Description

We believe SAExploration will survive the current dislocation within the energy sector and is worth in excess of $15 a share over the next three years, versus it current price of $3.50. SAE has been written up before and is a product of a broken blank check deal coupled with a dislocation in its primary markets.  However, peeling back a few layers reveals a company that is not directly affected by the price of crude, and is run by a management team that has both significant skin in the game as well as a long history of navigating energy cycles.  An in-depth look into the business reveals that SAE is not a commodity seismic player, but rather a best-of-breed logistical provider deriving 80% of its revenues from providing services leading up to a seismic shoot in some of the most complex operating environments known to the industry.

While not the focus of the write-up, if you believe the common has any value, then a safer and still attractive way to play this is the senior notes.  These were just registered for free trading and have about a 22% yield to maturity (2019) with a $150M face outstanding.

Business Summary

SAExploration partners with oil companies in the prospecting phase of their exploration activities.  As oil has become increasingly difficult to find and extract, major E&P’s are looking to more remote regions to find large reservoirs.  The first step to this process is targeting an area of possible reserves and running a seismic study.  In this process, vibrations are sent through land or bodies of water and the resulting signals are recorded.  These recordings are then processed by the oil companies to identify the location and size of any reservoirs.  In other words, SAE is essentially taking a giant ‘x-ray’ of a large piece of land or the ocean floor, which oil companies can then use to determine where and how to drill.

The process of collecting this seismic data can be complex, especially in the remote regions where SAE focuses.  Not only is the process itself technical, but it requires teams as large as 3,000 people operating in remote jungles, artic climates, or deep ocean environments.  Beyond these complexities, the company must also partner with local governments to obtain permission as well as navigate the logistics of supporting thousands of field workers in remote areas.  Specifically, they must set up base camps with catering, lodging and medical support.  The areas in which they operate can be so challenging that often all these supplies need to be brought in by helicopter or boat.  If that was not enough, the company also needs to operate in a manner that leaves minimal environmental impact as well as maintain a safe work environment void of injuries.  Major oil companies are sensitive to these issues, and while price is always an important factor, it is rarely the most important element of most of SAE’s projects.  SAE has a long and enviable safety record as well as the ability to deliver a quality project, and we believe the barriers to entry are sufficiently high.  To this end, SAE does not operate in the lower 48 of the US market where seismic is a largely commoditized service and they are not able to provide value add logistical services.

Significant Events

July 2013: The Company became public through a SPAC with an IPO price of $10 a share.  The founding shareholders and SPAC sponsors retained 54% of the equity.  Leading up to the IPO, the company had grown very quickly, tripling revenues in the prior 3 years.  It also became public with about $130M of debt.

September 2013: The Company had a small operational hiccup that caused margins to compress as a job experienced significant delays, yet the assigned crew still needed to be paid.  They affirmed 2014 revenue guidance and projected EBITDA of $45-55M, a significant increase over the $35M of trailing EBITDA.  

June 2014: SAE refinanced its $130M loan for $150M of notes due in 2019 that yield a 10% coupon. They were required to register the notes within 12 months, which has since happened.  This had a huge positive impact on the operating capacity of the business as it allowed them increase their borrowing power, pay lower interest rates, and extend the maturity by 4 years.

During this same time frame, the company won major contracts in Alaska and used their improved liquidity to purchase $35M of equipment to service this contract.  Work began in January and the expected payback period on the equipment purchase is 2 years.

October 2014: Oil prices plummeted and investors became nervous about the company’s ability to generate growth and earnings.  As the selloff in oil has become more drastic, the market continues to be afraid that lower oil prices will lead to less spending on seismic exploration, and possible insolvency of the company given its high debt level.

November 2014: The Company announced earnings, stating that they will miss their previous guidance and likely post breakeven results for Q4.  The main driver of the earnings miss was a delay in 3 major contracts that were expected to provide $135M of revenue in Q4.  However, these contracts were ultimately awarded and the earnings ‘miss’ was simply a deferral until Q1/Q2 of 2015.

Additionally, the company’s CEO bought over 225k shares on the open market after the earnings announcement when the price dropped to $4.  Given that the management team already owns 54% of the company, we view any material amount of insider buying as a major vote of confidence in the company’s liquidity profile and future prospects.  We held a call with the company’s Investor Relations team (which is outstanding) and they were equally perplexed about the magnitude of the stock’s dislocation.  Insiders have since continued to purchase the common equity in meaningful amounts.

