March 08, 2017 - 11:04am EST by
2017 2018
Price: 23.45 EPS 0 0
Shares Out. (in M): 339 P/E 0 0
Market Cap (in $M): 936 P/FCF 0 0
Net Debt (in $M): 1,095 EBIT 0 0
TEV ($): 2,031 TEV/EBIT 0 0

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Petroleum Geo-Services ("PGS") equity presents a compelling risk / reward proposition, with a probability-weighted return potential of >100% over the next 12 – 18 months. PGS is 1) un-loved: one of the most heavily shorted stocks in Norway, 2) mis-understood: market is focused on the rear-view mirror and missing the tightening S/D set-up w/ multi-year recovery potential and 3) under-valued: equity trades at ~3.1x 18E EBITDA and 0.7x BV = >50 – 85% upside on multiples alone reverting back to 10-year average historical multiples, respectively. PGS equity is depressed due to 1) structural concerns of offshore deep water projects + 2) depressed exploration capex given low oil prices. Relative to market concerns, we believe world oil demand cannot be met purely from US onshore + exploration is critical to ensure pipeline of projects. There are 2 ways to win w/ PGS: as seismic market recovers, 1) PGS multiple reverts back to normalized levels offering 50 – 100% upside and 2) divergence on earnings power as our 2018E ests are >25% above the Street … lastly, we believe there is the potential for further industry consolidation as TGS Nopec (competitor to PGS) has a net cash position and likely is more concerned about vessel supply moving forward (recent commentary supports) + there are couple notable vessel operators in cash-constrained position (most notably CGG which is attempting an out-of-court restructuring) which will further tighten S/D and creates additional upside optionality.


Instead of focusing on the future, PGS is mis-perceived for what it was in the past w/ concerns around the balance sheet / liquidity, end-market demand for exploration spend and over-supplied industry conditions w/ too many vessels and too little work driving down day-rates to cash break-even levels. We believe the market improperly values the changes that have taken place in the interim including: 1) de-leveraged BS w/ late 2016 equity raise resulting in net leverage of ~2.5x on our 17E estimate and 1.7x on our 18E figures + more-than-adequate liquidity w/ >$400MM currently and the biz will be FCF positive in 17E, 2) early signs of demand improvement w/ multi-client work starting to hook up (this is the early indicator for seismic) and green-shoots on vessel day-rates (sign of tightening S/D), 3) lastly, and perhaps most importantly, recent supply constraints are under-appreciated (discussed below) and supply response will be slow and costly (>12-mths and >50 - 75MM per vessel to bring back online) providing a multi-year recovery runway.


PGS is a leading marine seismic survey and data processing company operating in all the major offshore basins. PGS acquires, processes, analyzes, licenses and sells seismic data to oil and gas E&P companies. PGS has a young fleet with an average age below 4.5 yrs. Additionally, PGS owns and markets a valuable marine seismic data library (approx $650MM as of YE 16) and licenses the use of the data to clients on a non-exclusive basis. In simplistic terms, there are 2 key drivers to the PGS biz model:


1.     Multi-client (MC): In today’s current environment, PGS generates most (if not all) of its profits from multi-client work. MC work is attractive and largely mimics the unit economics of the TGS Nopec biz model – note that TGS historically has traded at >2.5x BV and is deserving of a premium multiple as less discretionary / cyclical demand profile. We estimate PGS generating >$425MM in 2017E mostly tied to its MC / imaging 

