Description

Cal. Dive International Inc. (DVR) 

Thesis:

I believe Cal Dive represents an interesting value proposition based on a market leading niche business with significant operating leverage and a clean balance sheet.   Its current value is derived from 2 points: 1 - Its current price dislocation is function of new issuance by its previous owner that is yet to be digested by the market 2 - the market does not appreciate the uniqueness of 2009 to their business, and is overly discounting their ability to grow going forward.  These factors have created a dislocation that allows an investor to purchase DVR at $7.38 a share, corresponding to a 0.99x book value and at 7.9x 2009 earnings.  The stock trades at a significant discount to its peers, is well capitalized, and has a history of repurchasing stock at depressed levels.  It has a competitive advantage in its current niche and provides upside potential with only a minor change in global sentiment as it has significant operating leverage.  The stock is currently trading at cyclical trough earnings as well as a depressed multiple.   I would place an $11.50 18 month price target (10x 2011 PE) with a $6.25 downside risk target, which provides an attractive 3.5 to 1 risk reward scenario

Overview:

Cal Dive is a Marine contractor that provides manned diving, pipe lay, pipe burial, and platform services to the offshore oil and natural gas industry.   The majority of Cal Dive's business provides services in the Gulf of Mexico OCS.  Through several acquisitions, they have begun to expand their business outside of the GOM.  They currently operate a diversified fleet of 31 vessels: 21 surface and saturation diving support vessels, six pipe lay, pipe bury barges, one dedicated pipe bury barge, one combination derrick/pipe lay barge and two derrick barges.  

Dislocation Factor 1: Secondary Issuance 

Cal Dive was a division of Helix Energy until December 2006, at which point DVR completed an IPO on the NYSE.  Helix however remained the controlling share holder of the firm.  As of Q3 2009, Helix owned and controlled a majority stake in DVR (57.2%).  In the course of 4 months, Helix divested its complete stake in DVR through 2 secondary offerings, one on June 10^th 2009, and a subsequent offering on September 23^rd, 2009.  It is the aftermath of these transaction that has created the inefficiency which currently exist between DVR's share price and its underlying value.

Helix Transactions:

As of December 31, 2009, Helix Energy owned 61.5mm shares, or 57.2% of Cal Dive.

Over the course of 2009, Helix used several opportunities to raise cash by selling their stake in DVR.

1 - 1/29/2009 Helix sells 13.6mm shares to DVR at $6.34.  The shares are retired by DVR

2 - 6/10/2009 Helix completes a secondary offering of 20.0mm shares at $8.50

3 - 6/10/2009 DVR purchased 1.65mm shares from Helix at $8.50, which are retired.

4 - 6/18/2009 Helix sells an additional 2.6mm shares into the market at $8.50

5 - 9/23/2009 Helix completes another secondary offering of 20.6mm shares at $10.00

6 - 9/23/3009 Helix sells an additional 2.6mm shares at $10.00.

Transaction Summary:

At the end of last year, there were 46mm shares in active float in the market place (not owned by Helix). 

During the course of 2009, these transactions by Helix resulted in an additional 45.8mm shares placed into the market. (Not including those retired by DVR).  Thus, from June 10, 2009 until today, the marketable float of the company increased from 46mm shares to 92mm shares.

The 100% increase in marketable shares has had an understandably profound effect on the stock price.  This coupled with a weak third quarter, and a mild Hurricane season (repair contracts) have placed significant pressure on the stock from its Aug 26 high of $11.75.  However, I believe the current $7.38 stock price represents a temporary market dislocation, and a valuable entry point. 

Dislocation Factor 2: Extrapolating 2009 Performance

Beyond the obvious effects of the credit crisis, 2009 was unique for several reasons which negatively affected earnings.    Cal Dive is both cyclical business and a seasonal business.  The winter and early spring seasons tend to be the slowest, as weather makes some work difficult   However, there is often work to be completed as GOM Hurricanes create opportunities in repair work.  I would not believe any forecast on future hurricanes, however this seasons muted hurricane activity will depress Q4 earnings significantly.  The long term average of repair work will be higher.  I don't believe analysts have appropriately normalized for this effect over a full cycle.  2009 also saw several delays in Pemex projects, beyond the economic slow down.  In order to meet internal revenue demands Pemex will be adding projects in 2010 and 2011.  Beyond pushing projects from 2009 to 2010, there is significant potential for additional contract work that will become available.  Though the GOM has been DVR's strong market, its recent acquisition has increased its potential for international expansion going forward.

Cal Dive has been acquisitive in the past, and it is likely to do so in the future.   In the past years it has acquired the assets if Acergy Inc (2006) Fraser Diving (2006) and Horizon (2007).  The addition of these assets has helped grow their international business, both outright and, and as a percentage of revenue:  Through Horizon it has made inroads into international markets and has begun winning contracts there which have offset the any longer term GOM slow down. 

