Description

RECOMMEND BUYING MDR

·      Project base case at least between $10 to $11 in one year and upside around $20+ in two to three years

·      Prefer MDR (over CBI) due to lack of debt at MDR and dynamic that MDR stock will rise if deal is cancelled, while CBI or may not fall depending on the case.  Also the potential for activist to enter MDR to try and block deal and force a sale of MDR.

o   Willing to miss any overbid for CBI which we view as unlikely.

MDR MGMT, SUCCESSFUL AT TURNING AROUND MDR, WILL NOW TURNAROUND CBI

·      Strong CEO in McDermott’s David Dickson

·      Dickson turned around MDR which four years ago looked very much like CBI does now despite.  Dickson has achieved this turnaround despite severe recession in offshore and subsea oil end market

·      Dickson is recreating the Technip North American Business he ran prior to MDR.

o   Technip’s North American business is both an offshore and onshore business.

o   Dickson:  “from my past, I've obviously come from the world of both onshore and offshore. And as I look to the future, I consider things such as technology, a diversification and scale. And when this opportunity came up that was able to satisfy in all 3 areas and I just think this is a fantastic opportunity for both companies to really create what is going to be a Tier-1 first class organization.

·      Technip is considered best in class

ATTRACTIVE ENTRY

·      MDR = OFFSHORE OIL E&P AT TROUGH OR CLOSE TO TROUGH IN CYCLE

·      CBI = A DISTRESSED SALE DUE TO PROJECT COST OVERRUNS.  MDR IS PAYING 6.25X 2018 EBITDA, THE VALUATION NETS DOWN TO <3.5X 2018 EBITDA IF YOU GIVE CBI TECH BUSINESS THE $2.5 BILLION VALUE THEY RECEIVED IN THE AUCTION. 

·      CBI HAS JUST BEEN DERISKED TWICE

o   NEW CBI CEO CLEARED THE DECKS WITH Q3 CHARGES IN OCTOBER

o   MDR MGMT JUST CONFIRMED THE SCRUBBED Q3 NUMBERS WITH THE ACQUISITION DUE DILIGENCE

·      RECENT CBI AGREEMENT WITH SEMPRA ON CAMERON LNG PROJECT DERISKS ONE OF THE MAJOR PROBLEMATIC PROJECTS

·      PRO FORMA COMPANY HAS OVER $1 BILLION OF LTM ADJ EBITDA AND $534MM OF LTM ADJ. NET INCOME (~ $1 PER SHARE) BEFORE SYNERGIES.   GRANTED THIS IGNORES THE PROJECT COST OVERRUNS RECENTLY AT CBI, BUT GIVES SENSE OF THE EARNINGS POWER IF THINGS GO RIGHT.  So, NEW MDR is less than 8x earnings before synergies (assuming they have projects under control) while comps trade at 9x EBITDA.

·      250MM IN COST SYNERGIES ARE SIGNIFCANT RELATIVE TO NEW MDR BASIC PROFITABILITY ($980 (640+340) + 250 = $1230) AND NEW MDR ENTERPRISE VALUE ($6.3BILLION) BUT SMALL (SHOULD BE EASY RTO ACHIEVE) COMPARED TO COMBINED COSTS (SG&A AND PROJECT COSTS) AT NEW MDR (MDR +CBI) of $8.5 billion.

o   Basically, they are targeting 3% of expenditures. 

o   The Bloomberg Gadfly article asserts $250MM is significant relative to CBI SG&A of approximately only $333 MM, but clearly does not understand GAAP Accounting and the fact that significant fixed and short term fixed/long term variable costs are absorbed in COGS.

o   Comments from the Deal Call:  Turning to Slide 20. You will see that we expect to generate significant cost synergies from the combination. We expect to generate annualized cost synergies of $250 million in 2019. This is in addition to the $100 million cost-reduction program that CB&I expects to be fully implemented by the end of 2017.  We expect to incur a onetime cost of $210 million to realize these synergies, of which, $170 million will be in 2018 and the remaining $40 million in 2019. These cost savings will largely relate to rationalizing 4 areas, including supply chain, G&A, operations optimization and other business-related costs. The $250 million goal is a number we have jointly identified through collaborative working sessions. And therefore, we have a high degree of confidence in our ability to achieve.

·      BASED ON DISCUSSIONS WITH MGMT WE BELIEVE COST SYNERGIES COULD EXCEEDED $250MM BY A SIGNIFCANT AMOUNT, POTENTIAL 50-100% MORE.

o   MDR CFO SAID PUBLICALLY IN THE DEAL CONF CALL:  With that said, these savings do not reflect our move to a new combined rigorous cost control culture.

·      REVENUE SYNERGIES MAKE SENSE, MAY BE SIGNIFICANT BUT ARE UNQUANTIFIED BY MGMT AND OFFERED (BY THE MARKET) FOR FREE

o   MDR CFO ”We also expect the transaction will lead to substantial revenue synergies and have jointly identified many opportunities to create pull-through. As an example, CB&I will be able to benefit from McDermott's long established presence in the Middle East and Asia to originate incremental projects such as petrochemical and refining facilities.”

