We’re buying the French stock CGG to gain exposure to the marine geophysical seismic subsector.
The Marine Geophysical Seismic Sector
Marine geophysical companies are synonymous with the discovery of new offshore reserves of oil and gas. So invest in them if you think that offshore oil and gas reserves being consumed today will need to be replaced. This is a sub sector you’d buy if you think the global demand for oil and gas in 5 years from now will at least be the same as it is today, if not higher.
Of all the sectors affected by the downturn in the oil and gas sector, the marine seismic survey market has perhaps been the hardest hit. Yet this sector (at least what is left of it) has the highest gearing to an increase in the price of crude.
Clearly no one is looking at this sector, which we can see as analysts have stopped covering them and a brief scan of the charts tells us they’re about as loved as steak at a vegan food festival. Few would dare tread here as many/most companies that have served the market for years have declared bankruptcy, and others have announced their intention to exit the market entirely. Actually, I doubt many investors would be familiar with the names mentioned we’ll be going through in this Alert.
Most of the players left in this sub-sector are priced at “distressed” levels. Yet they have all without exception been through bankruptcy, debt reorganisations, and/or private capital raisings. Even then, it’s not a sure thing all will survive. Indeed, some almost certainly won’t.
Yet without seismic surveying the world simply isn’t going to find new offshore deposits of oil and gas.
We don’t think investors are thinking rationally as some 30% of the world’s oil and gas consumed comes from offshore sources. Even if this composition declines markedly, it’s just not possible for it to go away entirely and as such, the rebound promises to blow the lid off those left alive to catch the windfall.
To say that we don’t need oil and gas from offshore sources is essentially implying that there will be little demand for oil 5 years from now. Frankly, that’s just bollocks.
We believe this is another “when”, not “if” trade with a huge payoff potential. With a lot of patience and a little bit of capital this trade could make a huge positive impact on one’s portfolio.
It is just what we look for here.
What is Offshore Seismic Surveying All About
If you want to find oil and gas offshore you need to employ the services of offshore seismic surveying vessels — ships that are solely used for the purpose of seismic survey in the high seas and oceans. These surveys are used for the purpose of pinpointing and locating the best possible area for oil drilling in the middle of the oceans.
This is a typical offshore seismic vessel in operation. It is pulling a “pod” of sensors behind it.
As the name suggests, seismic surveys use surface-induced seismic pulses to image subsurface formations. Basically, a seismic wave is generated underneath the earth’s surface, and then picked up by sensors called “geophones” as the waves bounce off subsurface formations — that is, layers of rock beneath the surface. This process becomes more complicated when there are hundreds or thousands of feet of water between the earth’s surface and the geophones.
The returning pulses are picked up by an array of geophones attached to lines towed by the ship. These arrays are called “streamers,” and consist of long net-like bands with hydrophones spaced evenly along the streamer.
The information gathered by the hydrophones is collected into an analog signal, before being converted to a digital signal and relayed to computers on the ship. The computers translate the information into digital maps of the subsurface, which geophysicists and geologists can analyze to determine the presence of hydrocarbons, which can save oil companies the gamble of sinking an unprofitable well.
While seismic surveys may be expensive, it ultimately pays off because it allows companies to hedge their bets, minimizing their potential loss, and maximizing their potential gains.
But when oil and gas majors are in a capital preservation, “stay alive for goodness sakes” mode and don’t have the appetite for exploration and development, little or nothing is spent on offshore seismic surveying.
We have previously discussed the “great depression” in capex expenditure on offshore oil and gas so won’t bore you with a rehash here. Whichever way you look at it, over the last few years expenditures has been at generational lows.
From the charts above we think it is reasonably safe to say that expenditure on offshore Seismic surveying has also been at generational lows.
We can cross reference this with the number of bankruptcies/debt reorganisations that have taken place over the last two years in the offshore seismic surveying sector. In no particular order:
- Geokinetics (2013: assets purchased by SAExploration in 2018),
- SAExploration (May 2016: debt reorganisation),
- CGG (June 2017: one of the biggest bankruptcies in France in recent years, exited from bankruptcy early this year),
- Dolphin Geophysical (December 2015: assets bought by Oslo-listed GC Rieber Shipping and private Rasmussengruppen and placed into a JV company – Shearwater Geoservices),
- Global Geophysical Services (went into bankruptcy twice over the last two years and has subsequently been liquidated),
- Gardline Marine Sciences (acquired by Dutch listed company Boskalis in mid-2017),
- Seabird Exploration (mid-2017 debt reorganisation),
- Polarcus (January 2016: debt reorganisation, capital raise in 2018),
- PGS (2016: capital raise).
So every independent offshore seismic vessel operator has gone through a debt reorganisation or some sort or a bankruptcy over the last three years. Think about that for a minute. Show me another sector (an entire sector) where everyone in that sector has been burnt and many have been burnt so badly they died from the injuries. Talk about a wipe out!
