XDC is a drilling and coil tubing onshore oil services company. It has a fleet of very new Tier 1 onshore drilling rigs, as well as large diameter electric coil tubing rigs. 

 

The company has a unique technology, it is the only company to be successfully running AC Electric coil tubing rigs. It's a technology that has taken the company many years to successfully commercialize and perfect. In essence, the rigs are able to use electric power to provide extremely high precision when doing coiled tubing jobs. All of this is done via an electronic processing unit which is pre-programmed for precisely the job at hand and hence the whole coiled tubing operation is automated. This allows the company to complete a coiled tubing job in 4 hours which would take other competitors upto 3 days since they use hydraulic units which are manually controlled and which keep getting jammed and have stoppages etc. Other companies (including Schlumberger) have been trying to do AC electric coiled tubing but have failed to come up with a solution so far after years of trying. This also makes XDC a takeover target although that's not needed for my valuation.

 

XDC has a bit of a marred history. When it first launched this technology and these rigs, XDC struggled itself to a) get them working properly to their potential, and b) educate their customers of their superior performance and why it was worth paying up for them. Since XDC had financed the construction with debt, it succumbed to these pressures and was facing bankruptcy when it was rescued by existing (and new) shareholders with a dilutive equity issuance in mid 2012. This has caused XDC to be a somewhat hated name in the Canadian investment community who still remember losing their shirt on the investment in the past. Meanwhile XDC got its act together and has been achieving high utilization on its assets. This has allowed XDC to work on de-leveraging over the last year and a half although there's still considerable debt outstanding. 

 

XDC currently has the following rigs. 

 

 

 

 

4x XDR 200

4x XDR 300 

2x XDR 400 

11 x XDR 500

 

The XDR 300 rigs are in the process of being moved to India. These rigs are of a peculiar size that have considerably high specs for a small-ish rig like this and hence is under-utilized in its current position where it gets around 19.5k per day similar to the 18k being fetched by the XDR 200 rigs. In India meanwhile these rigs would be perfect in Rajasthan where getting much better specced rigs would be considerably more expensive. Halliburton has arranged the work (Cairn India had asked Halliburton to recommend rigs for their requirement and Halliburton has put up XDC's XDR-300 rigs as best suited for the specs and cost). 2 of these rigs are currently moving to India and I believe the other 2 will follow as well, where they all get a 30k dayrate instead of 19.5k in US. Taking into account the 15k opex on these rigs, and 90% utilization, the EBITDA should go from $4.5m to $17.5m, a big jump (once all 4 are in India).

 

Meanwhile the other drilling rigs are all steady. Demand is strong for Tier 1 rigs. They are newish. You can see how HP's Tier 1 rigs have been performing. The ones under more pressure are the Tier 2 and Tier 3 older rigs. But the market is still very strong. US onshore E&Ps are going to start turning cash flow positive (after 7 years of cash flow negative) from next year and will remain so for a long time to come. If they were able to borrow (and sell assets and working interest) to keep activity going during cash flow negative years, it heralds very high activity to come for the coming decade in drilling (and fracking). Tier 1 drilling rigs should see a tightening and dayrates should strengthen...... easily by $2-3k per day if not more. I am keeping current dayrates constant in calculations (XDR 200 at 19k, XDR 400 and 500 at 29k). Using 12.5k opex for these rigs results is $84m EBITDA currently which should uplift to $97m when all 4 XDR 300 rigs are in India (first 2 are already there and just started working, and I am assuming they will be successful and remaining 2 move over to the higher dayrate). 

 

Coil Tubing is the main story of the company. The Tier 1 drilling rigs are nice and all, but others are new drilling rigs as well and they are doing fine. But the CT fleet differentiates due to XDC's technological advantage as I have explained. This means XDC's Coil Tubing rigs see much higher dayrate than the industry since they complete each job so quickly but also lower utilization because they have more mobilization time from one job to another (since they finish each so quickly). 