2.     Contract: In contrast to MC, PGS currently generates little / no profits on its Contract biz given imbalanced S/D. In today’s environment, PGS’ contract biz generates $200 - $225MM of revenue and minimal profits (compared to prior peak of $700MM and >$300MM of profits). While PGS mgmt is conservative, they recently noted green-shoots in the market as they are witnessing “higher highs” in day-rates (similar to the power market, this is an encouraging signal on S/D tightening). Given the time and money to bring supply back online (>1-yr and >$50 - $75MM per vessel), day-rates and margins are in the early stages of a 4 – 5 year upswing. Additionally, vessel owners will likely wait until margins go >20% before making any investment decisions putting PGS in a strong position over the next 3-years w/ upside optionality to day-rates. As S/D tightens, PGS will likely generate >$500MM of revenues and >$150MM of profit potential. In meeting w/ TGS (best-in-class asset-light operator), they believe >30% margins are very likely for vessel owners as the up-cycle starts to take hold making PGS perhaps an M&A target


Cap structure and creation multiples below: Based on 18E estimates, PGS is leveraged at less than 1.7x and the equity trades for 3.1x. Mgmt believes “mid-cycle” profitability is $750MM which would suggest PGS equity is trading at 2.4x (versus 10-year historical of 4.4x).


      18E EBITDA
    ($M) BV MV
Cash   $97    
$400MM Revolver   190    
Shipbuild financing   374    
Term loan B due 2021 (3.25%)   389 1.3x 1.2x
Total Net Debt through TL   857    
7.375% Senior Notes due 2018   26    
7.375% Senior Notes due 2020   212 1.7x 1.7x
Total Net Debt   1,069    
Market Capitalization   936    
Total capitalization   2,005 3.1x  



    Peak  Trough Mid multiple avg
Prior peak   $828     2.5x 80%
Current trough     $313   6.5x -32%
Mgmt mid-cycle est (1)     $750 2.7x 63%
17E EBITDA - our est     $438 4.6x -5%
18E EBITDA - our est     $648 3.1x 41%
(1) Given changes to fleet, larger share of multi-client, mgmt   
ests peak of $1Bln and trough of $500MM moving forward    


Summary investment thesis below:


-        Bottom-of-cycle conditions: seismic industry is currently operating at bottom-of-cycle conditions: (1) demand has fallen by ~70% and (2) supply has been cut by >50%. 

-        Multi-year demand recovery: unless one views deepwater as hopelessly out-of-the-$ (no need given US onshore), demand growth will be in excess of >10% per annum through 2020. PGS is best positioned to take advantage of this “coiled spring” in exploration capex spend

-        Supply constraints are under-appreciated: in speaking to PGS competitors, there are notable concerns around vessel certainty given 1) demand improvements, 2) and concerns around streamer constraints (2 things required for seismic is the vessel and equipment used by vessel / streamer). More importantly, given couple years of break-even conditions, I believe margins will have to expand well north of >20% for supply to be brought back online

-        Contract margins at 0% have only 1-direction to move: prior peak industry margins were 50% versus current break-even. Even TGS (asset light) acknowledges that normalized margins should be >30% for vessels …

-        PGS well positioned to be the winner in S/D tightening: Given PGS’ unique biz model (one of largest multi-client operator + significant contract exposure), PGS will benefit from demand tailwinds and supply constraints moving forward


Downside case / risks: There is extreme negatively around PGS. We believe most of the negativity is rear-view oriented. Specifically, the bear case on PGS is largely focused on 3 main arguments:


1.     PGS asset-intensity + lower for longer oil pxs = recipe for disaster

a.      While the bear case around oil prices worked out extremely well from 2015 – 2016 (PGS equity at 74 NOK / share in mid-2014 versus ~24 NOK / share currently), we view this argument as being in the rear-view mirror for the following reasons: industry supply of vessels has been reduced to a level that is consistent w/ demand = evidence is early evidence of improved multi-client biz (early indicator for demand) + very early signals of day-rate improvement on vessels (S/D indicator around vessels). Operating leverage works in both directions and generating 0% margins on PGS’ contract biz (versus >$300MM couple years ago) is a decent set-up for positive surprises moving forward assuming oil does not fall below $45 in the n-term