 Revenue                                               2006                       2007                       2008                       2009e                     2010e

US:                                             86%                 76%                   71%                   70%                    68%

International                                14%                 24%                   29%                   30%                     32%

Operations:

Despite the credit crunch, cap ex slow down, and economic crisis the company has had revenue growth in 2009.  The nature of the business makes the company somewhat defensive.  Cal Dive's future is tied to the future of the oil and gas offshore drilling business.  However, its correlation is not straightforward, as Cal Dive produces maintenance, removal and environmental work that must be completed regardless of new drillings and regardless of commodity prices.  Thus, it provides some downside protection if the economic recovery is stalled.  However, if economic activity increases, especially internationally, DVR has significant operating leverage.  Through Q3 and the beginning of Q4 there has been a pickup in activity internationally which DVR will be able to take advantage. Their current rig utilization will provide bottom line follow through as international projects come on line.  I believe Utilization will begin to pick up by H2 2010.

Utilization Rates:                                2006                       2007                       2008                       2009e                     2010e          

Saturation Diving                         92%                  91%                    87%                 75%                    81%

Surface & Mixed Gas                     90%                  60%                    64%                61%                    65%

Construction Barges                      87%                   91%                   50%                50%                    54%

Total:                                         91%                    71%                  64%                 60%                    67%

Management:

The management team has extensive experience, and Cal Dive has a reputation for efficiency and safety.  It is a well run company that has grown top line for the last five, and had grown Ebitda every year until 2009. Though the next 6 - 12 months may be difficult for the firm, its current valuation does not properly give value to Management's ability to grow the business and be accretive with acquisitions while maintaining manageable debt loads.  Long term utilization rates north of 70% are very achievable, and will result in bottom line earnings growth.

Insider Activity:

Except for the significant sales by Helix, the management team has not disposed of any significant shares.  During the two large transactions that disposed of Helix's share of the company, management was a net buyer.

Financials:

Financials:            2006                       2007                       2008                       2009e                     2010e                     2011e

Revenue            510                   624                    856                   891                    890                      935

COGS                287                    396                    603                   672                    668                      673

GP                     222                    227                    254                   218                    223                      262

SGA                    37                      48                        75                  70                     73                         76

OP Income          185                    183                      180                  139                  140                       176         

NI                        119                   106                      109                  85                     87                       112

Ebitda                  210                    213                      250                  214                   210                      246

Gross Profit:          43.6%               36.4%                 29.6%                24.5%               25.0%                 28.1%

Ebitda Margin         41.1%               34.2%                 29.3%                24.0%               23.6%                 26.3%

NI Margin              23.4%                16.9%                 12.8%                 9.6%                 9.8%                  12.0%

EPS:                       $1.91                      $1.24                      $1.05                      $0.92                      $0.94                      $1.21

The financial model above takes a conservative assessment of ramp up for 2010, resulting in utilization rates and income being pushed through 2011.  I believe the estimates offer a conservative approach if economic; if activity continues to increase, you could see pull through of earnings to 2010, especially in 2H.

 Risk:

The downside risk of this position would be the prolonged deterioration of shallow water drilling activity in both the GOM and internationally.  DVR plans to grow internationally and has made inroads into non GOM markets, but faces significant competition.  If DVR is unable to grow their non US revenue base, the company may suffer a secular decline.  Lastly, because of the acquisitive nature of DVR, there always exists the possibility of a non accretive merger, however historically DVR's management has managed integration very well.

Conclusion:

DVR is a solid business with relatively stable earnings.  Its ability to provide integrated underwater operations has made a leader in its markets, and it has significant potential to grow both top line and earnings over the next few years.  Its maintenance and repair business is stable, and it has allowed the company to grow top line in 2009 with only small drop in income during the difficult 2008 - 2009 period.  This is a testament to management as well as to the importance of their business.  At 0.99 book and less than 8 times earnings, the company can be purchased at very cheap valuation versus peers, and its historic prices.   The company's stability as well as its upside potential creates an interesting call option opportunity with minimal downside risk.  The company's low debt levels, (230mm net debt versus 214mm in Ebitda) provides significant flexibility and allows the possibility of another debt financed equity buy back (13.6mm shares purchased at 6.34 in January in a debt financed buy back).  That option, coupled with the long term value and uniqueness of their business provides the downside protection.  Their "moat" is their reputational leadership which can not be replicated.  The projects they are involved in depend on safety and operational execution; though pricing is important, a mistake in the execution can be a long term detriment to oil and gas companies, thus their leadership position in certain markets is very defensible.

Lastly, and most significantly, there is an understandable and temporary reason for the stock performance since September.  The market has simply not been able to digest the massive issuance which doubled the shares outstanding.  The threat that Helix would sell their holdings has always existed, and now that pressure will be removed from the market, I believe it will be a long term positive.  Though, it is not easy to gage how long it will take for the market to work through that issuance, I believe the current share price provides significant downside protection, and allows investors to purchase a stable business at depressed earnings and a depressed multiple which should return to normalized earnings and normalize multiples as the cycle

Catalyst

As 2010 proceeds, and projects return to the GOM, I believe investors will return to the name.  Namely, the beginning of 2 pemex projects should re-inforce the belief that Pemex will ramp up in 2010 -2011.  The digestion of the shares sold by Helix is much harder to quantify, however a share buy back similar to the one that occured in January of this year (at $6.34)should confirm the downside risk limit.  At less than 8 times earnings, and 1x book, this position is a longer term play, 12-18 months, based on the prospects of the business and the digestion of the secondaries.