Stolt Offshore Ltd. SOSA
June 30, 2002 - 5:06pm EST by
2002 2003
Price: 6.20 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 527 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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During the past two years, Stolt Offshore’s strengths and values have been masked by a number of external and internal problems that are in the process of being corrected. As the problems are solved, and because the company’s markets are growing rapidly, we predict that Stolt’s earnings will increase sharply over the next two years. Our specific estimates are $.50 per share for this fiscal year (November 30 year), $1.00 for next year, and then $1.50-2.00 for fiscal 2004. Because of the problems, Stolt’s shares have declined from a 1998 high of $24 to their present price, which is below book value. Given the company’s growth potential, we believe that the shares deserve to sell well in excess of 10X earnings. Therefore, we will not be surprised if the shares sell materially above $20 by mid-2004.

Stolt Offshore’s business is the deep sub-sea completion of oil and gas fields. After an oil or gas discovery is made in deep waters, the operator of the discovery negotiates a contract (usually a turnkey contract) with Stolt (or one of its handful of competitors) for the design, construction, installation, and/or servicing of the subsurface and surface infrastructure required to produce the oil and gas. For example, Stolt might install the sub-sea well-heads (along with valves, blow out preventers, etc.), lay and connect under-water pipelines that transport the oil and gas to processing facilities on the surface, and construct processing facilities. Because this work often is performed thousands of feet under the ocean where pressures are high and working conditions are arduous, Stolt and its competitors must have a great deal of technological competence and experience. Therefore, barriers to entry are high. Stolt is one of four companies that have a broad line of capabilities. The other companies are Technip-Coflexip (a large French company whose shares are listed on the NYSE), Saipem/Bouygues, and Halliburton-DSND.

The sub-sea completion of deep oil and gas discoveries is a relatively new business because, until about 1990, the technology was not available to work in deep waters. This changed in the late 1980s, largely because Tommy Thompson, an engineer who had worked at Battelle, developed and perfected remote operated vehicles (“ROVs”) that could perform tasks when operating thousands of feet under the surface of an ocean. Tommy Thompson’s goal was not to develop oil and gas reserves, but rather to recover hundreds of millions of dollars of gold from the ship SS Central America that sunk off the Carolinas in an 1857 storm. The story of the Central America, Thompson’s engineering feats, and the recovery of the gold is the subject of a fascinating book called Ship of Gold by Garry Kinder (Random House), which I strongly recommend.

Stolt is one of the pioneers of deep water sub-sea completions. The company was founded in 1992 when Stolt-Nielson (a firm that was the first to develop and own “parcel tankers” to efficiently transport chemicals) acquired and merged two small under-sea engineering companies. Stolt Offshore became publicly owned in May of 1993 (through an IPO) and today is about 45% owned by the public and 55% by Stolt-Nielson. In the late 1990s, Stolt Offshore became a much larger company after it completed two large acquisitions that gave it worldwide capabilities.

Today, Stolt owns an extensive fleet of equipment that has a net book value of $774 million. Included in the fleet are: 34 “construction” ships of a variety of types, 7 pipelay barges, and 95 ROVs. In a recent prospectus, Stolt claimed that: “we own or charter an impressive array of offshore assets. We believe that we have the largest fleet of sophisticated deepwater construction assets in the world, some of which are capable of operating at water depths of up to 2,500 meters. These assets position us to execute highly complex and demanding projects”. Later in the prospectus, the company stated that: “we possess innovative deepwater technologies and unique experience in deepwater developments. We have a long history of innovation and development of new technologies that have contributed significantly to the evolution of the offshore oil and gas industry”. Indeed, the company recently was given much credit for its successful engineering and development of the technologically challenging Girassol field located under 4,200 feet of water off the West Coast of Africa (imagine working with precision at a depth four times as deep as the Empire State Building is high!).

From 1993-1998, Stolt Offshore was a successful and highly regarded company. However, a series of problems commenced in 1999 – starting with low oil prices that incentivized the major petroleum companies to sharply reduce their capital expenditures. This slowdown now appears to be over – and in fact Stolt projects that its market will increase from about $7 billion last year, to an estimated $10 billion this year, and a projected $14.5 billion two years from now.

A second problem was the costs of integrating the two large acquisitions Stolt completed in the late 1990s. These extra costs recently have been eliminated. However, an additional problem stemming from the acquisitions was that Stolt agreed to repurchase (and has repurchased) 6.1 million shares at $18.50 per share from the seller of one of the acquired companies. This repurchase threatened to strain Stolt’s balance sheet – and, to avoid the strain, Stolt filed a prospectus to re-sell the shares to the public. However, given the low price of its shares, Stolt cancelled the public offer and instead sold 3 million shares to its parent (Stolt-Nielson) at $8 per share. Currently, Stolt Offshore has net debt of about $400 million vs. shareholder equity of about $600 million (or $7.15 per share on 83.9 million shares outstanding. Because the company has excess capacity, it is holding cap ex this year to about $62 million vs. DD&A of $87 million. Management appears confident that Stolt will achieve a high level of earnings and free cash flow commencing soon – and that within a few years its balance sheet will become very strong.

Another problem was that Stolt was found to have violated a patent. While damages are yet to be assessed, they will not be in excess of $115 million, and likely will be far smaller.

A final problem was very low margins on two large contracts: Girassol off the coast of West Africa; and Gulfstream in the Gulf of Mexico. Girassol was a complex completion that turned out to be more complex than Stolt had imagined – and Gulfsteam was a project taken at a relatively low price after the 1999 slow-down caused excess capacity in the industry. Both these projects have been completed – and, in spite of rumors that there were quality problems on some of the construction, both seem to have been technically successful. The fact that Stolt was just awarded a $240 million contract from Chevron/Texaco for the complex completion of the Bomboco (West Africa) field attests to the company’s reputation and capabilities. (note – Stolt’s customers are the large petroleum companies, such as Exxon, Chevron/Texaco, BP, and Royal Dutch/Shell.)

Looking ahead, the number of contracts available to Stolt is increasing sharply – and the company’s backlog is beginning to build. Revenues in the current fiscal year might be around $1.35 billion vs. $1.25 billion last year. Given the expected growth of the under-sea market, I estimate that Stolt’s revenues will climb to about $2 billion in fiscal 2004. With firming pricing and with leverage over fixed assets and costs, Stolt’s operating margins could increase to about 13% in 2004 (the company’s margins in 1997 and 1998 were 13.3% and 12.0%, respectively). After an estimated $15 million of interest expense and taxes at a 30% effective rate, net earnings, therefore, could be about $170 million, or $2.00 per share on 85 million fully diluted shares. To be conservative, I am using a 2004 EPS estimate of $1.50-2.00. Because the deep sea is a frontier that likely contains large hydrocarbon reserves, growth after 2004 could continue to be rapid.

Stolt’s shares trade on the NASDAQ and in Norway.


Problems that have masked the company's earings power and values are lifting. We project that, two years from now, EPS will be in the $1.50-2.00 range. The company is well positioned in a growing business -- and, as revenues and earnings rise sharply, we believe that the shares will rebound. Their former high, before the problems developed, was $24.
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