Geospace Technologies Corporation (GEOS)

Current Price: $6.78 / Target Price: $13.27 / Upside: +96%

As of July 14, 2020

52-Week Range: $4.61-$17.66

Market Capitalization: $91.8mn

Total Debt: $0.0

Cash: $18.9 mn

Enterprise Value: $72.9mn

Investment Thesis: Our buy recommendation for Geospace is based on the following:

• Geospace has developed a market-leading portfolio of cutting-edge seismic products. 

• Geospace has built a large fleet of rental equipment capable of generating $75 million annually of high-margin revenue. 

• The Adjacent Markets segment generates strong cash flows that are uncorrelated to the energy market. 

• The Emerging Markets segment has developed proprietary technologies for monitoring country borders and strategic perimeters and is the market leader in an end-market with vast potential. 

• Two investors recently filed Schedule 13D’s calling for a refreshment of the Board and improvements in capital allocation. 

• Geospace has a strong balance sheet including $19 million in cash (no debt), $28 million in net working capital, $63 million in rental equipment, and $32 million in property, plant, and equipment including six owned properties. 

• Geospace trades at 3.5x adjusted EBITDA, 0.4x tangible book, and 5.5x our Fiscal 2020 free cash flow forecast. 

Oil and Gas Markets (68% of sales): Geospace designs and manufactures seismic products that are utilized to conduct seismic surveys to identify and monitor oil and natural gas deposits.  Geospace designs and markets products for both land and marine seismic surveys.  The Company’s products are generally marketed to seismic contractors that complete seismic surveys for either oil and natural gas producers or for third party seismic data libraries which collect large amounts of seismic data that can be sold to producers.  The Company’s customers can either purchase the seismic equipment or lease equipment from the Company’s large rental fleet. 

Geospace divides the Oil and Gas Markets segment into three categories: Traditional Products, Wireless Products, and Reservoir Products.  The Company’s Traditional Products include geophones and leader wire for land-based seismic surveys and hydrophones and streamer recovery products for marine-based seismic surveys.  The Company’s Traditional Products are generally compatible with most major seismic data acquisition systems.  Traditional Products revenues were $9.5 million in Fiscal 2019 and have generally declined in recent years as seismic contractors increasingly demand wireless equipment.  Geospace competes with Sercel (a division of CGG), ION Geophysical, and INOVA for traditional product sales and leases. 

The Company’s Wireless Products include a portfolio of wireless seismic products that operate as independent data collection systems (nodes) allowing for easy deployment and greater flexibility without the hassle of wires or cables.  Each wireless node contains either 1-channel or 3-channel configurations with a channel serving as a measure of the recording capacity of the node.  Geospace develops and manufactures wireless products for both the land seismic and marine seismic markets.  The Company’s proprietary land-based wireless products include GSX and GCL.  Geospace has sold 441,000 GSX and GCL wireless channels and currently operates a rental fleet of 84,000 wireless channels.  We estimate the Company’s wireless channels sell for $400-500/channel and rent for $200/year.  Customers for land-based wireless equipment includes seismic contractors such as Dawson Geophysical (DWSN), SAExploration (SAEX), and Breckenridge Geophysical.  Geospace competes with Magseis Fairfield, INOVA, and Sercel for wireless land-based seismic equipment.  We estimate that Geospace has approximately 1/3 of the global market.  The Company’s wireless land-based equipment sales have generally declined since 2014.  Following the sharp decline in oil prices in 2014 and 2015, most seismic contractors had excess land-based seismic equipment and thus had little demand to purchase new equipment or rent equipment from the Company’s rental fleet.  Recently, seismic contractors have reported that energy producers are demanding seismic surveys with higher resolutions, requiring the use of more recording channels for each seismic survey.  Prior to the recent COVID-19 outbreak, seismic contractors noted that they were operating at or near capacity for their recording channels, suggesting that demand for recording equipment could increase in coming periods.

