August 11, 2009

Spin-off Idea: Pride International

Not a lot of spin offs came to the market lately. But I think that is about to change as companies will reorganize themselves and cut businesses that no one want to buy. There is two opportunities right now: Pride International Spin off of Seahawk Drilling and CableVision spin off of the Madison Square Garden business. I will introduce the Pride spin off and talk some other time about Cablevision.

Pride International (PDE) is spinning off its Gulf of Mexico operations to shareholders. Pride International is an offshore drilling company that leases rigs and vessels to producers. The company recently made strategic effort to focus on deep water and other high-specification drilling solutions. As a result the decision to spin-off its shallow water business. Jack-up revenues has been declining in over the last few quarters. Management thinks this GOM drilling is slow growth business and that's why they want to divest out of it.

The shallow water business or the leasing of jack-up rigs is concentrated in the Gulf of Mexico (GOM) only with no other international operations. The shallow waters of the GOM is a mature region that oil production has peaked some time ago. companies are moving deeper and deeper for new finds. Pride management is justified in dumping this low growth business to focus on the deep water. However, the questions is can an independent Seahawk make earnings grow on their own without the constraints of Pride management of investing in deep water segment?

The offshore and land drillers have been trading at very low valuation. The sector PE is around 10. some notable high margin and specialized businesses like DO, RIG and NE are selling at PE between 5-9. These businesses have very specialized field and very much have solid backlogs, unlike Seahawk, for years to come so the valuation seems puzzling?

The service companies are leveraged play on the price of oil and gas, particularly natural gas in the Gulf of Mexico. Currently Natural gas is at very low pricing levels that make some field uneconomical to operate. Most will making a call on the price of gas to invest in these GOM drillers. I want to avoid making such a call. I am not in the forecasting business but in the investing business.

This is an interesting proposition. The spin off will be completely debt free with management that is properly incentivized with restricted equity and options but the company operate in poor sector until Natural gas increase in value. The price of the commodity does not concern me a lot at the moment and will play a secondary factor in the decision making. I will look for more important things on the company level:
  • management compensation plan
  • management track record and prior accomplishments
  • accounting practices and policies
  • valuation once it is traded
  • competitive position in the industry
  • what are my risks
  • Will there be forced sellers?

Not every spin off is an automatic investment; the economics of the company must make sense as well. I will work on my analysis to see if this is worth establishing a position in.

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