Flotek Industries: Staying Afloat, Thanks To A Great Sale

About: Flotek Industries, Inc. (FTK), Includes: ADM
by: The Value Investor

Flotek Industries announced a very large sale, generating compelling proceeds.

The sale of Florida Chemical allows the company to pay off all of its debt while leaving plenty of cash to go around.

Despite the fact that shares nearly doubled already from very low levels, I see a speculative buying opportunity.

Flotek Industries (FTK) announced a transformative deal in which it will sell its Florida Chemical subsidiary to Archer Daniels Midland (ADM) in a $175 million cash deal. This deal has a big price tag, allowing the company to pay off its debt and leaving plenty of cash to improve its core energy business which is subject to so much discussion and debate.

I like the move a lot and am willing to initiate a small but very speculative position.

The Deal & Implications

Flotek has reached a deal with Archer Daniels Midland to sell Florida Chemical Company in a $175 million cash deal, becoming a pure play on the full-fluid custom solutions for the oil and gas industry. Both companies have furthermore agreed on long-term supply agreements in which Flotek will provide d-limonene and differentiated chemistries. Furthermore, both companies are exploring other chemistry technologies in both oil and gas as well as agricultural applications.

The deal could close as soon as this quarter with no material tax impact seen as a result of the deal. Note that Flotek acquired Florida Chemical back in 2013 in an effort to integrate the supply of citrus oil, benefiting the energy chemistry technologies business of the company. At the time, Flotek paid roughly $50 million in cash and offered 3.3 million shares which traded around $15 per share at the time, implying a roughly $100 million deal tag.

Flotek will use the money to pay off $50 million on the credit facility, consider investments worth $20-30 million in growth projects, and keep options open for the remainder of the money following the outcome of the recommendation of a Strategic Capital Committee.

About The Impact

The implications of this deal are huge. Note that Flotek has two segments: the Energy Chemistry Technologies segment, which posted $243 million in sales in 2017, and the $74 million Consumer and Industrial Chemistry Technologies segment, with the latter now being sold.

Note that based on the balance sheet provided for the third quarter ended September of last year, Flotek operates with $51 million in net debt. With net debt now being paid off, that leaves theoretically a net cash position of $124 million (assuming zero taxes), or little over $2.10 per share with 58 million shares outstanding.

This explains the positive market reaction with shares up 90% to $2.65 per share at the moment of writing. After all, with much of the valuation backed up by the net cash balances, the operating (energy) assets represent just $0.55 per share, or $30 million in actual dollar terms.

What Is The Issue - The Elephant In The Room

Trading at just a dollar in 2010, shares of Flotek have exploded to a high of $30 in 2014 amidst the US fracking boom as the fluid solutions provided by the company were in strong demand. Ever since we have seen a real bust again to a low of $1 in recent weeks amidst the turmoil in the oil market, but moreover worries about the performance of its products.

Reality is that there has been a ton of controversy/discussion about Flotek overstating the performance of its complex nano-fluids and FracMax application. Investors were furthermore a bit surprised by the recent management turnover with a new CFO being announced between Christmas and the end of the year.

Of interest is that despite the challenges in the energy sector, this is still a plus or minus $200 million business which did report a 12% fall in sales to $53.7 million in Q3 of 2018 (on an annual basis), but revenues were up 35% on a sequential basis. I furthermore note that adjusted losses came in at 6 cents in Q3, with GAAP losses a penny wider. While the losses run at $0.25 per share per annum. With interest expenses going out the door, this could narrow losses by five cents. Further costs savings as a result of the simplification of the business and interest on net cash balances mean that break-even results could be achieved rather soon.

A Speculative Gamble

Let me be frank, there are many investors far more knowledgeable about the energy business and Flotek at large at this point in time. The main premise of my appeal is that with energy assets essentially valued at half a dollar, or $30 million in actual dollar terms, that might look cheap given that this valuation (ex-cash) is applied to a $200 million energy business which is close to breaking even.

For that reason, I am happy to initiate a small position at around $2.60, despite the fact that shares have nearly doubled, as the sale of the non-core business simply looks very compelling, with proceeds being very high, especially in relation to the outright downbeat overall valuation of the business.

Disclosure: I am/we are long FTK. 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.

Additional disclosure: Speculative Position