Description

Opportunity Overview

Trico Marine Services’ shares represent a compelling buy today.  The company has historically traded at a material discount to its peer offshore supply vessel peers on a number of valuation metrics due to the age of its fleet and its significant exposure to the volatile Gulf of Mexico supply vessel market.  However, the combination of the recently announced acquisition of Active Subsea ASA and the ongoing transfer of existing Trico assets to more attractive international markets changes the profile of Trico materially.  Trico shares have upside potential of at least 30% with minimal downside risk should the company continue to execute on its strategy.

Trico’s Current Business

Trico operates supply vessels and anchor handling vessels that serve offshore energy companies.  Trico operates a fleet of 63 vessels in the Gulf of Mexico, the North Sea, Western Africa, Latin America, and now Southeast Asia through a joint venture.  The company exited bankruptcy in 2005 with a clean balance sheet and has worked since to transition its business away from high exposure to the volatile, spot market work in the Gulf of Mexico to

Valuation Gap

Trico has historically traded at a discount to its peers.  The discount has been attributed to a few factors:  the bankruptcy from a few years ago, the company’s old fleet of vessels, and the company’s heavy exposure to the shallow water Gulf of Mexico.  Most recently the company failed to order new vessels until shipbuilding order backlogs swelled and new construction prices surged making it unattractive for Trico to add to its fleet with new orders.  Trico looked to be stuck as an operator of an old fleet with heavy exposure to undesirable markets.  The company made some improvements to its situation by fixing its balance sheet and moving some vessels out of the Gulf of Mexico and into international markets.  Progress has been slow and the fleet age, still heavy Gulf exposure, and lack of meaningful new capacity additions kept the shares trading at a discount to peers and at low absolute levels.

However, the reasons for Trico to trade at a discount now no longer apply.  The combination of the Active Subsea acquisition and the continued shifting of assets will transform Trico by giving it higher quality assets, more diversified end market and geographic exposure, and longer-term and more stable customer relationships.  These reasons alone should substantially narrow the gap between Trico’s valuation and that of its peers.  Perhaps most importantly, the Active Subsea acquisition also turns Trico into a growth story over the next few years by providing meaningful revenue, profit, and cash flow growth.  This should help the company trade at more normal levels of absolute valuation instead of levels typical of decaying companies.

Active Subsea Acquistion

Active Subsea is a publicly traded Norwegian company that plans to operate subsea support ships for the oil and gas industry.  Subsea has 8 vessels under construction with delivery dates ranging from April 2008 through March 2009.  The vessels are all Vik Sandvik VS 470 multi purpose support vessels and are designed to support subsea and dive support operations in shallow to mid water depths.  The company does not generate revenue today.

It is important to note that Subsea does not actually perform any material subsea service activity, it simply provides the specialized vessels to the service companies that do so.  In this way, Active Subsea, and now Trico, provides off balance sheet financing to the service companies.  This allows the service companies to use their balance sheets for large capital outlays for other specialized equipment.

Active Subsea has already secured long-term contracts with 2 customers for 3 of the 8 vessels on order.  The contracts vary in duration from 2 to 4 years.  The company is in active dialogue for contracts for the remaining 5 vessels under construction.

Subsea Market

The subsea construction and service market is still in the early stages of a long-term growth period.  While global demand for energy continues to growth, producers are struggling to maintain supply.  Oil reserves are declining and depletion rates at producing oil fields are rising.  With many of the world’s land based energy fields already developed, energy companies are increasingly resorting to offshore exploration and production.

Trico management cites research that indicates offshore oil and gas production expenditures are expected to increase by 6% per year in North America and 5% per year worldwide form 2006 through 2009.  Subsea spending is expected to grow 36% per year in North America and 31% per year worldwide over the same timeframe.  As oil companies find new fields and develop production sites, subsea service providers perform a variety of tasks including surveying, seismic, trenching, pipelaying, and equipment installation work.  There will be an estimated 300+ offshore fields developed by 2010, with approximately 100 new developments from 2006-2010 alone according to Fondsfinans Research.  After this infrastructure is set up, subsea service providers need to inspect and maintain these offshore fields,, and this will create ongoing demand for their services.

Subsea support vessels are specially equipped to serve subsea service companies.  The vessels have cranes, engines, thrusters, generators, reinforced decks, and crew accommodations that are specially designed for subsea support work.

According to Fondsfinans Research, there are approximately 150 subsea vessels operating today.  The number of vessels is expected to increase to approximately 225 by 2010.  Industry utilization has ranged from 85% to greater than 100% since the mid 1990s.

Pro Forma Acquisition Analysis

As a result of the acquisition, Trico will go from a net cash position of $165m to a net debt position of almost $80m, which is less than 1x current EBITDA (and far less than pro forma EBITDA).

The acquisition of Active Subsea will generate significant revenue, EBITDA, and cash flow growth for Trico through 2009.

Operating Assumptions

PF Financials

Current Trading Valuations

Trico trades at less than 4.5x 2009 EBITDA – maintenance capex, less than 5x 2009 EBIT, and at a 23% ongoing FCF yield based on 2009 cash generated.

Sensitivity of Valuation

Using reasonable valuation estimates for 2009 EBITDA of 5-6x, FCF yield of 14-18%, and a PE range of 6-10x yields a share price that is generally near $45-55 per share which is a 15-40% increase from current levels.

