Description

An investment in Petroleum Geo Services represents an attractive value orientated special situation with good upside potential and limited downside. Perto Geo is trading at 5.9x EV / EBITDA – Capex – Investments and it carries a 29% pretax FCF yield to the equity. The company has generated significant amounts of real cash recently and is well ahead of bankruptcy plan projections on a cash flow basis. The cash balance increased by $45 million in the recently reported Q3 period alone. The company will emerge from bankruptcy in the next few weeks.

I recommend purchase of the common stock of Petro Geo, a Norwegian company, which has an ADR under the ticker PGOGY. PGOGY is a provider of seismic data and an owner and operator of FPSOs (Floating, Production, Storage and Offloading). Seismic segment: PGOGY works with oil companies and sells them 2D or 3D images of the earth’s crust on land or in the ocean. These images are needed to determine if a location should be drilled or not. FPSO segment: These are large movable ships that move in after the driller has done its work. The FPSO pumps and stores the oil.

PGOGY is about to emerge from bankruptcy and new ADRs will be distributed around November 12. Buying the ADRs will allow you to invest in the new reorganized equity along with the scheduled rights. One can purchase the new equity through investing in the bank debt, bonds and preferred stock of the old company or even the “when issued” stock of the new company. The implied new equity prices among these various securities are pretty similar so there is no real arbitrage between them. Please comfirm the ticker of the when issued stock.

PGOGY filed for Ch 11on 7/29/03 in New York. The company reached an agreement with its various creditors to reduce debt and distribute value. The company currently has bank debt, bonds, preferred stock and common stock. The bankruptcy plan has been confirmed and will distribute new stock and new bonds to the old banks and bonds, new stock to the old preferred stock and new stock to the old common stock. In addition, the old common stock has the option to participate in a rights offering set to be effectuated on 11/6/03. Through the plan, the old common stock will get 4% of the new equity. The rights offering will allow the old equity holders to get 22.5% more of the new equity for $63.75 million. The old equity holders, if the rights offering is fully subscribed, should represent about 26.5% of the new shares. (This excludes the portion of the rights offering that will subscribed by two major shareholders who have underwritten the deal).

A significant portion of the current PGOGY stock price represents the value of the rights (since the rights give the old equity 22.5% of the new equity at a low price and the old equity alone only gets 4% of the new company). Purchasing PGOGY and not participating in the offering would be foolish. However, one must own shares by November 5th in order to participate in the offering. As a result, Friday was probably the last day of trading that one could have purchased PGOGY and be allowed to participate in the offering with T+3 settlement. I think the stock declined at the end of the day on Friday because it became unclear in the marketplace if Friday was even good enough since the company set a 10AM EST ownership deadline for Wednesday. In any event, the when issued stock will most likely trade more liquidly this week and may be your best bet. The when issued stock was last quoted around $40 / share.




NEWCO Enterprise:

Shares of New Stock: 20
Stock Price $40

Equity Market Cap. $800

Debt:
Term Loan $5
7% 3 Yr Notes 250
10% 7 Yr Notes 746
Other Debt 192

Total Debt $1,243
Estimated Cash $50

Net Debt $1,193

Enterprise Value $1,993

LTM EBITDA – CPX- Inv. $338
EV / LTM EBITDA – CPX- Inv. 5.9x

FCF to Equity:
LTM EBITDA – CPX- Inv. $338
PF Interest Expense 107

Pretax Cash Flow $231
% of Market Cap. 29%

Valuation:

I have tackled the valuation by looking at the two distinct pieces of the company: Seismic and FPSO. I have applied conservative multiples to pre tax unlevered cash flows of each business.

Using a 6.5x multiple for Seismic EBITDA – Capex – Investments and a 7.5x EBITDA – Capex multiple for FPSO results in a stock price of around $57 of 42% higher than where is has been trading recently. I believe these multiples are conservative since they closely approximate multiples of pretax unlevered free cash flow.

Since the company is fairly levered, small changes in multiples can have a sizable impact on per share equity valuation. I believe this is a good thing in this case since the high amount of cash generation will allow the company to delever quite rapidly. I believe the company has learned from past mistakes and will use the cash more prudently going forward mainly to reduce debt. They have stated publicly that they plan to manage the business to maximize cash flow. The recent numbers bear this out as well.

The Businesses:

Seismic
The seismic industry has been in a downturn and may be reaching a bottom. Many, including PGOGY, got into trouble through over shooting locations on spec. These investments have been allocated under investments in muti client library. PGOGY spent massive sums building up its library that ultimately never generated the returns it had hoped. Giant write downs resulted. These poor investments along with an over leveraged balance sheet with looming 2003 debt maturities forced the company to file for ch 11.

PGOGY’s seismic business has moved away from these speculative type investments to focus more on proprietary or direct client work. Direct client work is much safer as PGOGY already has lined up a buyer for its work under specific terms. The downside is that PGOGY will not own the images as it does in Multi client work and is prohibited from reselling them. This shift has resulted in much lower investments and increased the cash profitability of the seismic business.

PGOGY is a leader in the Seismic industry especially on the marine side. This is unusual for a company exiting bankruptcy. Usually one has to pick among lower tier players as they come out of bankruptcy, but with PGOGY we are investing in an industry leader. Numerous conversations with major industry participants have confirmed this assertion as PGOGY is considered one of the most technologically advanced.

My conversations with industry folks indicate that there are still too many players out there but the demand side is picking up. Major oil firms have underinvested over the last few years. With higher oil prices and depleting wells major oil firms are starting to pick up the investment level and this will help the seismic players. It is worth noting that Berkshire Hathaway is in the process of acquiring Seitel – another seismic company in bankruptcy.

FPSO
The FPSO business is stable business with good cash flow characteristics. Operating margins have consistently been around 30%. Once a FPSO attaches to a well, the stay can last for many years depending on how long the well lasts. PGOGY’s FPSO’s are in the North Sea which generally have large wells. FPSO’s make money based on a day rate and some per barrel fee depending on the contract. There are currently 118 or so FPSOs in the world and only about 2 or 3 are not being used due to massive deterioration.

Catalyst

1.) Emegence from bankruptcy and new investor focus
2.) Completion of rights offering
3.) Rationalization of the Seismic industry and increased investment from major oil companies.
4.) PGOGY's shift to direct client work and away from more speculative multi client work.
5.) A more disciplined management of the business for cash flow and further deleveraging.