 

XDC has 2 specially designed CT rigs called XSR-200 Plus which are working in Saudi Arabia. There is another XSR-200 Plus rig not in Saudi Arabia (working in North Dakota at the moment) that is also likely to be moved to Saudi Arabia due to the success of the first 2 rigs working there. They are earning around $50k per day. XDC had a 20% JV partner in its Middle East operation who they have just bought out for cheaply which will provide a minor EBITDA uplift going forward. With the partner bought out, they can move the 3rd XSR-200 Plus rig to Saudi. These rigs are earning closer to $70k per day in Saudi Arabia and have been a cash cow. They have an opex about $22k per day, and with 65-70% utilization (they move around a lot) are generating $34m EBITDA for the 3 of them. 

 

Then we come to the regular XSR-200 rigs. The company currently has 4 operating. The utilization of these rigs bottomed in mid 2012 at 5-10% and has since steadily improved over the last 2 years to now reach 60%. As I explained earlier this was a result of both XDC having start-up issues on its next-gen technology, as well as gaining the confidence and teach-in of customers, on how beneficial it is. Now the CT rigs are in hot demand which has caused day-rates to improve as well, which along with the increased utilization has resulted in a big inflection in the results (and the reason the share price has rallied so much from mid-2012). 

 

I think the story is considerably de-risked now. The technology has proven itself in the field and customers can't get enough of these CT rigs. The company last month announced a massive increase in the Coiled Tubing rig programme. They already have 2 new rigs under construction which would have taken the working CT XSR 200 rigs from 4 to 6 by end of the year but the company announced an additional 6 rigs would would take the number of rigs to 12 by mid 2016. The rigs cost $9m each and will generate about $3.5m-$4m in EBITDA (now that utilization has reached 55-60% from the mid 2012 levels of 5-10%), which represents a crazy 2.5yr payback. This is part of the reason the company is deploying every spare dollar towards this extremely high ROIC investment programme. I think EBITDA from these units will eventually reach $5m each after they achieve 70-75% utilization, and that's without dayrate increases, which would be a less than 2 year payback. These rigs currently generate $60k per day and cost $35k per day to operate. 

 

Valuation

 

 

Fully loaded the company should generate EBITDA of $155m (the company is taken full delivery by mid-2016) assuming $20m in SGA. Other drillers (like Canelson, or Precision, or HP) already trade at a premium to XDC because of the company's checkered history. Canadians feel the company is too high risk and deserves a discount. I think the technology is now proven and deserves a premium (as it is a higher return business, with more growth opportunities, a potential take-out for the technology etc). A 7x multiple is not at all too high considering HP (which has Tier 1 drilling rigs) already trades at that for NTM. This results in EV of $1,081m. Net Debt is currently $127m with about $83m in remaining capex ($54m was added last month when 6 new units were announced). In the next 2 years (while you are not at full capacity) XDC generates EBITDA of about $260m in EBITDA and maint capex of $55m, About $7m in interest payments, and about $25m in taxes to generate aout $170m in FCFs which will be used to pay down debt as well as fund the capex programme. Adding this to the adjustment, gives me a target price 2 years out of $11.4. Discount by 10% for 2 years if you like and you get a target of $9.5 currently. 

 

I think there's very little downside to the company from current trading price. I think the multiple is low, the technology is supreme and is a clear takeout candidate, coil tubing is benefitting even within oil services. There are clear catalysts coming up as well including moving another 2 XDR-300 rigs to India as well as moving the 3rd XSR 200 Plus to Saudi Arabia. The balance sheet is not stretched anymore. The ROIC on the new coil tubing rigs announced is insane. And on top of all this there's a potential catalyst of large diameter "Fracking through coil" to really take off. If this happens, my target is closer to $15. I don't want to discuss about this too much since this is more of a bull-case scenario and there's plenty of upside as it is. Whiting recently conducted some tests of fraccing through large diameter coil from XDC and had fantastic results. Note that fraccing through coil currently happens already but others don't have large diameter coil (because of XDC's AC Electric rigs and automated process) which considerably hinders the economics and hence adoption. 

- Deleveraging

- Re-rating

- Technology Advantage

- More rigs moving to India/Saudi

- Take out candidate

- Execution and cash flow generation of new rigs