WEATHERFORD INTERNATIONAL WFT
April 24, 2014 - 4:30pm EST by
RSJ
2014 2015
Price: 18.35 EPS $0.60 $1.15
Shares Out. (in M): 773 P/E 30.5x 15.9x
Market Cap (in $M): 14,177 P/FCF 0.0x 0.0x
Net Debt (in $M): 8,292 EBIT 1,249 1,859
TEV ($): 22,469 TEV/EBIT 18x 12x

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  • Turnaround
  • Oil Services
  • Potential Spin-Off
  • Asset Sale
  • cost reduction
  • Sum Of The Parts (SOTP)

Description

Thesis: Weatherford International Ltd. (WFT) is at an inflection point in its restructuring plan which I believe will unlock significant value for shareholders. Assuming the management fulfills its mandate, I think the company is worth $26-28 per share, ~40-50% upside from where the stock is trading currently.

 

Company Description: WFT is a multinational oilfield service company currently domiciled in Switzerland (moving to Ireland shortly). WFT provides equipment and services used in a variety of energy-related activities including drilling, evaluation, completion, production and intervention of oil and natural gas wells. WFT operates in over a 100 countries and is active in most of the major oil-producing regions globally. In FY 2013, the Company generated revenue of $15.3 billion, adjusted EBITDA of $2.6 billion and adjusted EPS of $0.60. WFT has a market capitalization and enterprise value of $14.2 billion and $22.5 billion, respectively.

As a result of poor execution, weak internal controls and multiple accounting issues, the Company has suffered from “self-inflicted” wounds and seen its stock drop ~40% over the last three years. The Company’s results have been heavily impacted by over $1.5 billion in “non-recurring” costs since 2011, including ~$800 million in goodwill impairments, ~$250 million in penalties associated with a US government investigation, ~$230 million in losses associated with legacy turnkey drilling contracts in Iraq, ~$180 million in professional fees for accounting and tax restatements, ~$100 million charge on its Venezuelan assets due to currency depreciation and ~$70 million in bad debt expense associated with payments due from the Venezuelan state-owned oil company. Furthermore, earnings have been weighed down by non-core operations that are currently contributing negative operating profit.

 

So why is this situation interesting today? What has changed?

The combination of negative headlines, mixed Company-wide operating performance, unclear strategy, poor management decisions and accounting problems has served to obscure the earnings power of the WFT’s core business. I believe these overhangs are temporary and the dislocation will dissipate over the next 12-24 months. The basic thesis is simple yet compelling - this is an underperforming company that is making slow yet steady progress to improving its operating performance. The management team has changed its focus from solely on growth to return on capital, and has recently embarked on a number of restructuring initiatives to sell non-core assets, reduce debt, cut headcount and increase operating margins. The Company has also made two key changes at the senior management level – hiring of a new CFO (former Treasurer at Schlumberger) and an internally promoted COO - to spearhead the turnaround. While most of the hard work is yet to come, the Company has already achieved some noteworthy accomplishments including the resolution of all outstanding accounting and tax issues, an important milestone for the new CFO.

 

What is the magnitude of the mispricing? Significant, ~40-50% upside

On look-through earnings: assuming the management team delivers on its new mandate, core EBITDA margins should increase from ~20% today to ~25%. As such, I believe the Company can generate ~$2 in “normalized” eps per annum under this scenario. This compares to the $1.10-1.20 eps management has guided to for FY 2014. Using a historical average of 13-14x P/E, the fair value range is $26-28 per share.

On sum-of-the-parts value: WFT currently has a mix of five core and five non-core assets, and as part of the restructuring plan, intends to divest all the non-core assets which collectively generate ~$3 billion in revenue. The Company has already made some progress having announced the sale of its pipeline and specialty-service business to Baker Hughes last month. WFT expects to complete the remaining asset sales and spin-offs throughout 2014 and early 2015. When all said and done, these transactions should generate a total of ~$3 billion in proceeds which will help delever the balance sheet. The Company will be left with its five core businesses, four of which represent leading market positions: well construction, formation evaluations, well completions and lift systems. I value these businesses at ~$29-30 billion using a variety of valuation methodologies for each asset (see comp multiples analysis below). Subtracting net debt and the capitalized value of corporate expense/R&D, I get to an equity value of ~$21 billion or $27 per share.

