Value Investors Club / NINE ENERGY SERVICE INC (NINE 8.75% due 11/2023)

Description

I am probably going to regret this, but I think NINE is sitting on good numbers for the quarter, which are going to be released tomorrow am.

Executive summary for the thesis is as follows:

Nine Energy Services (NINE) is a N. American-based oilfield services company
NINE issued $400mm of senior unsecured notes in October 2018 to fund acquisitions of Magnum Tools Intl and Frac Technolgy
These acqusitions added valuable IP to NINE's portfolio but were poorly timed, as the market softened in 2019 before the 2020 oil production collapse amidst the COVID-induced recession
The company bought back $80mm face value of bonds at an average of 29c on the dollar in 2020 and 2021
The current operating environment is very favorable for oilfield servicers, and NINE's revenues are accelerating: 1Q22 revenues were +75.5% y/y and 11.3% q/q. Revenues and EBITDA growth are expected to have accelerated in 2Q: Revenues were guided at +15% q/q, EBITDA will likely grow 25-35%
I am projecting $96mm EBITDA for NINE in 2023, which implies a 2.2x creation multiple for the bonds
With minimal debt ahead, and favorable operating environment for the next 6+ quarters, the bonds have favorable upside/downside
Staying away from the equity due to dilution risk

Nine Energy services is a N. American-based oilfield services company. The boilerplate company description from it's 10-K is as folllows:

Nine Energy Service, Inc. (either individually or together with its subsidiaries, as the context requires, the “Company,” “Nine,” “we,” “us,” and “our”) is a leading North American onshore completion services provider that targets unconventional oil and gas resource development. We partner with our exploration and production (“E&P”) customers across all major onshore basins in the U.S., as well as within Canada and abroad to design and deploy downhole solutions and technology to prepare horizontal, multistage wells for production. We focus on providing our customers with cost-effective and comprehensive completion solutions designed to maximize their production levels and operating efficiencies. We believe our success is a product of our culture, which is driven by our intense focus on performance and wellsite execution as well as our commitment to forward-leaning technologies that aid us in the development of smarter, customized applications that drive efficiencies.

We provide (i) cementing services, which consist of blending high-grade cement and water with various solid and liquid additives to create a cement slurry that is pumped between the casing and the wellbore of the well, (ii) an innovative portfolio of completion tools, including those that provide pinpoint frac sleeve system technologies as well as a portfolio of completion technologies used for completing the toe stage of a horizontal well and fully-composite, dissolvable, and extended range frac plugs to isolate stages during plug-and-perf operations, (iii) wireline services, the majority of which consist of plug-and-perf completions, which is a multistage well completion technique for cased-hole wells that consists of deploying perforating guns and isolation tools to a specified depth, and (iv) coiled tubing services, which perform wellbore intervention operations utilizing a continuous steel pipe that is transported to the wellsite wound on a large spool in lengths of up to 30,000 feet and which provides a cost-effective solution for well work due to the ability to deploy efficiently and safely into a live well.

Obviously, oilfield services is a cyclical, commodity business. However, NINE acquired two companies in 2018 with valuable IP: Magnum Tools Intl and Frac Technology. These acquisitions were funded with $400mm of unsecured debt. These assets help create a moat around NINE's business. In particular, they have a best-in-class dissolveable plug product called the Stinger (among others):

Source: Company presentation from November 2020 (https://investor.nineenergyservice.com/~/media/Files/N/Nine-Energy-IR/reports-and-presentations/nine-energy-service-investor-presentation-q3-2020.pdf)

Unfortunately, the acquisitions were poorly timed as the market turned over in 2019 and collapsed with oil production in 2020. Amidst the downturn, NINE bought back $80mm face value worth of these notes at an average of 29c on the dollar in 2020 and 2021.

