Description

CMG is an under-followed, small-cap producer of mission critical reservoir simulation software with several change agents at hand.  The company competes in a duopoly industry structure and has leading market share in the unconventional reservoir space.  The energy industry is far behind many other sectors in its digital transformation process.  There is a substantial opportunity for leading software and machine learning offerings that can help maximize asset value by accelerating revenue and reducing costs and risk.  Leadership change at CMG in mid-2022 has enabled a transformation from a highly technical, research-oriented culture to one that is more commercially focused.  The company has broadened its product portfolio to give more focus to conventional reservoirs, is successfully targeting clean energy opportunities such as carbon capture, and is starting to deploy capital actively towards M&A.  Free cash generation at the company is inflecting higher.  Trading at ~20x forward FCF for a high quality business that should grow revenue double digits for the next several years, we believe CMG offers very attractive returns. 

Business Description and Industry Structure

CMG makes reservation simulation software for the oil & gas industry.  Its product allows engineers to accurately determine where extraction should take place and how reservoirs will behave.  The software models storage sites and uses predictive physics to examine how those sites will react at various injection rates and locations.  The company has more than 600 customers across 60 countries, including 75% of the world’s top 25 largest oil companies.  Its physics modelling tools, deep relationships and experienced highly skilled personnel make CMG a key customer partner, generally costing ~$50-100k annually.  CMG’s revenue mix is ~85% software / 15% services, and the company generates robust EBITDA margins in the mid to high 40’s. 

There are two primary competitive offerings in the space; Schlumberger’s Eclipse product is the largest player and CMG is number two.  In the more complex and faster growing unconventional reservoir sector, CMG has close to 50% market share and Eclipse is in the mid-40s range.  There are several copycat software offerings but with far limited data and lower efficacy, the barrier to enter this market is extremely high and these companies have seen minimal traction.  

Investment Thesis

Mission Critical Software with High Switching Costs

CMG’s software is best of breed and extremely sticky with four decades of simulation data creating a permanent accuracy lead that informs major customer spend decisions.  CMG’s data and IP make it the clear leader in oil & gas simulation.  The company has the longest history in the space and a strong brand and reputation.  Customers rarely switch simulation providers; the transfer of the reservoir data alone would be time and energy intensive, and the risks associated with poor resource allocations and operational decisions are very high relative to any potential cost savings.

Cultural Change to Greater Commercial Focus

Historically, CMG was known for its strong engineering culture and customer support orientation (highly consultative approach), and as such their brand is very highly regarded.  However, CMG was not known for commerciality, rarely taking price, cross-selling functionality that might cost more but benefit the client, and often failing to capitalize on natural available opportunities. 

After a long period of static growth in revenue and profitability, in May 2022 a new CEO Pramod Jain was brought in to run CMG.  We believe the move was catalyzed by CMG board member and Constellation Software executive Mark Miller (head of CSU’s Volaris division).  Mark had been a CMG board member but became Chairman shortly before Jain’s hiring.  In fact, two Constellation board members are also board members at CMG; interestingly both individuals sit on only one public company board outside of Constellation (other than CSU spin Topicus), CMG.  We believe these board members have added significant value to CMG’s operational execution and capital allocation focus and capabilities. 

Since joining the company, Jain has made significant changes and upgrades to the executive team.  We have found Jain to be thoughtful, focused and driven.  Importantly, he has strong shareholder alignment as his compensation is heavily share price oriented, with significant tranches if the stock hits $15 and $20.

Jain has begun the transformation of the business to one that is more metric driven and sales and performance oriented, leading to a company that exerts pricing power appropriately and has faster growth.  Management has worked to better segment its customer base and has realigned incentives for the sales team.  CMG also launched a new product offering to sell into the conventional reservoir space, a naturally synergistic area with the core platform that received less focus historically.  Additionally, CMG has aggressively targeted revenue opportunities within the clean energy space.  They are the dominant player in the rapidly growing carbon capture business which currently represents a high teens portion of revenue and are also targeting large opportunities in geothermal and hydrogen.

M&A as Accelerant

Jain and his management team made their first significant acquisition in September 2023 of a cloud-focused seismic data storage and interpretation business named Blueware.  While the transaction is small at ~$29mm and Blueware is a young company, the growth and margin opportunity is significant.  Jain is personally spending the majority of his time running this unit, and CMG will continue to publish standalone acquired company results so shareholders can properly assess the transaction.  We believe over time Blueware could contribute up to $0.15 in FCF/share to the company.  Furthermore, CMG has seen a noticeable pickup in in-bound seller interest after announcing this transaction and has a full- time business development person (former CSU) in place to pursue opportunities.

Execution and Valuation

Execution under the new management team has been solid.  After a long period of stagnant growth from 2017-2022 (both topline and EBITDA), revenue growth has accelerated into the double digits and even mid-20’s the past couple of quarters. 

CMG trades for 20x forward FCF and is inexpensive for a duopoly market software player that has a dominant position in both traditional extraction and newer cleaner energy opportunities.  Through a combination of exercising its latent pricing power, benefiting from a more metric driven commercial culture, and further product evolution, we believe CMG can achieve consistent double-digit top-line growth for the next several years.  Furthermore, with its net cash balance sheet position and increased focus on complementary M&A, CMG may accelerate top and bottom-line growth rate inorganically.

The market at various times has displayed skepticism around the durability of the duopoly industry structure and the long-term trends in traditional energy consumption, but we are confident in the significant moats around CMG the value around its IP.  The company has decades of regression testing and validation expertise and with its continued successful diversification into large clean energy opportunities which now represent almost 1/4 of revenues, the business is well diversified for strong durable growth ahead.  Through a combination of double-digit top line, modest margin improvement and complementary capital deployment, CMG likely offers a high teens+ compounding opportunity.

Catalyst

Price increases

Product rollout + sales team alignment

Recognition of growing energy transition segment

Tuck-in M&A