which, to my mind, limits the downside risk.
In any case, the long-term outlook for energy is still very bullish. I doubt, as the market appears to imply, that the world's supply/demand issues energy has changed dramatically in the last three weeks. Once again, it is the casino atmosphere of the market, with little attention paid to actual business fundamentals, which is causing prices to fluctuate wildly. I'm not sure many people realize that oil at $40 is still very bullish (all the stocks are valued at $40 or so a barrel and big companies have already hedged to benefit for quite some time from high oil prices). For a good discussion of oil investing see this post (read the section entitled: "Still Stoked About Energy"). Now on to why you should buy TTES.
When stocks meet the criteria below, they usually make for good investments.
Criteria I: Has the stock fallen significantly?
Yes. As noted above, TTES's stock price has nosedived in recent weeks, along with other energy plays. So this is more a market correction, rather a company-specific problem. At the same time, it is important to note that TTES is a very illiquid stock, since 86% of the float is controlled by the First Reserve Fund. First Reserve is a huge and highly respected private equity firm. Find out more about them here. Low-float stocks can get very hard during market sell-offs because of the liquidity issue.
Criteria II: Is the long-term outlook for TTES's business/industry solid, so as to give me confidence that this recent dip is merely "noise" and the result of short-term oriented gamblers?
Yes. Since I am bullish on energy stocks, and in particular stocks of energy service companies (see this blog post for the major reasons why it may pay to play service companies over producers in this stage of the upcycle), I am bullish on TTES's prospects for the next several years. Without getting too technical, TTES manufactures and resells products to oil and gas companies that:
Stop and monitor the flow of liquids and gases and to protect equipment and personnel from excessive or sudden changes in pressure and are major mechanical and pressure control components of drilling and well servicing rigs.
I honestly have no particular insight into the quality of TTES's products, but the ownership by First Reserve, gives me confidence that the company is selling value-added products and services that will be in strong demand over the coming years as the exploration/development budgets of energy producers increases or at least remains at recent levels.
Criteria III: Are there specific upcoming events that could lead to major positive changes for TTES's underlying business and hence justify a legitimate rise in TTES's stock price?
The major reasons to own this stock are actually based on recent events and possible upcoming events.
TTES is exploring strategic alternatives.
In particular, from TTES's 10Q:
On June 20, 2005, we announced that the Company had retained Simmons & Company International to assist in evaluating strategic alternatives to enhance stockholder value. There can be no assurance that any transaction will be entered into or completed as a result of this process.
Simmons is one of the most highly respected energy-specific investment banks. Simmons himself is the author of the book, "Twilight in the Desert", a popular book detailing the potentially dire situation of oil in Saudi Arabia.
In general, I have made money in stocks that have hired investment banks to explore strategic alternatives. Some sort of liquidity transaction, usually an acquisition of sorts, is announced within a year. In the case of TTES, I think an important event will happen by the end of 2005, since the compensation of the CEO of TTES has been tied to a sale of the company.
From a recent SEC Filing:
On August 25, 2005, the Compensation Committee of the Board of Directors of the Company approved the First Amendment to Employment Agreement (the “Employment Agreement Amendment”) entered into between the Company and Gus D. Halas, the Company’s president and chief executive officer. The Employment Agreement Amendment provides for the payment by the Company to Mr. Halas of a transaction bonus in the event of a change in control of the Company on or prior to December 31, 2005, based on the “transaction value per share.” If the transaction value per share, or the aggregate amount received for each share of the Company’s common stock by the Company’s stockholders in connection with a change in control, equals $20.00, the transaction bonus will be equal to $5,230,769. In the event the transaction value per share is higher or lower than $20.00, the amount of the transaction bonus will be increased or reduced by the product of $461,538 and the difference between the transaction value per share and $20.00. For example, if the transaction value per share were $12.10, the closing price of the Company’s common stock on August 25, 2005, the transaction bonus would be approximately $1,584,619.
I think the above makes it quite clear that TTES will be doing something big before the end of 2005. As such, by holding the stock here, for at least a couple of months, you are not taking too much risk and you will likely be rewarded with a nice return should the company pursue a transaction (i.e. acquisition). I definitely feel that First Reserve would like to somehow sell its position in TTES as valuations in the energy sector remain attractive. The only way they can do that is via some sort of acquisition or large merger which would dilute their shares and increase the liquidity of the stock. My bet is on an acquisition.
It is interesting to note that TTES has already divested at least part of its business since the August announcement. From the 8-K:
On September 29, 2005, T-3 Energy Services, Inc. (the “Company”), along with its wholly-owned subsidiary, A&B Bolt & Supply, Inc. (“A&B”), entered into an Asset Purchase Agreement with A&B Valve and Piping Systems, L.P. (“A&B Valve”) under which the Company expects to sell substantially all the assets of its distribution business operated by A&B. A&B distributes products and supplies to the oil, gas and pipeline industries, including valves, pipe, fittings, fasteners and flanges. The transaction is expected to close in October 2005, subject to the satisfaction of various closing conditions that the Company believes are customary for transactions of this type.
Interestingly, the business that was just sold by TTES was an underperfomer. Companies usually sell-off bad-performing business when they are shopping around the entire company for a sale.
Criteria IV: Is the valuation attractive? What is the upside here?
I don't see much need to go into valuations here, since as the filing above implies, the company believes that $12 per share is a good price level to enter into a bonus arrangement with the CEO. So I'm quite convinced that $12 per share is probably a floor for the stock price. Furthermore, from the latest 10Q:
"At June 30, 2005, warrants to acquire 327,862 shares of common stock at $12.80 per share remain outstanding." I think it's a good sign when you can buy publicly traded shares at a price beneath the exercise price of securities granted to insiders (who are generally granting themselves what they perceive to be cheap shares).
In any case, a quick look at the financials shows that TTES did $0.22 per share in the most recent quarter. As for upcoming quarters, it is important to note that TTES helps repair and service rigs, so I'm sure they got alot of new business because of Katrina. In addition, the recent sale of the underperforming division will easily shave off some debt and reduce interest expenses (probably by half). Finally, at the of the June quarter, TTES entered into a joint venture partnership as detailed below (from the 10Q):
On July 20, 2005, the Company completed a joint participation agreement with Servicios Y Maquinaria De Mexico, S.A. de C.V. (“SYMMSA”), a subsidiary of GRUPO R, a conglomerate of companies that provide services to the energy and industrial sectors in Mexico. The Company and SYMMSA have agreed to incorporate T-3 Energy Services Mexico, S. de R.L. de C.V. (the “Joint Venture”), which will be operated and controlled by both parties in equal percentages. Under the terms of the agreement, the Company will provide the Joint Venture with its pressure control products and services, trademark and trade name, license know how and other services. SYMMSA will provide the Joint Venture with the exclusive use of its real estate, building facilities, machinery and equipment, labor force and will assist the Joint Venture in its marketing and sales efforts in Mexico.
Putting it all together, I think it is a no brainer that TTES can easily earn $1.00+ per share in the coming year, giving a floor to the stock at about $12 (the company does have a high depreciation expenses, which leads to me to really estimate cash-flow per share at a minimum of $1.30 per share).
Hold TTES till the end of 2005.