Description

A friend of mine got into the oil business in 2010 after graduating from Stanford Business School. He labored for 10 years developing different shale projects. After a decade of watching his lesser intelligent friends who had gotten into tech zoom past him in wealth, he finally threw in the towel and decided to join Silicon Valley. No one is looking to start a long-term career in oil these days... 

That likely means that now is the time to look at oil. 

How do you bet on oil when Western governments are trying to kill it the same way they killed coal? 

You invest in the area that has the least incentive to see it die – the Middle East. 

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National Energy Service Reunited Corp (NESR) is a MENA focused oil field servicer that is levered to key structural themes going forward that trades at half the multiple of the Big 3 (Halliburton, Baker Hughes, Schlumberger). Despite having higher EBITDA margins than their competitors, they are being mistaken for a commoditized basic service company when the reality is they have captive customers and growing market share in a region that is making a push to hire local. The Big 3 might have a technology edge, but they are not run by Arabs or owned by Arabs – NESR is. 

Key Investing Points: 

1) Oil field servicers which have been decimated by the gigantic fall off in capex over the last six years should see pricing and volumes return. 

Oil field servicers are of course levered to capex spending in oil. Over the last six years, we have seen oil field capex plummet to levels last seen in 2006 when oil demand globally was roughly 85mm barrels a day. Even during a pandemic-stricken year like 2020, the demand for oil was still 91mm barrels a day with an expectation by the EIA that it will exceed 100mm barrels a day in short order.  As we eat through inventories, the markets will wake up to the fact that spending on drilling is unsustainably low and has to rise over the next several years. 

US shale producers, however, will be timid and focused on cash return to shareholders for the near to medium term. A lot of the new spending will occur within lower cost regions like MENA. As some context, OPEC hasn’t added capacity in more than a decade and in Saudi Arabia, spending has heavily shifted towards natural gas, which represents almost 60% of the onshore rig count and most offshore rigs. 

Usually the US E&Ps lead the way in capex spending – 

“Here is what we find so fascinating. Most US E&P companies aim for lower spending in 2021 even as international budgets are up – amazingly this means that US E&Ps are being more disciplined than their international counterparts.” (Raymond James Capex Report - April 5th, 2021) 

Now, the MENA region will be leading the way. 

• State-run ADNOC in the UAE approved in November a mammoth $122 billion capex program through to 2025 as Abu Dhabi pushes to raise capacity by about 25% to 5 million b/d.  

• Saudi Aramco spent $27 billion on cap ex in 2020 but will see that number jump to $35 billion in 2021 and likely over $45 billion by 2022 – their stated goal is to raise spare capacity by 1mm barrels a day.

This tailwind of increased spending on capex will be not just for 2021 but for the next ten years. 

Longer term, even if we rapidly transition off oil – see a decline of over 50% in consumption – the MENA region will be the relative winner as their share of world oil production will rapidly increase. 

2) NESR is a national champion with an Arab board, investors, and management team and a strong moat within the MENA market. 

If you visit the UAE or Saudi Arabia, you notice quickly that the low skilled jobs are filled out by South Asian migrants and the high skilled jobs are filled out by Westerners. The leaders in the region in particular MBS recognize that developing home grown talent is key to their long term political and economic success – and that means rewarding national firms as opposed to foreign multi nationals. This is increasingly the government policy, which has been supercharged by MBS.

While it is headquartered in Houston and listed on the NASDAQ (which means you don’t have to worry about navigating laws in a complicated foreign jurisdiction), NESR is otherwise a Arab company with Arab management and board and ownership and strong local market offices. 

The board is filled with folks that have close ties to the various regional governments –  

- Nadhmi Al-Nasr is a Saudi national who was tapped by MBS to run NEOM – he ran large mega projects at ARAMCO for several decades. He is one of the few non-royals inside MBS’ inner circle. 

- Yousef Al Nowais is a member of the Al Nowais family – an Emirati family that runs one of the biggest conglomerates and is extremely close to the Emirati royal family. He was a senior executive at Abud Dhabi National Oil Company (ADNOC) for several decades – him and his family own collectively 8% of NESR. 

The largest shareholders are the Olayan Saudi Holding company (20%) and Mubbadrah (15%). 

