Description

(all figures in USD)

DESCRIPTION:

Polarcus is one of the global providers of marine three dimensional (3D) towed streamer services. The company has positioned itself as a major force in the seismic industry, having grown its number of vessels from 0 to eight, capturing 12% market share within five years. With the newbuilding program finally completed and having now reached the critical mass to operate efficiently, we believe it has a unique position to exploit a tighter contract market in the years ahead. Strong cash flow from operations should deleverage an overly leveraged balance sheet. As debt concerns ease, we expect the valuation discount to narrow.

ACTIVITY

Seismic is the principal technology used to locate and define subsurface accumulations of oil and gas. For more background information on the industry I refer to VIC write-ups on PGS and TGS-Nopec. Polarcus is a pure-play marine seismic company headquartered in Dubai, opposite the Dubai Drydocks shipyard where most of the company’s vessels were built. The company was founded in December 2007 by the management and key shareholders of EasternEcho after it was acquired by Schlumberger subsidiary WesternGeco. Polarcus listed on the Oslo stock exchange in September 2009.

Polarcus survived the crisis, securing $1.5B financing to build a fleet of 8 high-end seismic vessels. The last 2 vessels were delivered during 2012. In 2013 there will be 63 high-end vessels in operation giving Polarcus a 12% market share. 

The seismic industry is characterised by low barriers to entry and an uncoordinated supply side. Incentivised by high oil prices in 2008 and a bullish outlook for spend, seismic companies entered into a speculative newbuild cycle that added 11 and 12 3D vessels in 2009 and 2010 respectively, representing large additions of 17% and 18% to the 3D fleet. Lower spend following the downturn then triggered a rationalisation of excess capacity from the incumbent players in two ways:

1) Retirement of older vessels
2) Consolidation to maintain market share and upgrade fleet

In September 2012, CGG Veritas acquired Fugro, the latest development in a consolidation of the industry. Today, the top 3 players have 72% of the market and the top 5 represent 90%. This consolidation has improved discipline on the supply side to the extent that demand is estimated to exceed supply during the 2013-2015 period. It takes over 2 years to build a vessel and therefore visibility on supply is good until at least 2015.

Demand for 3D seismic is expected to grow with >10% per year supported by the current oil price, lower reserve replacement ratio’s, the high cost of finding etc..

In the absence of a substantial drop of the oil price it is very likely that day rates will exceed mid-cycle rates of $270,000 per day for the next 2 years.

MANAGEMENT

Polarcus was founded by Carl-Gustav and Peter Zickerman, who together own c.11% of the company. The Zickermans have substantial experience in the seismic sector, having been involved in the start-up of SeaBird Exploration, GeoBird Exploration, and EasternEcho. SeaBird and Geobird are today a combined entity with 9 vessels mainly operating in the lower end 2D market, and are no longer under Zickerman ownership. EasternEcho was acquired by Schlumberger in 2007, weeks after the company listed on the Oslo stock exchange. Dubai Drydocks, the shipyard that builds Polarcus’ vessels, is also a significant shareholder with c.9% ownership.

The management team is extremely experienced, led by Rolf Ronningen (CEO), who was previously CEO of EasternEcho, and prior to that president of Marine operations at PGS, an established competitor. Most of the senior management team come from EasternEcho and other top-tier seismic companies like CGGVeritas, PGS, WesternGeco and Fugro. 
Most of the major oil companies require a 5-year track record from seismic companies. Given the experience of its management and operations team, Polarcus has so far been able to break this barrier faster than usual.

The company has survived a severe financial and economic crisis and has taken delivery on time and on budget of 8 seismic vessels.
With a new and uniform fleet Polarcus is well positioned to take advantage of a recovery of the industry.

Management has stated that its objective is to de-lever the company (as opposed to increase fleet) and therefore we see little risk in terms of capital allocation.

Founders & Mgmt.: Aligned with shareholders

Founder  Zickerman Family still owns  > 10% of the company
Initial start up capital at 11 NOK/ share in 2009
Followed subsequent capital increases (at lower prices)
CEO Rolf Ronningen invested 1 mio $ at 11 NOK /share
CEO bought another 100,000 shares at NOK 3,15 in Dec 2011, the CFO bought 75,000 shares at the same time
Today Exec management and BOD owns 2% of Polarcus
Initial founding shareholders have a warrant for 21,250,000 shares at 11 NOK if stocks prices is > 22 NOK for more than 30 trading days

DEBT

The company estimates net debt to be $837Mio by the end of the year (3.4X Ebitda2013) making Polarcus highly levered compared to its peers. Excessive debt has been a main concern in the investment case. However, the market outlook has improved and all vessels are now operating, so this problem is set to ease over the next few quarters, as cash flow from operations ramps up. A few days ago the company announced to be in exclusive negotiations with Turkish Petroleum Corp over the sale of the 8-streamer Samur combined with the provision by Polarcus of seismic data acquisition, management and crewing services for the vessel. The price is expected to exceed the price Polarcus paid for the vessel (>$135M) and will improve the balance sheet.

VALUATION

Based on the industry dynamics described above we expect day-rates to exceed mid-cycle rates of $270,000 per day from 2013 until at least 2015.

At mid-cycle rates we currently pay 7.9 times 2013 earnings and only 4.6X FCF.
EV/EBITDA is 5.3 and EV/EBIT 10.2.
With a clear path to rapid deleveraging we believe Polarcus deserves at least a sector historical average earnings multiple of 11 or 39% upside. All industry estimates we have seen for day-rates exceed $270,000 providing further upside.

The Price to Book is 1.22 with book value consisting of vessels with a replacement cost of >$1.44 per share (20% above current share price).  

RISKS

• Substantial drop of the oil price
• Another Macondo-type event

DOWNSIDE PROTECTION

• Marketable assets with a market value and replacement cost above current valuation.
• During the recent crisis the industry remained cash flow positive. Polarcus has a new and uniform fleet with a break-even below industry averages.

SUMMARY  

Polarcus has limited downside based on valuable assets and substantial upside on an industry returning to mid-cycle valuations. Polarcus took delivery of its last vessel at the end of Q2 and all vessels are now throwing off cash flows. All industry signs point to a sustained recovery, at least until 2015. Strong cash flow generation and the sale of a vessel to Turkish Petroleum should ease debt concerns.

Catalyst