Description

Trico Marine (TMAR) 8.875% Sr. Notes due May 2012

I recommend that members buy the 8.875% Sr. Notes due May 2012 of Trico Marine Services (TMAR) at 50% of face value or better.

Business Description
TMAR is the fourth largest (Tidewater (576), Seacor (235), and Seabulk (125)) owner and operator of boats used to service offshore oil exploration rigs. At the end of 2003 TMAR owned 84 vessels. 7 AHTS, 11 PSV, 10 Crew boats, 9 line-handling boats and 47 supply boats. TMAR’s ships average 16 years old, TDW (a good proxy for the industry) average 22 years old. TMAR’s ships provided transportation of people and materials to and from offshore rigs, haul rigs, and provide support for construction and take down efforts associated with offshore drilling. TMAR operates in the Gulf of Mexico (GOM), North Sea, off the coast of Brazil and off the coast of West Africa. TMAR operates in a commodity business exhibiting significant operating leverage. Offshore oil/gas support operations is a global business. Ships currently in one part of the world can be moved to another in order to take advantage of relative market demand. Moving boats is costly and in order to be economic there must be significant differences in relative demand. Currently the offshore oil/gas service market (particularly in the Gulf of Mexico and the North Sea) is experiencing a downturn. Despite the high price of oil/gas, offshore rig counts have decreased for over 2 years. The majors have experienced a number of costly offshore dry holes and have reduced offshore E&P spending (this trend may be reversing itself based on recent reserve write downs and announced increases in E&P spending). The reduction in offshore activity is evidenced by the business and stock performance of offshore service companies, seismic companies, and companies specializing in owning rigs.

TMAR’s Performance
2000 2001 2002 2003
Sales $132 $180 $133 $123
EBITDA $55 $87 $35 $26
GOM EBITDA $44 $2 $3
INTL. EBITDA $43 $33 $23

I have attributed G&A 50/50 between GOM & INTL., The company reports G&A as 1/4 INTL & 3/4 GOM.

Structure
TMAR has two divisions, Domestic and International. Domestic is pretty much the GOM, and International is everything else, with the North Sea being the largest component. Currently all of the company’s cash flow is being generated by the international division. In the past, the GOM operations have contributed on par with the international operations. Each of these divisions have secured debt that is senior to the 8.875% Sr. Notes. The Domestic division has $55m of debt secured by TMAR’s GOM boats. The International division has $87mm debt, $22mm term and $65mm revolver both secured by TMAR’s international assets. TMAR’s NOK denominated revolver has $30mm of availability, which reduces by 5.7mm bi-annually in March and September. The company has two vessel secured notes totaling $16mm. Total debt Senior to the 8.875% Sr. Notes is about $155mm. The company has roughly $30-40mm of cash after completing the $55mm domestic Bear Stearns facility. The 8.875% Sr. Notes, economically speaking, are the equity of a consolidated TMAR. Currently the Sr. Notes are trading without accrued interest, indicating the market’s belief that TMAR will not make the May 12, 2004 interest payment due on the 8.875% notes. I expect TMAR to do a pre-arranged ch.11.

Restructuring Scenarios
I expect TMAR to propose a restructuring in which the 8.875% Notes are converted to nearly 100% of the equity in reorganized TMAR. I expect that the Secured debt will not suffer a money default and will be reinstated as part of a ch.11 reorganization. Assuming a restructuring without paying any future interest on the 8.875% Sr. Notes, the Company’s trailing operating cash flow (cyclically depressed and possibly a through) of roughly $26mm (peak was over $80mm, EBITDA has averaged $50mm over the past 4 years) will cover the necessary capex of between $12-16mm and the roughly $10mm of interest expense from the reinstated secured debt. Under this scenario the company will have somewhere around $30mm of cash, no cash burn, and a capital structure that is sustainable in a further downturn while affording the former 8.875% Sr. Notes holders a leveraged participation in 100% of any company/industry turnaround. To get a sense of the potential up side opportunity, TMAR’s EV peaked at around $800mm. At 50% on the Sr. Notes you are paying $125mm of all value above $155mm.

