Description

PGS equity is timely and offers ~100 - 150% upside (offshore energy tangential play), and has many of the investment characteristics I admire as its hated on (err, for >10-years now, yet is one of the best ways to articulate a thesis in offshore energy), mis-understood (most don’t realize one portion of biz / library covers most of enterprise and remaining asset / vessels are in the early innings of FCF inflection with high probability of driving $300MM+ of FCF generation per annum that receive for free on a $660MM market cap) and under-valued (>100-200% upside / Investor Day later this month will be interesting on articulating what the upside case might look like). PGS equity strangely has a very similar set-up to RYAM insofar as the debt played out (no longer the risk), the earnings inflection is here & now, yet the market stubbornly refuses to believe and / or is focused on the rearview … in the meantime, the puck is moving fast and PGS will likely be in a position to refinance the existing debt (providing multi-year runway) in the n-term. Similar to RYAM, previously wrote up PGS debt in early 2021 (enterprise value has stayed constant yet debt overhang has been fixed), the play now is on the equity which is greatly de-risked and offers 100-200% upside optionality. If I’m right, PGS will transition to being back on-the-run for investors over the next 3-6 months especially as PGS is on a path to net cash position in less than 2-years (debt to equity transfer of value), the equity offers a ~50% FCF yield to equity and will be one of the more asymmetric ways to articulate a long bias in offshore energy.

I admit I’m a sucker for buying stuff cheap particularly around offshore energy - PGS checks off this box as it trades at less than ~1.5x my estimate for 2023E EBITDA (factoring in 23E FCF generation) with a glidepath to refinancing the balance sheet and having a multi-year cycle recovery ahead. More importantly, I especially like buying things that have limited downside as PGS’ data library is the crown jewel, is coveted (TGS opportunistically bid on this business unit ~2-years ago when PGS was on its hands & knees, yet PGS denied the bid as it significantly undervalued the library and PGS fought through on their own to fix the balance sheet versus taking the TGS opportunistic lifeline) and the library likely covers the current enterprise. Additionally, PGS’ other side of the house (vessels / think rig operators driven by S/D and ultimately day rates) is on the cusp of a material earnings power / FCF inflection and likely has a path to durable ~$250 - 350MM+ per annum of FCF generation. The vessel portion is the thrust of the thesis and serves as a free option … applying a 1.5 – 3.5x FCF multiple to the vessel biz unit (i.e. not pushing the assumptions) gets to ~50% to 200% upside. Notably, the vessel biz operates in a duopoly industry structure (used to ~8+ in prior upcycle) which will drive above-normal margins moving forward – applying a ~2.5x seems punitive enough? = ~125%+ upside to the equity. If you’re in the …well… bullish offshore energy camp, and have a more exotic taste for multiples, and apply a 3.5x multiple (not even sure what this translates into around the rig operator space), gets to ~200% upside. As a result, v similar to RYAM, the puck is moving from the debt into the equity, and I like the heads-I-win + tails-I-win BIG set-up. Having downside floor value w/ the library is a key variable + potential for extreme v large outcomes if the long-awaited offshore energy cycle finally comes and vessel pricing power turns the PGS contract biz into a FCF machine in the n-term – the asymmetry of the trade is what’s most interesting.

The #1 overhang on PGS (for years) has been the balance sheet. The 2^nd controversy (let’s not ignore) is the long awaited seismic up-cycle (hasn’t been robust yet, and seismic is the “tail on the dog” so if you’re constructive on offshore energy, you’ll see hyper-vol upside in seismic … just hasn’t occurred yet). As it relates the first issue, debt overhang on PGS has abated driven by two things: 1) biz is starting to cash flow (witness Q3 2022 and you’ll see similar dynamics play out in Q4 / Q1 release), and 2) PGS issued $250MM of equity in 2023 (not too far off of current share price) + $50MM of new senior secured debt. As a result, PGS ND has shifted from ~$1Bln (last time I wrote up the term loan on VIC) down to ~$525MM by YE 2022E (and should be inside of $200MM by YE 2023E which is a remarkable balance sheet transformation). Previously wrote up the PGS debt in early 2021 and TL has fully played out at this point (bid-only and likely ~par). Ironically the enterprise value has not moved much over the past 2-years (was ~$1.1Bln then … and remains close ~$1.1Bln w/ YE22 BS). So, over the past 2-years, we’ve gained lot more evidence around the offshore energy cycle yet PGS enterprise value has stayed constant (and much healthier mix of debt / equity at this stage, and again, current share price not too far off of where the equity raises occurred in 2023). IMHO, its timely to focus on PGS equity as the debt overhang issue is almost fully removed (low leverage levels + credit market refinancing opportunity in the n-term), and the business has runway. Also, lot of good analysts who look at seismic (I tend to agree w/ the Barclays analyst’s comment – “Seismic has already had its recession, it was deep & long and the resulting under-investment is now only just beginning to be rectified”), I’ve been in & around tracking the seismic space for the past 20-years … industry was a “career-maker” in the early 2000s for some folks, but transitioned into a “career-breaker” for most folks in the 2010-2022 period … and the topic of the day is where the puck is moving from here on out as the stock is essentially at / close to the historic lows. Very similar to prior cycles (10+ year movements), my guess is seismic has legs and will see a bullwhip effect (tail on the dog) that we are only in the v early innings. More importantly, PGS is likely the best positioned for the bullwhip effect as unique position of being one of only 2 vessel operators (other player / Shearwater is private). Other data library players will be consumers of PGS vessels (up until now, it’s been great to be short vessels as benefit from a decade of deflation) but will now day rate inflation (PGS wins big in that environment). My guess is PGS will do closer to ~$650-$700MM of EBITDA in 2023E and the enterprise value (factoring in FCF generation) will likely finish YE 2023E at $850 - $900MM (so 1.3x EBITDA) on modest leverage ($200ish of ND at YE 23E).

