Description

NESR is a high-quality, pure-play OFS company in Middle East & North Africa (MENA), a region with high barriers to entry and a steady growth trajectory from NOCs developing gas and unconventional fields. For color on the Company’s history and product offering. I refer you to BlueFIN24 write up in May of 2021. The thesis is pretty simple and relies on a near term catalyst. We are able to buy this Company’s stock at the same price as it was in 2020 while Weatherford (WFRD), which I consider the closest comp due to similar product offerings and large MENA exposure, stock price has increased over 500% since 2021. This opportunity exists because On March 10, 2022, subsequent to the companywide adoption of a new SAP ERP system, management concluded that the SEC Fillings for the fiscal year ended 2018 to 2020 as well as first three quarters of 2021, contain errors primarily related to accounts payable reconciliations and accrued liabilities. Therefore, the U.S. GAAP statements for the foregoing time periods needed to be restated. Based on a preliminary analysis, the Company believes that the aggregate amount of the restatement, for all of the impacted and potentially impacted time periods, will be in the range of $60 to $90 million. Nasdaq, on December 15, 2022, granted the Company's request for continued listing on the Nasdaq Capital Market provided that the Company regains compliance by filing its Annual Report on Form 20-F for the fiscal year ended December 31, 2021 with the SEC on or before April 25, 2023, as well as provide satisfactory disclosure regarding its interim 2022 financials and compliance with annual shareholder meeting requirement. Once the 2021 20-F and 2022 Interim Financials are filed with the SEC and available to the Company’s shareholders, the Company anticipates holding its next annual meeting of shareholders.

One has to believe a two key assumptions to consider this investment:

1. The company would regain compliance with Nasdaq Capital Markets listing requirements by April 25, 2023.
2. The Company’s business has grown in line with its industry or better

I have no particular insight on whether they will regain compliance with Nasdaq by April 25, other than its an oddly specific date that falls on a Tuesday. The biggest risk is that it misses this deadline and cannot get another extension, in which case the stock will trade down. However, its worth noting that the low in the stock when the Company announced its restatement obligation, was less than 10% lower than today’s price. Plus more than half the Company’s shares are owned by the top 6 long term shareholders, who are unlikely to dump due to a filing delay. To ameliorate this risk, I have a starting position in this name and intend to wait until they meet the filing deadline to increase it. I suspect, I may end up buying the stock up 20% on the day of the positive announcement which is balanced by a potentially similar downside if they have a negative announcement.

In terms of getting some confidence in the business’ growth trajectory, I look at the growth in spending in the Middle East region, their large awards announcements that indicate they are getting their fair share of that growth and looking at the growth trajectory of WFRD that has beaten and raised every quarter since 2021, as well as its commentary on the strength they are seeing in MENA region.

In their latest earning call, WFRD CEO emphasized. “Middle East is probably the area we're the most excited about, as I've referenced multiple times on the call. We think the Middle East growth will be head and shoulders above all of the other regions, and will really spearhead the overall company growth and should be high teens to 20-plus percent just on a stand-alone basis.”

NESR is establishing itself as the “national champion” and historically grew faster than its peers with better margins. It’s not unreasonable to believe that they will have grown at a similar or better rate than WFRD which has shown a 60% growth in revenues since 2020 and a 300 bps improvement in margin while facing headwinds from its Russian operations. As a further confirmation of the momentum, NESR last month entered a long-term wireline services platform contract in Saudi Arabia, which greatly expands the scope of services provided over a nine-year contract term. Additionaly, in November 2022, company was awarded a long term contract for Directional Drilling services in Kuwait, covering Directional Drilling ("DD"), Measurements while Drilling ("MWD"), Performance Drilling, Well Engineering and Logging While Drilling ("LWD") services for five years, with an option to extend an additional year. This contract is similar to the DD contract announced in September 2022 in Saudi Arabia for a term of upto 4 years, Management said that this award in Kuwait represents another key DD anchor contract, through which the Company will introduce its burgeoning portfolio of high end MWD and LWD technologies as they are commercialized. Overall, these multi-year platform contracts are anticipated to enhance both the growth and margin profile of the Drilling & Evaluation ("D&E") segment, as equipment in these specialized product lines are deployed with the higher anticipated drilling rig increase. These contracts exhibit the accelerating momentum in adding high margin business and amelioration of cyclicality. Particularly notable is the long tenor of these contracts, exhibiting a long term commitment by NOCs to expand production as has been stated by Saudi Arabis, Qatar, Kuwait etc. 

Early 2022 analysts were estimating a 10% growth in each of FY 2021 and 2022 accelerating to 20% growth in FY 2023. Also margins were estimated to decline from 26% in 2020 to 23% in 2023. Based on these estimates the cumulative growth in revenues from 2020 to 2023 is approximately 50% versus over 60% for WFRD and a decline in margins of 300bps versus an expansion of WFRD margins by 300 bps. I consider these old estimates to be quite conservative in light of what has traspired in terms of the growth in spending as well as margin improvement by OFS companies at large. But let’s consider these estimates as the base case, which imply 2023 EBITDA of approximately $300MM and 2024 EBITDA of approximately $400MM and approximately $100MM of annual capex. FCF after capex, interest, taxes and WC is estimated to be $120MM and $180MM for 2023 and 2024, respectively. This free cash flow conversion from EBITDA is estimated over 40% compared to 37% for WFRD. Year end 2022 net debt was estimated to be approximately $250MM.

WFRD trades at approximately 7X 2023 EBITDA. Assuming a 6X 2023 EBITDA multiple for NESR implies a stock price of $17 per share, 130% higher from here. I expect the stock price to at least double from here in 2023 as long as the Company gets current with its filings, which is a matter of when, not if and should happen this year. Since February 2020 prior to restatement announcement to now, NESR stock price is roughly 16% lower while WFRD has increased by over a 100% in that time frame. NESR is frozen in time due to lack of current numbers, but we can estimate with a good degree of confidence that they should be at least as good as the estimates last year. Once filed this valuation disparity should disappear.

Catalyst

Current SEC filings