|Shares Out. (in M):||300||P/E||0.0x||0.0x|
|Market Cap (in M):||222||P/FCF||0.0x||0.0x|
|Net Debt (in M):||600||EBIT||0||0|
Boart Longyear appears to be a very successful destroyers of value in an industry that generally has good economics (please see my prior write-up on Board Longyear where I successfully caught a bounce in the shares and my write-ups on Energold for more color on the best player in the hard rock drilling sector). Despite Boart being the industry goliath with nearly twice as many rigs as number two driller, Major Drilling, Boart has never operated the business well, or had any capital discipline.
After IPOing in 2007 at a pre-split-adjusted 15 a share, it has successfully destroyed capital at every opportunity it has had. First, in 2007 and 2008, it leveraged up to acquire other drillers at peak multiples that made no sense. Then when the bottom fell out of the industry in 2009, it chose to raise equity capital, in order to avoid tripping up covenants. In total, they issued $698 million in equity at the lows and tripled the share-count. Well done mates…
So did they learn anything about debt in a highly cyclical industry? Glad you asked. The answer is a categorical no. Mark Twain once said something about history rhyming… Welcome to the Boart Longyear. Less than a year after the massively dilutive capital raise, they once again started up dividend payments while they leveraged up the balance sheet to buy more drill rigs and expand the empire.
From 2009 to 2012, Boart produced $430 million of cash flow from operating activities, paid $103 million of that to shareholders in dividends, spent $673 million on acquisitions of drill rigs and once again faces a crisis as drilling demand has slackened in 2013. Despite a generational bull market in commodity prices that has seen world-wide drilling demand increase nearly 10-fold from 2002 levels of $1.9 billion and stay at an annual expenditure range of $8.4 billion (2009) to $21 billion (2012) since 2006 ($7.5 billion), Boart is somehow in trouble. Except, this is a new Boart—Craig Kipp, former CEO and mastermind of the value destruction was unceremoniously fired in October of 2012. Apparently, the board felt that having no CEO was better than letting Kipp destroy the business and it took them nearly six months to formally hire his replacement. On April 1, 2013, Boart hired Richard O’Brien as CEO. O’Brien spent 6 years as CEO of Newmont Mining where he consistently pulled down $10 million a year in compensation running the number 2 gold miner in the world—now he’s at $200 million market cap Boart Longyear. Clearly, he sees something on the upside.
What has happened in the past year to create this crisis? At current metal prices, miners aren’t making much money and they sure aren’t doing expensive drill campaigns. Most indexes of junior mining stocks are making multi-century lows—they aren’t raising speculative money to go look for resources. Drill utilization is down from 70% in June of 2012 to 45% as of mid-September, and utilization is still dropping. First half adjusted EBITDA is down from $208 million in 1H 2012, to $80 million in 1H 2013 and EBITDA is still dropping as utilization drops. In summary, it’s a mess over there.
So what is management doing to right the ship? To start with, they’re cutting costs—fast. Headcount is down from 11,400 in June 2012 to 6,100 as of mid-September. They’ve announces $160 million in cost cutting initiatives. They’ve collapsed 23 operating zones into 11 and eliminated excess support personnel (over 500 people thus far). They’ve sold off non-core businesses like their environmental and infrastructure drilling services operations. Basically, they’re lowering costs and making the business more efficient—previously, Boart had chronically been the lowest margin drilling company out of the large drilling companies.
In addition to this, management is looking to reduce inventory and release working capital of $100-$150 million over the next few years. Finally, capital spending should decline substantially as there is plenty of equipment from the overspending during the past few years.
Along the way, the company has taken its share of charges—which have rightly freaked out investors. In total, the company took $383 million in write-downs and impairments. Included in this are $122 million of equipment write-downs and $35 million of employee severance along with write-downs of intangibles, goodwill and a bunch of other categories. Basically, these were the big bath charges to re-set the company and move forwards.
Last month, the company issued $300 million of new senior notes due 2018 which has allowed Boart to pay down their bank debt and avoid covenant breaches. The net debt now stands at $540 million. I have no color on when a turn-around will come in the mining sector, but I believe that Boart has cut costs to a point where based on current utilization levels, the company will muddle along with a small profit and some negligible positive cash flow, until the sector does turn. Boart is guiding towards about $200 million in run rate EBITDA (after the cost cuts have been effectuated), which based on $50 million of cap-ex, $50 million of cash interest and $25 million of cash taxes, will leave about $75 million of positive cash flow. Will they hit this target? Probably not—but I don’t think they’ll miss too badly going forwards. Any positive cash flow will be used to pay down debt.
In the end, the mining industry has certain base rates of drilling needed in order to operate their mines. In addition the global mining industry has continued to mine more minerals than they discover each year and for most of the past 30 years, have they continued to do that. At some point, they will have to go back to exploring for minerals and Boart will be a beneficiary of this trend. I don’t see utilization dropping much more and anything to the upside is just gravy to the $75 million of cash flow estimate.
Why not buy the equity? I don’t think this is a bad play, but I worry that if things get worse, there will be a dilutive equity offering. Offsetting this, since May 2013, 6 directors have acquired 1,985,577 shares for about $1 million dollars and some of these directors made multiple purchases—including the new CEO who bought 300,000 shares in total.
I would like to suggest looking at the 2021 7% senior unsecured bonds that trade at 74 currently—for a YTM of 12.5%. There are $300 million of these bonds outstanding currently and they traded at 102 as recently as May 2013. Looking at the capital structure as of June 2013, there was $792 million of working capital, of which $250 million was trade and receivables and $411 million was inventory that has already had a number of write-downs. There is another $505 million of PP&E that has also seen a number of write-downs. On the liabilities side, there are $1,016 million of liabilities, with most of that being $300 million of bonds and $300 million of bank debt. After quarter end, much of that bank debt was re-financed with the $300 million senior secured bond offering.
Looking at this from a liquidation scenario, I think the unsecured bonds are still well protected by the receivables, inventories and PP&E. Once the company has finished shrinking into its new cost structure and the number of charges slow down, I think the market will look at this as a company that is viable and still cash flow positive at the bottom of the cycle—which should lead to a re-valuation of the bonds in our current yield starved world. If things get worse, an equity offering is almost certain—which will give additional protection to the bonds. Either way, I think the bonds are money good and should trade up towards par over the next year—giving a very healthy return to investors.