 

($mm)               2014e EBITDA                    Multiple                  Valuation

Artificial Lift             660                               10.8x                        7130
Other Core*           2750                                7.5x                       20625
Total Core            3410                                8.1x                      27755
PF Cost Savings**    250                                7.5x                        1875
PF Core                3660                                                             29630
 
Land Rigs               400                                 5.25x                      2100
Other Non-Core      175                                 5.25x                        900
Total Non-Core     575                                                               3000

Less: Corp/R&D     (425)                                8.1x                     (3460)

Less: Net Debt                                                                          (8292)       

Equity Value                                                                              20878

Shares O/S                                                                                  773

Per Share                                                                               $27.00

* Using steady-state EBITDA for the Simulation business which is likely to be a 2015 event
** 50% of the $500mm is allocated in Core EBITDA
 
 
Catalysts? Multiple

While the Company has made good progress thus far - two key appointments, the financial restatement and an asset sale - this is an execution story. The Company is clearly at an inflection point and is transitioning from an unchecked growth mantra to disciplined capital allocation. As such, execution on the following fronts will serve to unlock value:

  • Sale of the three non-core assets: drilling fluids, testing services, wellheads – a 2014 event
  • Spin-off: the international land rig business – earmarked for early 2015
  • Cost cutting: a reduction in headcount of 7,000 employees is expected to lead to ~$500 million in annual cost savings; $466 million has already been identified
  • Reducing debt: at ~3.2x net leverage, this is a priority; WFT will use the bulk of the asset sale proceeds and internally generated free cash flow to pay down debt to ~1.5x
  • Margin expansion: strong execution on the aforementioned should lead to sustainably higher operating margins

The company is scheduled to report Q1 results this evening and hold the conference call tomorrow morning. Focus items include performance of the core business, update on divestitures and cost cutting.

 

Risks? Two main levels of risk: macro (oil) and company-specific (execution)

At a macro level, WFT’s business is ultimately driven by oil drilling activity, and therefore any decline in oil prices affects global drilling activity. Fortunately, liquid instruments exist to hedge out commodity exposure. I am relatively positive on oil-service industry fundamentals. Oil companies produce ~90 million barrels daily to meet consumer demand which is growing ~1.2% per annum. Concurrently, we are seeing a decline rate in existing wells at ~5% per annum. As a result, oil is getting harder and more expensive to produce. In the absence of significant new discoveries, oil companies have to pump more barrels to meet current demand. This bodes well for oil service companies such as WFT that facilitate production. At the micro level, while I am encouraged by the restatement and Company’s progress so far, there is much to do on the operating front. Additionally, you can never be 100% certain that other issues won’t surface given the jurisdictions that WFT and quite frankly all the other multinational oil-services companies operate in. While WFT is cheap on both an absolute and relative basis, I am factoring in 20% potential downside in a bear case.

 

Free/cheap options? working capital release, IPO/sale of artificial lift, sale of the company

On the working capital front, I estimate that additional value of $1-1.50 per share is available from basic blocking and tackling to bring inventory turns and receivable/payable days in line with industry peers. The artificial lift business is the crown jewel in WFT’s portfolio and generates ~20% of the Company’s EBITDA. A sale or IPO could add incremental upside above our sum of the parts value. The only pure-play in the sector (Lufkin) was recently purchased by GE for 13.5x forward EBITDA. Finally, in the event the current management team fails to execute, a sale of the entire company is very feasible.

I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

- Sale of the three non-core assets: drilling fluids, testing services, wellheads – a 2014 event
- Spin-off: the international land rig business – earmarked for early 2015
- Cost cutting: a reduction in headcount of 7,000 employees is expected to lead to ~$500 million in annual cost savings; $466 million has already been identified
- Reducing debt: at ~3.2x net leverage, this is a priority; WFT will use the bulk of the asset sale proceeds and internally generated free cash flow to pay down debt to ~1.5x
- Margin expansion: strong execution on the aforementioned should lead to sustainably higher operating margins
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