Future EV($mm) $150 $250 $350 $450 $550 $650 $750 $850
Return* to 8.875% Sr. Notes -100% 0% 100% 200% 300% 400% 500% 600%
*assumes notes are converted to roughly 100% of newco equity

TMAR seems more attractive than other offshore service providers, because it is cheaper on a multiple basis, more importantly, the 8.875% Sr. Notes offer significantly more upside in a turnaround, and assuming a restructuring, the Sr. notes should have ample time to wait for a turn around to materialize.

Alternatively, and very unlikely, TMAR could continue to pay interest on the 8.875%. Barring a near term (by the end of 2004) industry turnaround, the company will run out of money in 12-18 months and the 8.875% notes holders may not come to own 100% of the upside in a reorganized company. I view continued interest payments as negative for the 8.875% holders. If the business turns around, upside will be capped at par value, and if the business doesn’t experience a near term turn around, the 8.875% Sr. Note’s bankruptcy recovery of 100% of the equity of newco could be threatened.

TMAR recently announced the hiring of Lazard and Kirkland &Ellis, both firms have prominent reorganization departments.




Multiples through the 8.875% Sr. Notes priced at 50% of par

LTM 4 Year Ave. 4 Year Peak
x EBITDA 8.5 x 4.5 x 2.6 x
x EBITDA- Capex NM 10.5 x 3.2 x
As % of Tangible Assets*--- 57%

*bookvalue, not market value, TDW recently took a major write down on their GOM fleet, and it is likely that TMAR should do the same.

Valuation
8.5 x EBITDA aint cheap, but this is a cyclical business and 3.2 x a peak EBITDA-Capex is cheap, assuming that the business will have another up cycle. .57% of book is cheap, but that book may be subject to a significant write off. The investment boils down to buy assets, and hope to later sell earnings/cash flow.

Cycle
TMAR’s business is driven by offshore oil/gas exploration and production, more precisely, the number of offshore rigs. It takes roughly 2 boasts to adequately serve each rig. Historically offshore production and rig count has been highly correlated with oil/gas commodity prices. In 2001 there were over 180 off shore rigs in the GOM, now there are around 90. Beginning in late 2002/early 2003, the relationship between oil/gas commodity prices and offshore rig count decoupled, commodity prices have remained strong and offshore rig counts have continued to drop. We do not need oil to stay above $30 per barrel for there to be a turn around in the offshore market. If oil were to drop below $20 and stay there for an extended period of time, it would likely hurt the chances for a recovery in offshore rig count. If oil were to rise, or stay above $30 for another year or so, the probability off a recovery in offshore activity must be near 100%. Each of the last 2 years the industry has predicted 2nd half recoveries that have failed to materialize. Perhaps the third time will be the charm, but assuming TMAR competes a restructuring as outlined above, the 8.875% Sr. Note holders will be able to participate in the next up cycle weather it comes in 2004, 05 or 06. Nobody knows when or if the cycle will turn (or if it will get worse), but based on recent announcements of major and minor E&P companies intending to expand their exploration efforts and the apparent beginning of a turnaround for the seismic companies, it seems possible that offshore E&P may heat up in the next 12-18 months. The UK government’s recently enacted tax incentives aimed at encouraging independent exploration in the North Sea is also a positive sign. Even if the GOM never comes back, TMAR Sr. Note holders can make a nice return on the International business. Markets in which new E&P projects are developed will drain marginal capacity from the GOM helping to support higher day rates and utilization, even with no increase in GOM projects.

Summary –
Restructuring likely – if up cycle 8.875% Sr. Notes make 3-5x their money. If business gets worse, the reorganized Sr. Notes have somewhere between 2-4 years of liquidity to wait for a turn around, if none materializes they could be wiped out and get zero. If the preceding scenarios have 50/50 odds, the expected return is somewhere between 1.5 & 2.5x your money. Even if it takes 5 years that’s a good IRR.

Catalyst

Catalyst – restructuring and pick up in offshore E&P spending