·      LEVERAGE IS MANAGABLE

o   $3.3 Billion of funded debt at closing which should be about 2.6x gross debt and 2.2x net debt

o   Leverage incorporates normalization of CBI’s working capital (i.e. project losses).

·      UPSIDE CAN BE SIGNIFICANT.

o   SHOULD SYNERGIES BE IN-LINE WITH GUIDANCE PLUS A SMALL AMOUNT OF REVENUE SYNERGIES, AND DEBT PAYDOWN, NEW MDR COULD EASILY TRADE AROUND $20

·      NEGATIVE MARKET REACTION TO VALUE CREATING TRANSACTION DUE TO WRONG SHAREHOLDER BASE AT BOTH CBI AND MDR TO INVEST IN NEW MDR AND SIGNIFICANT RECENT PROBLEMS AND RECURRING DISSAPPOINTMENT AT CBI.

o   CBI shareholders consisted significantly of hedge funds looking for a pop on the Technology business sale.

o   MDR shareholders were not looking for leverage, a new turnaround and had made a bet on an offshore market pureplay.  New MDR will be two thirds onshore…

ATTRACTIVE GOING FORWARD DYNAMICS

·      CBI’S U.S. ONSHORE BUSINESS MAY BENEFIT FROM SURGE/ACCELERATION IN DEMAND DUE TO TAX REFORM ENABLED ACCELERATED DEPRECIATION OF CAPITAL EXPENDITURES IN THE U.S.

o   Many projects that were being contemplated/borderline for the customer may now get greenlit

o   A surge in activity may create a scarcity of providers driving up pricing.

·      CBI’S INTERNATIONAL ONSHORE BUSINESS WILL BENEFIT FROM MIDDLE EAST NATIONAL PLAYERS MOVING DOWNSTREAM AND MDR’S MIDDLE EAST RELATIONSHIPS.

·      MDR’s U.S. OFFSHORW BUSINESS MAY REVIVE GIVEN RERCENT TRUMP ADMINSITRATION INITIATIVES

·      COST SYNERGIES ARE VALUABLE BUT GIVEN NO VALUE BY THE MARKET

o   MDR DECLINED 11% POST TRANSACTION ANNOUNCEMENT DESPITE NO PREMIUM CONTROL ACQUISITION FOR CBI AND $250MM IN PROJECTED COST SYNERGIES

ENGINEERING AND CONSTRUCTION (PARTICULARLY FIXED PRICE) JUST AN OK TO POOR BUSINESS MAKES THIS MORE OF A LONG-TERM TRADE THAN A COMPANY TO OWN FOREVER

·      Cyclical

·      Prone to blowups

·      Cb&i’s technology subsidiary, however, has a strong moat

·      New mdr’s increased diversification and scale mitigates some of the cyclical risk and fixed price blowup risk.

·      Strong mgmt can mitigate the risks

Valuation and Entry for standalone MDR is attractive.

·      Stock has declined >10% since merger announcement despite significant cost and revenue synergies and opportunity to turnaround CB&I

o   Shareholder turnover due to MDR changing profile due to merger (leverage, turnaround, majority onshore vs pure play offshore)

·      10x standalone cash EPS

·      < 7x 2018 EV/EBITDA

·      Approximately 1x tangible book

·      Trough market for offshore and subsea end markets

·      Oil prices showing signs of recovery

·      Potentially entering inflationary macro environment

·      Late cycle subsector of oil and gas

·      MDR may trade up should there be an overbid for CB&I.

Valuation for CBI very low relative to history

·      Distressed sale reflects project specific cost overruns not earnings power of the business.

·      Market looking at LTM EBITDA of $640MM as opposed to much larger earnings power demonstrated by past profitability.

·      While total price for CBI (at current MDR stock price) is <7x expected standalone CBI 2018 EBITDA.  Using the $2.5 billion high bid for Technology Business implies <4x for CB&I RemainCo. 

o   Technology and RemainCo each are worth more together than apart.  MDR knows this and will benefit.

PRO FORMA VALUATION VERY ATTRACTIVE

Price including projected cost synergies is 5.6x EBITDA

·      Cost synergies might be low.  CBI CFO suggesting they could be as much as twice the projected $250MM.

·      Revenue Synergies seem obvious as Middle East nationals develop downstream projects

·      U.S. focused Power Generation, Refining, LNG, and Petrochemical development should benefit from accelerated depreciation under “tax reform”

RISKS

·      Further cost overruns at CBI destroy value

·      Collapse in Oil price prolongs bottom of cycle for MDR’s offshore and subsea.

·      Global recession that drives down oil prices

·      Collapse of shale gas industry limiting supply of natural gas for gas power and LNG projects

·      Saudi Aramco is 75% of MDR Backlog

o   Revolution/War in Saudi Arabia changes priorities or management of Aramco

o   If MDR’s relationship with Aramco tainted by corruption

·      Another strong Hurricane season in the Gulf

·      MDR shareholders vote down the deal.

Catalyst

Management road show promoting deal

Stabilization of CBI projects

New Project Wins

-Acceleration in U.S. offshore projects

-Acceleration in Middle East onshore downstream projects

Meeting synergy guidance

Realization or Guidance of synergies well in excess of guidance