Geospace has also developed a marine-based wireless data collection system called OBX.  The OBX nodes are placed directly on the ocean floor and can be deployed to depths up to 3,450 meters.  Prior to the recent development of ocean-bottom nodes, marine seismic data was collected from ships that towed long lines of streamers that contained hydrophones utilized to detect changes in pressure.  Ocean bottom nodes generate higher-quality seismic data that is preferred by geophysicists.  Demand for OBX systems has increased dramatically.  To satisfy the strong demand, Geospace has invested heavily in expanding production of OBX nodes, with the Company spending nearly $50 million over the last five years to build up the rental fleet that now exceeds 34,000 nodes.  OBX nodes are more expensive to manufacture than similar land-based nodes (we estimate approximately $2,000/node) and sell for ~$10,000/node.  The high upfront cost and a general transition of marine seismic contractors to asset-light business models has resulted in most customers looking to rent OBX nodes.  We estimate the rental day-rate for OBX nodes equates to an annual rate of ~$2,500/year, resulting in a payback period for Geospace of under one year.  The Company has noted on recent conference calls that the Company’s rental OBX fleet is almost fully utilized.  Given the Company’s current OBX rental fleet of 34,000 nodes, 90% utilization at a rate of $2,500/node generates annual rental revenue of $76.5 million.  Even with the decline in oil and natural gas prices associated with COVID-19, Geospace has noted that OBX rental demand has remained strong.  The Company’s customers for ocean-bottom nodes include TGS Geophysical Services, Petroleum Geo-Services, BGP, Seabird Exploration, Shearwater Geoservices, and WesternGeco.  Geospace competes primarily with Magseis Fairfield for ocean-bottom nodes, and we estimate Geospace commands approximately 50% of the ocean-bottom node market. 

The Company’s Reservoir Products category manufactures products that help oil and natural gas producers maximize the recovery of hydrocarbons extracted from a reservoir.  Geospace has developed permanently installed reservoir monitoring systems known as (“PRM”) for land and ocean-bottom applications to provide time-lapsed seismic data.  Geospace is the global leader in PRM applications and the Company’s technology has been utilized in seven fields.  The Company’s most recent PRM mandate was a $172 million contract from Statoil for two North Sea fields that were installed in 2013 and 2014.  Geospace estimates that there are up to 200 fields globally that could benefit from the installation of a PRM system, but the Company has not received any PRM orders since 2014 due to ongoing weakness in the energy market. 

In November 2018, Geospace expanded its expertise in PRM technology with the acquisition of Petroleum Geo-Services’ PRM technology known as Optoseis®.  The acquisition provided Geospace with fiber optic PRM technology in addition to the Company’s electro-sensor technology.  The purchase price included $1.8 million in cash at closing and contingent earn-out payments of up to $23.2 million over a 5.5-year period based on eligible revenue generated during the period.  Geospace has recorded a contingent consideration liability of $4.6 million related to the Optoseis acquisition.  We have assumed a 22.5% earn-out rate suggesting Geospace expects OptoSeis revenues of approximately $20.4 million through May 1, 2024. 

Geospace currently competes with Alcatel-Lucent for PRM mandates as many of the Company’s former competitors have either been acquired or have gone out of business.  Geospace continues to be in active dialogue with potential customers and said on the May 2020 conference call that the Company expects at least one tender for a PRM system to be released by September 2020.  We expect Geospace to compete for this potential mandate and for all future contracts.  PRM technology is typically installed at large, offshore fields and revenues on such projects can easily exceed $50 million and generate gross margins approaching 50%. 

Adjacent Markets (32% of sales): Geospace leverages its existing manufacturing facilities and seismic technologies to manufacture products that are utilized outside of the energy sector.  Many of the seismic products developed for the Oil and Gas Markets segment have direct applications in other products with little or no modification.  The Company’s Adjacent Market segment is divided into Industrial Products and Imaging Products.  Industrial products include applications such as water meters, mine safety application products, and earthquake detection systems.  Imaging products include products that employ direct thermal imaging and digital inkjet technologies for applications in commercial graphics, textiles, and flexographic printing.  In Fiscal 2019, the Adjacent Markets segment generated $30 million in revenue and $7 million of EBITDA.  We believe the Adjacent Markets segment alone could be valued at or near the Company’s current enterprise value if the segment operated as a stand-alone entity. 

