ION Geophysical ("IO") 9.125% 2nd lien due December 2021 trading in the low 80s represents a compelling risk / reward proposition, with a 1-year and 2-year yield-to-par return profile of ~30% and ~20%, respectively, and current yield of >11%. By YE 2017, IO will have less than $105MM of net debt and the creation value through the 2nd lien is less than $100MM pro forma for the repayment of the 3rd lien upon its maturity in May 2018 (IO will have >$60MM of cash on hand at YE versus $28MM maturity in May 2018). Notably, there is >$115MM of equity market capitalization below the debt so the debt / TEV is less than 50% and leverage using my 2018E estimate is less than 1.7x through the debt.
As previously written up by huqiu in late 2015, IO essentially has three value drivers (discussed in more detail further below): 1) multi-client library with a book value of ~$97MM as of June 2017 and significant recent momentum especially in the Gulf of Mexico and Brazil (backlog of $62MM as of July 2017 versus $30MM in June 2016), 2) device / offshore equipment with a tier 1 competitive position + a steady margin software business for processing seismic data (notably, IO has spent $345MM on R&D over the past 10-years mostly toward this segment) and 3) a $-losing (but potentially lucrative) Ocean Bottom Services (“OBS”) segment that currently generates $0MM of revenue and burns -$12MM of FCF per annum but has significant upside optionality with new business wins (most likely in 2018).
The IO 2nd lien has limited downside given robust collateral coverage: data library + stable earnings power from devices / software + free option around OBS segment. Under conservative estimates, the business is worth in excess of $300MM driven by the following: 1) 1.25x multiple on the library book value, 2) 50% haircut to PP&E and current assets and 3) 50% haircut to 10-year accumulative R&D spend. Put a different way, the MC library likely covers the entirety of the debt and the software business likely is worth an additional $100 - $150MM. The remaining two business units (devices and ocean-bottom services) are valuable but can effectively be written down to 0. Historically, IO has traded at a 10-year median multiple of ~4.5x and 1.4x P/Sales. Conservatively assuming 2018E sales of $213MM (ascribes $0 revenue to OBS segment) and EBITDA of $71MM, this would imply a TEV of $300 - $325MM (versus less than $100MM “creation value” through the 2nd lien post the pay-down of the 3rd lien in May 2018).
Based on my 2017E estimate of $50MM EBITDA, leverage is 2.3x and the equity trades at 4.6x. Based on my 2018E estimate, leverage is at ~1.7x and the equity trades for ~3.3x. Average 2007 – 2016 EBITDA would suggest a creation multiple of less than 1x through the debt.
$21.7MM Revolver (1)
Equip cap leases + Other
9.125% Snr Secured 2nd lien
Total Net Debt through 2nd Lien
8.125% Snr Secured 3rd lien
Total Net Debt
(1) As of June 2017, borrowing base under Credit Facility was $21.7MM and will flex up into 2H of year
IO is a seismic exploration service provider to the oil / gas industry. IO acquires, processes, analyzes, licenses and sells seismic data to oil and gas E&P companies. Additionally, IO has a leading position in both streamer positioning systems and navigation software + an Ocean Bottom services segment. In simplistic terms, there are 3 key drivers to the IO biz model:
1.Solutions - IO helps O&G exploration and development cos create maps of subsurface structures to identify hydrocarbon reserves by commissioning seismic surveys and processing seismic data collected. IO may bear part of the cost of the survey in exchange for being able to market the data to 3rd parties later under the Multi-Client (“MC”) model. Historically, IO has obtained very respectable pre-funding rates averaging >100% and very good ROIC on investments. Solutions segment is THE main driver of n-term profitability growth for IO and we get the last 2 segments for “free”
2.Systems + Software: 1) mftrs marine seismic equipment – includes streamers (long strings of sensors that marine vessels pull behind them to record reflected shockwaves), streamer positioning systems (control the position of the streamer sensors) and ocean bottom cables (essentially streamers on the ocean floor). The challenge w/ equipment is that the end-mkt customer are competitor seismic cos (CGG, WesternGeco, PGS, Dolphin, etc) and the industry is suffering from a downturn w/ a greater lag to recovery before investing in new equipment. 2) control software for marine seismic equipment – develops and licenses software to the marine seismic cos as well as E&P cos. This biz has high EBIT margins of ~50% and relatively stable profitability that suggests there is the potential for real value in this biz (software alone could be worth upwards of $100MM)
3.Ocean Bottom Services (OBS): contractor to create seismic surveys using ocean-bottom cables. This segment currently generates $0 revenue and burns -$12MM per annum. IO has a crew on staff that is waiting for contracts to work on. Historically, this biz has benefited from high margins and large contracts. Mgmt. is very positive on the l-term outlook of this biz. We are underwriting NO improvement on the OBS segment but believe this offers a “free option” on a >$50MM revenue (perhaps upwards of >20MM EBITDA) contract.
Collateral coverage analysis:
The two graphs below highlight collateral coverage using 1) EBITDA multiples (2018E estimate is $70 - $80MM) – and 10-year historical median multiple is ~4.5x EBITDA (and 1.4x sales 10-yr median) and 2) valuing the library + R&D (w/ haircut) + current assets (w/ haircut). Under both scenarios, the enterprise is worth >$300MM versus YE net debt of ~$105MM providing significant downside support.
NOTE: 10-yr historical multiple is 1.4x sales and 4.5x EBITDA
Total Net Debt - YE 17E
EV/MC library multiple (1)
Book value of MC library (Dec 16)
EV of MC biz
PP&E + Current Assets (ex cash) - haircut by 50%?
R&D (accum past 10-yrs) - haircut by 50%?
% recovery (LIBRARY VALUE ONLY / 0 for software / OBS)
I do not hold a position with the issuer such as employment, directorship, or consultancy. I and/or others I advise hold a material investment in the issuer's securities.
2H 2017 results, OBS contract wins in 2018 (not underwriting), potential sale of biz or parts of biz, potential 2ndary equity capital raise to deleverage the BS