2.     BS risk / 2018 maturity overhang

a.      Bears pointed out this risk but once again this is a rear-view mirror issue … as PGS fully addressed in late 2016 when it raised >$260MM in new equity and used the proceeds to pay-down / refinance most of the 2018 maturing debt. This was a significantly positive event as it reduced the debt burden, reduced interest expense by approximately $16MM per annum and provided an additional >2-years of runway … PGS is now effectively a cycle-bet on exploration spend with >3.5-years of runway 

b.     It’s also worth highlighting that PGS raised the equity in late 2016 at 22.50 NOK / share versus current ~23.50. The equity raise was completed ahead of OPEC supply announcement when oil was trading in the 45 – 47 range. Oily equities have subsequently rallied by >10% and PGS is largely unchanged largely due to disappointing Q4 2016 figures (can discuss more in the thread, but most of the disappointment was due to YE timing around multi-client work)

3.     JV concerns / liquidity required to fund this JV

a.      Bears like to point out uncertainty around PGS’ 45% stake in Azimuth. Azimuth majority owner is a PE company called Seacrest and Azimuth has developed a portfolio of 6 E&P companies. Bears like to highlight 1) challenges w/ knowing if truly “arms-length” and 2) funding requirements of >$100MM

b.     We believe PGS’ investment in Azimuth is safe and more valuable than the market expects. PGS made an investment in Azimuth of >$70MM in early 2016 to maintain its 45% stake and has no funding requirement for the next 2-years. PGS has no obligation to invest in Azimuth and can be diluted at their discretion. Additionally, PGS marks the assets on the BS at >$110MM as of YE 2016 and we believe 2 of the 6 E&P companies are closer to divestment over the next 2-years which would be a positive liquidity enhancement to PGS (bears ignore this). Overall, I see greater upside optionality from monetizing these assets versus downside 


FV scenarios below (equity and debt): Blended weighted average FV / share of ~$5.75 (or >100% upside)


-        Downside case: -15% to -20% downside for the equity assumes punitive assumptions of 1) 18E EBITDA consistent w/ Street expectations (overly-punitive as assumes minimal improvement in day-rates = minimal profitability from Contract biz versus >$300MM at prior peak) and 2) multiple that is at 1.5-standard deviation below “10-yr historical norm”)

-        Base case: +120% base case for the equity assumes 1) $650MM EBITDA (our estimate) and 2) 10-yr historical average multiple (also implies 1.4x BV which is in-line w/ historical average)

-        Upside case: +190% upside for the equity assumes 1) $750MM EBITDA (mgmt mid-cycle) and 2) 10-yr historical average multiple (implies 1.7x BV multiple which is still well inside of 0.5x standard-dev move)



  Low Mid High
18E EBITDA (1) $500 $650 $750
Multiple (2) 3.50x 4.40x 4.40x
Implied TEV $1,750 $2,860 $3,300
Less: Current Net Debt (3) $1,095 $1,095 $1,095
Plus: FCF generation 17E - 18E $25 $175 $275
Plus: JV value (4) $113 $175 $250
Implied Equity Value $793 $2,115 $2,730
Shares out 339 339 339
FV / share USD $2.34 $6.25 $8.06
Current USD-equiv $2.76 $2.76 $2.76
vs current -15% 126% 192%
BV implied $1,384 $1,534 $1,634
Implied Px / BV multiple (5) 0.6x 1.4x 1.7x
% prob 25% 50% 25%
Weighted-avg FV $5.73 107%  
Debt Coverage analysis:      
TEV / 16A Current Net Debt  1.60x 2.61x 3.01x
TEV / PF 18E Debt (incl JV and FCF)  1.83x 3.84x 5.79x
(1) $500MM Street est vs our est $650MM and mgmt mid-cycle 750MM
(2) 10-yr historical avg is ~4.4x       
(3) Does NOT factor in restricted cash of >$32MM at YE 16  
(4) Values are conservative ($113.1MM as of YE 16)  
(5) 10-yr historical avg is ~1.3x w/ 0.4x standard-deviation  



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.


2017 results and clarity around cycle

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