Emerging Markets: The Emerging Markets Segment consists of the border and perimeter security technology acquired through the July 2018 acquisition of Quantum Technology Sciences (“Quantum”).  Quantum develops products that utilize seismic technology to monitor borders and other strategic perimeters.  Quantum was acquired for a cash closing price of $4.4 million and a contingent earn-out payment of up to $23.5 million over a four-year period.  The Company’s technology detects both above and below-ground (tunnel) activity and is a cost-effective alternative to physical barriers, cameras, and other detection methods.  Geospace has successfully combined Quantum’s software applications with the Company’s ruggedized hardware to develop products that are ready for deployment. 

In April 2020, Quantum announced its first large contract, a $10 million award from U.S. Border Control to provide a seismic technology solution at the U.S./Mexico border.  The contract is expected to be fulfilled by the end of calendar 2020.  The procurement specifically pursues technology developed by Quantum under the Small Business Innovation Research (SBIR) program that provides Quantum with exclusive data rights with the U.S. Government.  The technology also qualifies as a program of record, indicating the United State government is supportive of the technology and future expenditures can be allocated specific line items within the United States budget.  Geospace indicated on the May 2020 conference call the $10 million award represents approximately 2% of the addressable market for this specific seismic application, suggesting the total addressable market for this application could exceed $500 million.  We are not aware of any competing technology and expect the Company’s strong competitive position suggests future contracts are likely.  Additionally, Geospace noted during the conference call that the Company also responded to a Request for Information (RFI) proposal from U.S. Border Control for a seismic application to detect movement across bodies of water, representing an additional future addressable market for the Company.  Quantum also generated revenue in the recent quarter by providing the Company’s seismic border solutions to a defense systems integrator for use in their security applications.  Geospace suggested this initial award represented the first of potentially many mandates that could come from defense system integrators. 

To date, the acquisition of Quantum has been a material drag on the profitability of the Company, with Geospace investing approximately $5 million annually to develop and launch Quantum’s border seismic products.  Geospace has recorded a contingent consideration liability of $6.3 million, suggesting Geospace expects Quantum to generate $28 million in revenue (assuming a 22.5% royalty) through July 27, 2022.  While still in its early stages, Geospace believes Quantum and the Emerging Markets segment could one day exceed the Oil and Gas segment in size.  The Company believes the gross margin contribution for the Emerging Markets segment could be comparable to historical Oil and Gas gross margins (approaching 50%).  Should Quantum’s technology prove successful and be widely deployed, this would likely result in a large upward shift in the Company’s profitability and cash flows. 

Corporate Segment and Research and Development:  The Company’s corporate segment includes ~$14 million annually for the general and administrative expenses of the Company’s Houston headquarters.  While not allocated to corporate, Geospace has recently spent $15-16 million annually on Research and Development activities that are included in segment operating expenses.  While the R&D spending detracts from operating profits and cash flows, it also shows the commitment and willingness to continue to invest in product development across all segments of the business even through an extended downturn in the energy market. 

COVID-19: The COVID-19 pandemic has had a negative impact on the oil and gas market and demand for many of the Company’s products.  COVID-19 dramatically reduced demand for transportation, resulting in an oversupply of oil which caused oil prices to fall from $60/barrel at the end of 2019 to under $20 in March 2020.  Although oil prices have since rebounded to $40/barrel, the sharp price decline has caused many oil and natural gas production companies to reduce capital expenditures and exploration activity, which has reduced demand for seismic data and seismic equipment.  On the Company’s May 2020 conference call, Geospace noted demand for traditional seismic products had declined due to COVID-19.  Importantly, Geospace said that demand for the Company’s OBX rental equipment has experienced only a slight reduction in response to COVID-19 with only one short-duration rental contract being indefinitely postponed.  Geospace has also continued to receive requests to provide quotes on new OBX rental contracts.  Geospace also continues to be in conversations with multiple clients interested in deploying the Company’s PRM systems.  In the Adjacent Markets segment, demand for water meter products has remained strong but certain customers of the Company’s graphic imaging products have seen a reduction in activity due to fewer events and gatherings taking place.  Geospace is designated as an essential business and the Company’s operations have continued.  The Company’s headquarters and main manufacturing facilities are in Houston, Texas, and the recent increase in COVID-19 cases in Texas could impact manufacturing output in future periods. 