April 2015: The company announced Q1 earnings, and killed it.  They have slimmed down their growth profile, retrenched in their key markets, and driven execution at the project level.  The margins demonstrate great execution and the stock bounded off its lows of $2.40 to the current share price.  In tandem, the company announced that it is pursuing contracts in the shallow and deep ocean market as well as exploring efforts to leverage their logistical expertise to sell into adjacent verticals.  As an example, they may help mobilize a team that needs to build/maintain a pipeline into the remote rainforest – providing camps, medical services, etc.  They are early in this effort but believe it can be meaningful and mitigate dependence on oil prices.  We would highly encourage listening to their discussion of new verticals in the most recent earnings call.

Valuation:

At the present valuation, the company’s market cap is about $50M and they have $152M of debt outstanding.

For SAE, we looked at what would happen if the company stopped growing altogether.  This represents a very unlikely scenario as revenues grew 58% in 2014, especially given that a significant portion of revenues were pushed into 2015.  Our model assumes flat revenue, and EBITDA margins normalizing in the 14-15% range, and small cap-ex needs. Even if revenue growth were to flatten completely, we believe the company would warrant a 5-7x pre-tax FCF multiple and the stock would more than triple over the next 2-3 years.  In all likelihood, absent another 35% drop in oil prices, we expect the company will post at least modest growth, providing greater upside than the numbers shown above. If you believe SAE can make it through to the other side, it offers outstanding returns under almost any scenario.

The Opportunity

A revenue and earnings miss coupled with declining oil prices has caused an overreaction in SAEX, and even when we assume zero growth going forward, we see significant upside in the stock.  We also believe the recent sell-off has been driven by the SPAC funds, who are non-natural holders for the stock and have no interest in the underlying company.

The recent refinancing of the debt has eased our fears of a liquidity crunch and the company has also secured a $20M revolving loan from Wells Fargo that remains undrawn.  As further security, they have about $30M in excess accounts receivable that should soon convert to cash.

We believe that as earnings normalize and fundamental investors learn the story, there is a strong prospect to more than triple our investment over the next 24-36 months with minimal risk of permanent loss.  With Eric Rosenfeld on the board we feel capital allocation will be prudent, and governance isn't an issue.  Per our estimates above, a 7x pre-tax multiple would yield stock price above $19 (if growth emerges in a few years).  With solid liquidity and an inside ownership of 54%, we believe the company will start to shift its cash flows from historic growth profiles to paying down debt (likely retiring it in the open market) or building liquidity.  Today, the equity trades at 1.5x trailing EBITDA, a number that reflects a fear premium more than an actual risk.

The largest risk to the story is another dramatic downward movement in oil prices.  This would affect the exploration budgets of oil companies, both driving SAE’s revenue numbers down on a go-forward basis andcompressing multiples further.  However, these types of projects are generally complex and involve months of planning, thus companies rarely cancel them on such short notice.  The company has a robust backlog and bids outstanding number that they publish.

When we posed our concern that a continued slump in oil prices would negatively affect the business going forward, the company responded with 4 rebuttals that we view as very credible.

1.       They first explained that much of their work in emerging economies works within the context of concession licensing.  Here E&P company’s must drill or move forward on the project to keep the concession.  Drilling is far more expensive than a seismic study, and usually seismic satisfies any concession requirements to keep the clock ticking as active.

2.       This same management team was able to not only survive the last downturn in oil prices, but doubled the size of the business during that time.  They certainly believe they can at least keep revenue flat and recent large wins in the ocean market reaffirm this.

3.       Its primary customers are large majors and large independents.  As such, they are looking out a number of years for massive reservoirs that can generate resources for decades to come.  As their customers plan five years out, their decision-making is not based on short-term oil prices.  Even with the dislocation, you simply can’t pursue long-term large reservoirs with a short-term exploration plan.  SAE also doesn’t operate in the lower 48, where the market is more spot-oriented and doesn’t exhibit such characteristics.

4.       The company leases a good portion of its seismic equipment, giving it a variable cost structure. They purchase only when they are confident in close to 100% sustained utilization.  This equipment is very expensive and others who own theirs are pressured to maximize utilization, often leading to operating at a loss.  

In any case, we believe the worst is already priced in.  We can also pair this with a short on number of companies that we believe are more susceptible to short-term E&P budgets such as levered drillers or junior E&P’s.

While we think the equity is very attractive, we also believe the bonds are very compelling for investors who prioritize more downside protection and an income component.  We have seen them quoted at 63 recently.

We would urge investors to reach out to their IR department post earnings.  We have found Ryan to be incredibly informed, responsive and candid about the sector and the company as well.

Risks:

Another big leg down in oil

A large saftey issue

Operational Leverage

Catalyst

Building Liquidity

Making it through the cycle

Demonstration of sustained earnings power, and margins