SUMMARY

NESR is an under-the-radar energy service stock that has the fastest growth rate in the sector and the lowest valuation.  This is a chance to get involved before analysts and before it gets included in stock indices. There is no sellside coverage and little buyside coverage because the company was a SPAC until 6/6/18.  The stock is currently around $10 and my near term price target is $24 (near term generally means 12 months for me but in this case it could be much sooner). My target is a combination of earnings growth as well as multiple expansion.  There is strong visibility for organic growth and this will be complimented by acquisitions that help fill out their product offerings and geographic reach. My 2019 ebitda estimate is $264m and using a 10x multiple = $24 stock price. NESR should command a premium valuation relative to peers because it is lower risk and faster growth.  Plus, the CEO is a veteran executive from SLB with tons of experience operating in the region and in M&A. Overall, this is a unique opportunity because the valuation is depressed as there is no published research on the company and it is relatively new in its current structure (note many firms cannot own SPACs).

BACKGROUND/DESCRIPTION

NESR went public 5/12/17 as a Special Purpose Acquisition Company (SPAC).  While I generally do not have a favorable opinion of SPACs, I believe this one is unique.  First, it has already successfully converted from a SPAC to a common stock. Second, the companies acquired to form NESR have successful multi-year operating histories.  NESR is the combination of Gulf Energy SAOC (GES) and NPS Holdings (NPS). Both of these are best-in-class energy service firms located in the Middle East with impressive track records.  NESR is engaged in most energy service activities including drilling, testing, cementing, electric line logging, etc... They’ve been working with some of the largest energy companies for decades and include as customers Shell, Exxon, BP, Total, Saudi Aramco, Qatar Petroleum and Gazprom.

MACRO THESIS

NESR is focused on the Middle East which is the lowest cost region in the world to extract oil.  Even when oil prices were $40, both GES and NPS were profitable.  In fact, earnings for the combined 2 companies increased each year from 2013 to 2017 (see table further down).  This is very different than US peers. NESR should have good visibility and earnings for many years despite fluctuations in the underlying commodity.    

The second macro thesis is that it is important to be local, specifically in Saudi Arabia.   One of their large customers, Saudi Aramco, is making a concerted effort to use more local suppliers.   The graphic below is from their website declaring that they intend to use 70% local suppliers by 2021—up from 35%.  This is significant as Saudi Aramco plans to spend >$300b dollars on suppliers over the next 10 years. If NESR wins just a small fraction of this business, it will be upside.

MANAGEMENT

NESR was the creation of CEO Sharif Foda and Director Thomas Wood.  Mr. Foda was a 20-year veteran at Schlumberger (SLB). While he was there, he was in charge of 30,000 employees and $20b in revenue.  He has extensive experience and relationships in the oil service field, particularly in the Middle East. SLB, as the premier global energy service firm, is an ideal background for the leader of a company like NESR.  His relationships and reputation are critical to acquisitions and in building a strong team. Mr. Wood is a serial entrepreneur in the energy industry. He founded both Xtreme Driling Corp and Savanna Energy Services Corp, and has been involved as a director in numerous E&P companies.

Both Mr. Foda and Mr. Wood’s interests are aligned with shareholders as they own a combined 5.75m shares of NESR.  Their fortunes are largely tied to the performance of the stock.

FINANCIAL MODEL

The pro-forma historical record, which is in their investor slide presentation, shows a track record of consistency.   It also shows that this is a healthy 30%+ margin business.

The table below shows key items in my long term financial model.  I project organic revenue growth of 12% per year. Acquisition growth adds $50m in revenue to start and ramps to $150m per year.  I assume all free cash is used towards acquisitions and the average multiple paid is ~7x ebitda. My EBITDA margin assumption is consistent with recent trends of 33%.  This translates into >$600m ebitda by 2023 and $400m of free cash flow.  

NESR management forecasted first year ebitda of $200m and second year ebitda of $247m.  I am at $264m in 2019 because these figures were given before NESR won a new $200m revenue contract on 5/15/18.  This contract is over 3-5 years (4 yr avg), so it should add an additional $50m revenue per year. This is ~10% incremental growth through 2021, so my 12% organic revenue growth assumption may be conservative.   Note that I am using 114m fully diluted share count which assumes all warrants (17.7m) are vested—stock must be above $11.20 for this to happen. This also means the company will be net debt free due to cash proceeds of $198m from exercised warrants.

PEER COMPARISON AND VALUATION

NESR had significantly faster revenue growth than peers over the past 5 years and this was without adding leverage.  The company intends to keep leverage fairly modest (<2x). NESR should continue to take share as they win more local business, add new services and extend into adjacent geographies.   The roll-up aspect of the story is very early in its development and can continue for >5+ years.

NESR is trading at a significant discount to peers based on all metrics.  Below is a table of ev/ebitda. NESR’s closest peer company, SLB, trades at 12x ’19 ebitda and HAL trades at 8.3 ’19 ebitda.  I would argue that NESR should trade at a premium to international diversified energy companies because it is focused on the best region, has the fastest growth rate and the lowest leverage.

TARGET PRICE

My 5 year target price is $54, which is 10x 2023 ebitda of $600m.

Without any acquisitions, my price target would still be a healthy $37, which is 10x $320m ebitda.   

My near term target prices are based on 3 scenarios:

Base Case:  $24 (+133%) or 10x my ’19 ebitda $264m. 6% FCF yld.

Bull Case:  $32 (+210%) or 12x my best scenario ’19 ebitda $300m. 5% FCF yld.

Bear Case $8.5 (-17%) or 5x my worst scenario ’19 ebitda $200m. 12% FCF yld.

RISKS

1)    Poor liquidity in the stock, but this should be improving.

2)    Management will likely issue stock for large acquisitions.  I trust that management will only do this for very attractive acquisitions.

3)    Geopolitical risk in Middle East, although this will impact the stock price more than company fundamentals.