Management Team and Insider Purchases:  The management team at Geospace is led by President and CEO Walter (Rick) Wheeler.  Mr. Wheeler became the Company’s CEO in January 2014 where he succeeded long-time CEO Gary Owens.  Mr. Wheeler joined Geospace as a design engineer in 1997 and previously served as the Company’s Chief Operating Officer.  Mr. Wheeler is an engineer by training with a degree from Rice University in electrical engineering.  Robert Curda is the Company’s CFO and was promoted to the role on January 1, 2020 after serving as the Company’s Operational Controller since 2005.  Mark Tinker is the CEO of the Company’s Quantum Technology Sciences subsidiary.  Mark has led Quantum since January 2014 and has a Ph.D. in geophysics from the University of Arizona.  The Chairman of the Board of Geospace is Gary Owens, who served as the Company’s CEO from 1997 through 2013.  The Board of Directors and management team have relatively small equity stakes in the Company with Chairman Gary Owens holding 225,924 shares (1.9% of shares outstanding) and Rick Wheeler holding 117,306 shares (0.9% of shares).  There were several insider purchases during April and May 2020 including a purchase of 5,000 shares by CEO Rick Wheeler at $5.92. 

Shareholder Activism:  Geospace has recently been the subject of two activist shareholders.  On February 12, 2020, Sansone Capital Management (holder of 4.4% of the Company) filed a Schedule 13D that included a letter highlighting advocating for a refreshment of the Company’s Board of Directors and a reduction in the size of the Board.  On May 26, 2020, Nierenberg Investment Management (holder of 5.1% of the Company) also filed a Schedule 13D.  The recent shareholder activism resulted in the retirement of one board member in June 2020.  We suspect actions from the activists could result in the retirement of additional board members and the election of several new board members that have a greater alignment with the Company’s shareholder base.  Any future directors nominated by shareholders will likely be focused on the Company’s capital allocation policies that could lead to a reduction in the capital intensity of the business and a potential return of capital to shareholders. 

Removal from Russell 2000: The most recent rebalancing of the Russell 2000 small-cap index took place in June 2020 and resulted in the removal of Geospace from the Russell 2000 Index.  The Russell 2000 rebalancing resulted in significant selling pressure for Geospace shares with one investment bank estimating that index-tracking investment funds would be forced to sell almost 1.9 million shares (14.6% of outstanding Geospace shares).  The Company’s removal from the Russell 2000 does not reflect the future business prospects for the Company, and the share price decline provides an attractive entry point for long-term investors. 

Balance Sheet: Geospace has historically maintained a conservative balance sheet which has helped the Company to survive multiple energy market cycles while continuing to invest in the Company’s technology.  Geospace currently has $19 million in cash and securities and no debt outstanding.  Geospace also has a large working capital balance including $18 million in accounts receivable and $35 million in inventory.  The Company’s rental fleet has a net book value of $63 million including 34,000 OBX stations and 84,000 GSX/GCL channels.  As of 9/30/2019, Geospace also had $61.7 million in Federal NOLs and $15.2 Canadian NOLs that are not recognized on the Company’s balance sheet but will reduce cash taxes in future periods. 