Comparable Company Valuations

If Trico were to trade at the same multiples as its competitors, its shares would trade at $51 to $58 per share a 20-40% increase from current levels.

Risks

Overcapacity in the supply vessel market.  Trico’s current business is platform supply vessels and anchor handling vessels.  The global demand for these vessels is expected to expand materially in the next few years, but new additions to global fleets are also expected to rise substantially.  A big unknown is what the supply/demand balance will be as new vessels become available.  Also, the potential retirement of old vessels is unknown but could impact the market for supply vessels.

Delays in vessel construction.  Actice Subsea has already experienced some delays on 2 of their vessels, which have been delayed by 1 ½ months already.  Delays are driven by shipyards operating at capacity and labor and spare parts shortages.  The shipbuilder expects to get back on schedule with remaining vessels, but continued delays are possible.  In addition, equipment manufacturers are also operating at peek capacity and are struggling to deliver key components which could delay ship availability further.

Macroeconomic weakness.  Economic recession would lower the demand for energy and this would impact pricing and utilization in the services businesses.  This risk is somewhat offset by secular growth offshore and term contracts, but would certainly impact spot market business.

Age of vessels.  Trico still has a large number of older Gulf class vessels.  Management has invested significant capital over the past several years so that these vessels can continue to operate.  In addition, transfers to West Africa, parts of Asia, and South America extend the lives of these vessels.  Management seems convinced that these vessels can continue to operate profitably for years, but there is risk that some portion of the fleet may need to be retired sooner.

Catalysts

The acquisition of Active Subsea transforms the profile of Trico.

Turns Trico into a growth story.  Revenue is expected to increase approximately 40% as a result of the acquisition from $250m to $350 by 2009.  EBITDA is expected to increase by $60-70m as a result of the acquisition of Active Subsea from the current base of approximately $100m, or an increase of 60-70% by 2009.  Free cash flow excluding new build expenditures is expected to increase from approximately $80m to approximately $140m or 75% by 2009 as virtually all incremental EBITDA flows through to cash flow due to the very low cash tax rate of 6%.

Increases term contracts to a majority of the business of revenue.  Trico’s North Sea vessels already operate largely on medium to long term contracts.  All of the subsea business will be operated under long term contracts of up to 5 years.  Pro forma for the acquisition, term contracts will account for the vast majority of Trico’s business.

Turns Trico into a young fleet.  Gulf class and crew/line handling vessels accounted for more than 50% of 2006 revenue, but pro forma for the acquisition, should account for approximately 33% of 2009 revenue.  Thus, more than 2/3 of revenue will come from newer vessels (North Sea class, new builds, and Active Subsea boats).

Turns Trico into an international business, with minimal Gulf of Mexico exposure.  Management estimates that 89% of 2009 operating income will be generated from international operations.  Thus, the volatile US Gulf of Mexico declines to 11% of operating income.

Exposes Trico to more attractive markets.  As mentioned above, the subsea market has more favorable growth rates than the supply vessel market.  In addition, there has been significantly less new capacity added to the subsea vessel market compared to the supply vessel market, which brings Trico into a less competitive end market.  Trico management has indicated that it expect 50% of total EBITDA to be generated from the higher growth subsea segment by 2009. 

Relationship with China Oilfield Services Limited (controlled by CNOOC) adds to earnings beginning in 2008.

Trico established a joint venture with COSL which is owned by CNOOC.  The company transferred 14 vessels to this joint venture.  These off balance sheet vessels will begin to contribute to earnings in 2008.  CNOOC is spending billions of dollars to expand its capabilities beyond Southeast Asia.  Trico gets direct JV participation in this growth opportunity and a chance to transition more vessels out of the Gulf and to the JV over time.  My analysis excludes all impact from the China JV, so this is additional upside.

Continued shifting of vessels out of the Gulf of Mexico.

During Q3 2007, Trico for the first time in its history had more Gulf class vessels operating internationally than in the Gulf of Mexico (21 international vs. 20 in the Gulf).  Management will continue moving vessels into international markets where they can earn higher day rates, have higher utilization rates, and operate under term contracts.  By the end of 2008, management expects to have only 12 vessels operating in the shallow water Gulf of Mexico.

Continued transformation of the business.

Management may complete additional subsea acquisitions.  As it announced the acquisition of Active Subsea, management indicated that it was also in negotiations to operate vessels for other subsea service companies and to acquire vessels from other subsea service companies.  This would further transition the Trico business to make the subsea market the vast majority of Trico’s earnings and cash flows.

Potential strategic acquisition of Trico.

Trico could become an acquisition target.  Even after the Active Subsea acquisition, Trico is still small relative to major industry players including Tidewater, Choest, SEACOR, and Bourbon S.A.  As an example, Tidewater has spent approximately $2 billion on its fleet modernization strategy and has another $700 million of new vessels currently under construction.  Tidewater is also committed to spend $300-400m to continue to modernize and grow its fleet.  Trico could be a strategic asset for a number of its larger competitors by providing geographic diversity, customer diversity, and access to assets that are generating cash flow today (instead of ordering vessels for delivery in a few years). 

Trico is still relatively small in the supply vessel market

Favorable tax legislation.

Norway looks set to pass a new tax regime which would lower the book tax rate of Trico from 42% down to 22%.  The company will continue to pay 6% cash tax.  In addition, Trico still maintains $97 million of NOLs to offset US earnings.

Catalyst