As mentioned in prior posts, I’m fond of situations where the puck is clearly moving towards an inflection in earnings power, yet the market is still stubbornly focused on the past. In the case of PGS, market can’t shake the perception that its over-leveraged and was close to teetering. For anyone that’s open about their offshore energy bullish addiction (I shyly admit I buy the bull case on offshore as war in Ukraine exposes the energy markets on so many fronts and I like owning free call options), PGS is arguably one of the better plays. The rational is PGS equity has hyper-asymmetry w with very limited downside (data library provides solid floor values in / around current levels particularly as TGS showed their hand in mid-2020 during the “energy lows” and bid $600MM for the library … and my guess is TGS is still very much keen to own some / all of this biz) and 2) significant upside optionality from tightening S/D backdrop on the vessel portion of the biz - that’s the thrust of the thesis.

Why now: Vessel industry (i.e. contract biz) is witnessing a strong upcycle and the market refuses to believe. Unlike the past when the vessel industry was hyper-competitive / dogfood with 10+ players (even then, industry minted it during upcycles), the vessel market has consolidated down to ~2 players (PGS and Shearwater) and -75% of supply is out of the market versus ~9-years ago . Shearwater is a disciplined 2^nd actor which is a great dynamic. Equally important, even lacking industry discipline, PGS previously would make 35- 45% EBITDA margins on its vessel operations (with limited capex) during upcycles. My guess is that a 2-player market might even see a greater benefit from the current upcycle, YET street estimates remain muted (largely due to the terrible history of seismic and PGS in the past). Lastly, while the bear case is appealing (look at the past 8-years goes the argument), I think bears stub their toes when they look at recent 2022 evidence where PGS got ~35% pricing YTD September 2022. I’d argue the pricing environment has the potential to get even more constructive for PGS / Shearwater in the v n-term.

Divergent view: Market values PGS on its library ALONE and gives no credit for vessels.

• On the library side (i.e. where the market values PGS as a whole): TGS put out a low-ball ~$600MM bid for the library in August 2020 when oil was a “death spiral”.  PGS’ library is coveted and likely worth the current enterprise value. Additionally, the current BV for library is under-stated but that’s a point for discussion. My guess is library worth closer to $800 - $1Bln (if not more) or effectively where the enterprise is trading.
• Powerful (and free) upside option w/ vessels: 2022 provides an early signal of the pricing power as pricing up ~35%+. My guess is that 2023E will see stronger pricing than 2022. Assuming >40% pricing, PGS should see >$125MM of EBITDA upside from the vessel biz unit alone (as a result, consolidated PGS probably does ~$650-$700MM of EBITDA in 2023E factoring in both biz units).

Fair value: Difficult to know what this type of business should trade for, but see below:

• Low case: Assume library worth close to what TGS wanted to bid in 2020 (terrible market) and apply a 1.5x multiple on 2024E vessel FCF, gets to ~45% upside on equity
  • Like this dynamic, even if you assume TGS bid from 2-years ago (during death of oil) is directionally still accurate (v punitive), just need to believe in short duration up-cycle before industry peters out and valuation implies vessels have NO value … well in about 2-years …
• Mid case: Assume library worth closer to ~$800MM (not much premium to 2020 TGS bid) and apply a 2.5x multiple on 2024E vessel FCF gets to ~120%+ upside on equity
• High case: Assume library worth closer to ~$970MM and apply a 3.5x multiple on 2024E vessel FCF gets to ~200% upside to the equity

Adding it all up, and assuming low case is 20% probability, mid is 50% and high is 30% (dunno, seems about right given evidence of cycle strength), gets to ~125%+ upside as blend. As result, ultimately think equity is likely worth closer to ~15-25 NOK / share (vs current ~7.7 NOK / share). Whether you hedge the currency risk is your own risk-appetite (take a flier on NOK or not). Additionally, getting a balance sheet that likely turns closer to debt free in less than 2-years and a biz that generates decent FCF to the equity (depending on duration of up-cycle) of close to ~50%+ versus current market capitalization.

Catalysts:

Investor Day January 2023

Refinancing the TL in 2023 (or when window properly open)

Vessel pricing power

2023 results

Potential for TGS to bid for library or entire asset (as TGS is short vessel capacity)

Catalyst

Investor Day January 26, 2023

Refinancing the TL in 2023 (or when window properly open)

Vessel pricing power

2023 results

Potential for TGS to bid for library or entire asset (as TGS is short vessel capacity)