Geospace also has two large notes receivable that are not included on the Company’s balance sheet.  In January 2020, Geospace sold 30,000 channels of GCL equipment to SAExploration for total consideration of $12.5 million including $2.5 million in upfront cash and a $10 million, 3-year note.  The note bears interest at a 7.0% rate with monthly amortization payments.  SAExploration has experienced ongoing financial difficulties and Geospace has decided to not record any revenues or recognize the receivable as an asset until Geospace is confident the entire note will be collected.  In Fiscal Q1 2020, Geospace stopped recognizing rental revenue from an OBX rental customer that was behind on payments and recorded an $8.1 million bad debt charge in Fiscal Q2.  On May 26, 2020, Geospace entered into a settlement with the customer.  Geospace received $2.6 million in cash and will receive $13 million in senior secured bonds from the customer to cover both the bad-debt charge and the unrecognized rental revenue.  The bonds will be secured by the assets of the customer and will mature in 24 months.  While collection of these notes is not assured especially given the recent decline in energy prices, both notes are secured with collateral.  Neither note is recorded on the Company’s balance sheet and even partial collection of the notes could contribute meaningful cash to Geospace as the combined notional value of the notes is 33% the Company’s current enterprise value.  

In addition to the current assets and notes receivable, Geospace also owns six properties with a total net book value of $32 million.  The property portfolio includes the Company’s headquarters in Houston along with two additional Houston properties as well as owned property in Russia, Canada, and Colombia.  We obtained recent tax assessments for the owned Houston property which is included below. 

We have toured the Company’s headquarters in Houston and believe the property’s fair market value easily exceeds the appraised value of $12.8 million.  In addition to the 19.2 acres of land and almost 400,000 square feet of building space, the facility has a full line of valuable manufacturing equipment.  During our tour, we noted that Geospace owns three large spooling machines that each cost up to $10 million.

In our view, the recent shareholder activist filings increase the likelihood that Geospace could monetize a portion or all of the Company’s asset base and reduce the capital intensity of the business.  Even prior to activist involvement, Geospace sold a 77,000 square foot building in June 2019 for $8.6 million (appraised at $4.9 million).  Additionally, the Company’s building in Bogota, Colombia is currently listed for sale, and Geospace has expressed optimism that the property can be sold at a premium to book value.  While Geospace has thus far decided to manufacture its products internally, Geospace could look to monetize the Company’s properties and manufacturing equipment and outsource the manufacturing process while retaining all intellectual property.  Such action would dramatically reduce the capital intensity of the business and likely provide substantial proceeds that could be returned to shareholders or reinvested in the business. 

Segment and Income Statement Projections: We project the Company’s income statement by first forecasting segment results for each of the Company’s segments.  We forecast the Oil and Gas Markets results by projecting revenue for each of the segments categories (Traditional Products, Wireless Products, and Reservoir Products).  We project Traditional Project revenues will decline through Fiscal 2020 and Fiscal 2021 due to decreased exploration activity and a rotation toward wireless products.  We forecasted Wireless Product revenues by projecting Wireless Product and Services revenues and Wireless Rental Revenues.  Wireless Products and Services revenues are projected to decline in Fiscal 2020 before rebounding in Fiscal 2021 and Fiscal 2022.  We forecast rental revenues by applying our assumptions for future utilization and rental rates for the Company’s OBX rental fleet.  We expect Wireless Products Revenue to increase in Fiscal 2020 and conservatively project revenues to decline slightly in Fiscal 2021 and 2022 due to declines in utilization and rental rates.  For our Reservoir Products forecast, we estimate the Company has a 50% probability of winning a $25 million PRM contract that will commence in Fiscal Q3 2021, resulting in $3.1 million in quarterly PRM revenues in subsequent periods.  Segment EBITDA is expected to range between $40-46 million in coming years with operating margins increasing due to lower depreciation expense. 

We forecast the Adjacent Markets results by projecting revenue for Industrial Products and Imaging Products.  We expect revenues in both categories to decline in Fiscal 2020 before rebounding in Fiscal 2021 and Fiscal 2022.  Operating margins are expected to temporarily compress on reduced operating leverage before rebounding in subsequent years.  Our forecasts do not account for any new product line extensions that might be available to Geospace.  We continue to believe the material revenues and operating profits generated by the Adjacent Markets segment are not fully appreciated by the market and the segment would have significant value on a stand-alone basis.  