- Olayan was founded by Sulaiman Oliyan and is now run by his children – they are one of the leading merchant families in Saudi Arabia with close ties to the Al-Sauds. Lubna Olayan gave an address to open an Riyadh investment conference that MBS sponsored shortly after the Khashoggi murder – MBS showcases her as an example of female Saudi business leaders. She and her family have been untouchable during the recent tumult. 

- Mubbadrah is one of the leading holding companies in Oman, founded by Hilal Al-Busaidy and Yasser Al Barami – two former engineers who worked at the major oil field servicers and then left to start a company that levered their close industry ties to get contracts – their firm was later bought out by the entity that would become NESR. 

Connections matters a great deal in this region – the close ties that the board members and shareholder groups have with the leaders of Oman, the UAE and Saudi Arabia are a barrier to entry that a multi-national would have an impossible time trying to replicate. They ensure that NESR will have years of high margin contracting work. 

NESR compliment this by also investing in the region – they built R&D facilities in Oman and are building an R&D center within Saudi Arabia – which is exactly the sort of technology transfer efforts that MBS is trying to bring about. 

“NESR’s model, akin to the larger technological changes we are seeing globally, will create an open platform for innovative technology companies in the upstream space to come to the Kingdom and will benefit the Saudi oil and gas industry”

- Dr. Ah-Qahtani (Aramco VP for Upstream) 

As it is NESR is one of the few pre-qualified service providers for Saudi Aramco. Even if another smaller OFS wanted to enter the space, it would take them years to pre-qualify to even bid on business. 

3) NESR has low hanging fruit that is unavailable to the big three. 

NESR does not have to bid against the big Three on big lump sum turn key projects that can often times end up being albatrosses – they are nimble enough to be able to grow on smaller projects. They have a revenue base of $1bn today versus the big three which collectively do more than $55 billion a year in revenue.

So they are in many respects in a category onto themselves bidding on relatively easier – more commoditized projects with few competitors - and as a result have consistently higher EBITDA margins than the big three - their margins stayed high during COVID while the big three saw their margins collapse and go negative.

As well as much higher revenue growth – they substantially grew revenue even during COVID. 

Today, NESR is a low single digit % of the overall MENA market but is targeting 15% total market share longer term – in other words, they have a long runway of growth going forward – which can be attained through winning smaller projects. 

Even if oil stays subdued, there is a whole new potential area of growth within the MENA region as the countries like Saudi Arabia look to develop their natural gas reserves (for their own internal energy consumption) and export more oil. NESR is at the forefront of developing Saudi Arabia and UAE’s shallow off shore gas reserves. 

4) Despite a clear moat and competitive advantage via its network of relationships and an ability to grow much more quickly with lower hanging fruit projects off a low revenue base, NESR trades at a fraction of its peers. 

The market penalizes for NESR for doing more relatively commoditized drilling and completion work without recognizing the location where they are doing this and the barriers to entry that are relevant in said locations. 

A Weatherford could try to enter the space but would have a hard time competing against the network of relationships established and the increasingly stringent requirements that countries like Saudi Arabia are imposing on employing local workers. 

Valuation: 

Assume historical revenue run rate growth of 20% and an EBITDA margin of 25% - you get to $300mm in EBITDA by 2022 and then apply a 10X multiple to that in line with their competitors – you get to $30 a share versus today’s share price of $13.  

I’d argue for a company that is growing revenue at 20% a year with industry leading margins of 25%, it should trade for a much higher multiple than its peers – but will let the market figure that out.  

In the meant time, this is the best way to play the obvious secular bull market in energy capex and to get specific and privledged exposure to the MENA region.

None of this is rocket science - it is just recognizing that NESR has a key competitive advantages in its relationships and identity as a local operator and that those advantages should only increase in the coming years given the current political regimes in the region. 

RISKS:

- The normal sort of geo-political risks that come with operating in the Middle East. 

Most of NESR’s work is concentrated in relatively more stable countries of Oman and Saudi Arabia and the UAE - that said a regime change in any of these countries could prove problematic.

- Low float and liquidity.

A fraction of the float is actually outstanding roughly 30% with the rest of it locked up among board members and various insider groups. 

- Margins revert as more companies focus on the ME.

The premise of this thesis is that the relationships that NESR has are sticky and hard to disrupt and NESR still comprises such a small % of the overall MENA servicing market that there is not an imperative yet to try disrupt their margins. 

Catalyst

- further contract wins particular in off shore natural gas for UAE and Saudi Arabia

- upcoming quarters and general industry and company specific re-rating