While these open market purchases were highly accretive, they drained the company's liqudity, which leaves the bonds trading at distressed levels today given their November 2023 maturity and recent going concern language on the company's 10-Q. As of 3/31/22, the company had $75mm of liquidity by way of $20mm cash and $55mm available on their ABL. By my estimate, the company has enough liquidity to make their interest payments over the next twelve months.

As everyone is probably aware, energy markets have been huge winners in 2022 given the COVID-driven supply constraints and the Russia/Ukraine war. Oilfield servicers have been huge beneficiaries, as pricing has swung in their favor and activity is picking up given the spike in the price for cruide oil. NINE's growth is likewise accelerating:

Source: company presentation (https://investor.nineenergyservice.com/~/media/Files/N/NEE-IR/news-and-events/events-and-presentations/2022/06-23-2022/nine-energy-service-jpm-presentation-2022-vfinal.pdf)

I am modeling $64mm EBITDA for 2022 and $96mm for 2023. The company's liquidity is sufficient to fund working capital use:

Some key inputs underlying these assumptions:

Given where we are in the current cycle, and the fact that NINE generated > $100mm as recently as 2018 and 2019, I don't think these projections are especially heroic. If the company is run-rating $100mm EBITDA by the 3Q, which I think is achievable, then at 3.2x run rate EBITDA they'll have a decent shot at refinancing the bonds. If the HY market doesn't warm up by the 4Q of this year, I think the company can secure new financing from private sources.

They also have authorization to issue up to 120mm shares ($80mm current equity market cap). Additionally, in their latest form 10-Q, they specificially mentioned the possiblity of issuing shares or convertible debt to shore up their liquidity:

Our plans to satisfy these obligations include refinancing or restructuring our indebtedness, seeking additional sources of capital, selling assets, or a combination thereof. Any such transactions may involve the issuance of additional equity or convertible debt securities that could result in material dilution to our stockholders, and these securities could have rights superior to holders of our common stock and could contain covenants that will restrict our operations. Our ability to successfully execute these plans is dependent on our financial condition and operating performance, which are subject to prevailing economic and competitive conditions, and certain financial, business, and other factors, many of which are beyond our control. There can be no assurance that we will succeed in executing these plans. If unsuccessful, we will not have sufficient liquidity and capital resources to repay our indebtedness when it matures, or otherwise meet our cash requirements over the next twelve months, which raises substantial doubt about our ability to continue as a going concern.

Their CFO is a former banker at JPM, and I wouldn't be surprised to see some sort of capital markets transaction to get the bonds higher. For example, they could issue a $20mm convert with say an 8% coupon with a strike at a 30% premium, representing 25% dilution to the equity, and use the proceeds to buy back bonds. Assuming an average price of 70, they could retire nearly $29mm of debt and net save roughly $1mm of cash interest. This is just one scenario I came up with, but I think doing so will help get the bonds higher and enable a refinancing.

If the company does end up filing for ch. 11, with barely any debt ahead in the stack, I would expect bondholders to take most of the equity. At 2.2x early/mid-cycle EBITDA, there are worst places you could be. For context, NexTier Oilfield Solutions (NEX) trades at 2.8x 2023E EBITDA:

Biggest risk is a complete credit market meltdown shutting them out of the refinancing. But it's hard to see these bonds trading back to the 29c level at which the company was buying them back. Perhaps the lack of liqudity in the post-reorg equity will shave off another half turn or so. At 1.5x 2023 EBITDA implies a 45c recovery. So 35pts of upside (par) vs. 20pts of downside (45) implies 1.75:1 upside/downside for this trade.

The dilution risk for the equity makes the bonds more attractive. Unfortunately, this isn't easily hedgeable because a PE sponsor owns most of the equity which limits the tradeable float.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

Catalyst

Earnings beat

Debt refinancing

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			2022	2023
Price:	65.00	EPS	0	0
Shares Out. (in M):	320	P/E	0	0
Market Cap (in $M):	208	P/FCF	0	0
Net Debt (in $M):	320	EBIT	0	0
TEV (in $M):	400	TEV/EBIT	0	0