The Emerging Markets segment consists entirely of the results of Quantum Technologies.  Since the acquisition of Quantum in July 2018, the segment has been a material drag on the Company’s profitability as Quantum has readied its technology for wide-scale deployment.  We project Fiscal 2020 revenues to increase as the Company’s defense integrator customer utilizes Quantum’s technology in additional projects.  We forecast revenues and profitability to increase further in Fiscal 2021 as Quantum delivers on the initial $10 million contract with U.S. Border Control and receives subsequent orders in similar size.   

The results of each operating segment are combined to form our consolidated income statement forecasts.  We project revenues to increase through Fiscal 2022.  We expect Geospace to realize material improvements in profitability due to higher OBX rental revenues, revenue contributions from Quantum and PRM contracts, and a reduction in prior one-time impairments and write-downs.  We expect Geospace to generate Adjusted EBITDA of ~$30 million over each of the next three years and Net Income in excess of $10 million starting in Fiscal 2021. 

Cash Flow Statement: We forecast adjusted EBITDA of $26 million in Fiscal 2020.  We do not expect Geospace to pay any meaningful cash interest expense or cash taxes due to the Company’s net cash position and sizeable net operating losses.  For Fiscal 2020, Geospace has forecasted cash capital expenditures of $6 million and expenditures of $6 million on rental equipment, resulting in Fiscal 2020 free cash flow of $13 million.  Geospace has also suggested future capital investments in the Company’s rental fleet will be greatly reduced, which should result in strong free cash flow generation in future years. 

Target Valuation: Our target valuation for Geospace is based on our discounted cash flow analysis.  We utilize a 12.5% discount rate, and a 3.0% terminal to obtain an enterprise value of $160.9 million.  We add $18.9 million in net cash to obtain a target equity value of $183.8 million, or $13.27/share. 

Floor Value: We also conducted a Floor Value analysis to estimate the value of the Company’s assets in the event of an orderly liquidation.  We included each of the Company’s asset accounts as well as the face amounts of the Notes Receivable from SAExploration and an OBX customer that are not currently included on the balance sheet.  We applied haircuts to these accounts based on our estimates of liquidation value to obtain a liquidation value of the Company’s assets of $126.2 million.  We subtracted all the Company’s liabilities excluding contingent consideration to obtain a target floor value of $111.7 million or $8.25/share, representing a 22% premium to the current share price.  The Company’s sizeable base of tangible assets results in a liquidation value that is higher than the current share price.  We believe this provides investors with a meaningful margin of safety in the event our financial projections prove to be too optimistic. 

Risks: There are several notable risks to the Company’s business that should be highlighted:

• Geospace has generated operating losses in recent years that may not be reversed. 

• Geospace is dependent on oil and gas exploration activity which has decreased due to the decline in energy prices. 

• The Company’s markets are competitive, and the Company’s products are subject to technological obsolescence.

• Geospace may not be able to collect its accounts receivable and has previously taken losses on doubtful accounts. 

• Future spending on border security is dependent on government programs which may not be continued. 

• Geospace has several activist shareholders that could divert management attention and Company resources.

 Conclusion: Based on our DCF valuation of Geospace Technologies, we derived an intrinsic value of $13.27/share, representing potential upside of +96%.  We also conducted a Floor Value Analysis to project what Geospace could be worth in the event of an orderly liquidation and obtained a price of $8.25, representing potential upside of 22% in the event that all of the Company’s operations are liquidated.  This combination of attractive upside and limited downside provides an attractive investment opportunity.  Additionally, recent insider buying and the emergence of two activist investors support our valuation and provides additional assurances that future capital allocation decisions will be conducted to maximize value for shareholders. 

Disclosure:  This document is for investor informational purposes only.  This document does not constitute an offer to sell or a solicitation of an offer to buy.  The author may have a position in the securities mentioned and may add or exit these positions without notifying the reader. Although this document has been prepared from sources deemed reliable, no representations can be made as to its accuracy or completeness.  Past performance is not indicative of future results.