For your interest, here is what happened since 2012: the best performing stock, PGS, is down some 60% and the others by 98% or more. NINETY EIGHT percent! We knew that it was bad, but looking at the numbers I couldn’t believe it.
The overarching reason for all these bankruptcies is because many of these companies were built and leveraged to service the oil industry with oil prices significantly higher than where they’ve been over the past two to three years and more.
Spending on offshore seismic surveying was the first to be cut by explorers when the price of oil turned down, and hence these companies bore an incommensurate loss of revenue and cash flow. Couple this with a leveraged balance sheet, it was a recipe for financial disaster.
From the charts below you can see: seismic contracting activity went to near zero from 2014 to 2017.
Ok, that is all in the past, but even with a significant debt restructuring, the market continues to expect more of the same. And this is where we believe our opportunity lies.
But there is more to it than bankruptcies. Once the world’s biggest offshore seismic surveying company, WesternGeco (part of Schlumberger), is shutting up shop.
The Exit of WesternGeco
Formed by the merger in 2000 of two of the world’s largest seismic contractors, Western Geophysical (founded in 1933) and Geco-Prakla, Schlumberger, owners of Geco-Prakla, paid cash to Baker Hughes, which then owned Western, for a 70% stake in a joint venture of the combined companies. In May 2006, Schlumberger bought out Baker Hughes’ 30% stake for a reported $2.4 billion, making WesternGeco one of its subsidiaries.
In January 2018, Schlumberger announced that it would be exiting the seismic acquisition business.
The exit was announced late last year with the president of SLB, Kibsgaard saying that “the present outlook provides no line of sight for the market recovery.”
Kibsgaard said that he believed that Schlumberger’s seismic acquisition business could not provide the desired full-cycle returns or compete internally for funding. Kibsgaard commented, “the only product line that does not meet our return expectations going forward, even factoring in an eventual market recovery, is our seismic acquisition business.”
Schlumberger says that going forward, its WesternGeco unit will adopt an asset-light model based on its multi-client data processing and interpretation businesses. The company says it plans to honor its existing contracts and customer commitments and cold stack equipment as it evaluates divestment options.
I’m guesstimating that most of WesternGeco’s vessels will be heading to the scrap yard. Wonderful news really. Supply destruction is a wonderful thing if you’re looking for deep value asymmetry.
I am willing to put my head on the block and say that SLB’s “cold stacking” of the WesternGeco business was a great long-term bullish contrary sign for offshore seismic vessel operators.
It more or less marked the bottom of the sell off in Petroleum Geo Services (a great proxy for the sector).
It marked the bankruptcy of CGG:
And it occurred just after Polarcus made its ultimate low (for the time being, at least):
How many times have we seen big companies buy assets when they are all the rage (top of a cycle) and offload them at the bottom of a cycle because there is “no clear line of sight for the market recovery”? I guess every asset at the bottom of a cycle is thought of as “non-core”.
This All Reminds Me of Coal Miners in Early 2016
Let’s go back in time to late April 2016 and relive the landscape for coal stocks. Just a few years prior we had the likes of:
- Patriot Coal
- Arch Coal
- Walter Energy
- Alpha Natural Resources
These were the big US producers and they all got the snot kicked out of them and went bankrupt.
On top of that, there were big companies like Anglo American who were looking to offload their coal assets. They were in trouble and had to reduce debt. Beats me who the hell would have bought the assets. If Anglo had gone through with their plan, that buyer would have gotten the assets for an absolute song.
Then there was Cliffs Natural Resources who sold their coal assets towards the end of 2015 and Consol Energy who offloaded all their coal assets by the end of 2016.
Sentiment towards coal was absolutely toxic. Coal was “old economy” stuff, dead and buried and never coming back again. Investment managers treated these stocks like you’d treat a suicide bomber in a shopping mall. You’d run for your life… the other way.
Seems that everyone overlooked the minor fact that the world still got some 40% of its electricity from coal fired power stations… just like today where 30% of the world’s oil and gas comes from offshore sources. History repeats.
Everything is so easy in hindsight. Back in early 2016, it was so hard to see through all the bearish banter on coal to see that coal had a future… any future. I think the same thing is occuring in the offshore seismic survey sector right now (actually, offshore drilling and services as a whole).
Yes, change does happen, but not as quickly as everyone believes particularly with industries that aren’t subject to “technological breakthroughs” like electricity and energy.
Well, dead and buried? Not so quick. the VanEck Vectors Coal ETF (KOL) rallied some 250% over the next 2 years. That is huge for one sector.
Wish you had invested in coal stocks at the start of 2016? Well, you would have had to have been thinking rather differently than the entire market, and since we’re social creatures, that’s always easier said than done.
If you did manage to buy some coal stocks, then it would probably only have been in small amounts. Heck, we missed that play and it’s what we do here, so let’s not kid ourselves.
Anyway, I guess you get my point. It was the hardest trade to do but it ultimately became one of the most rewarding. Ok, so you missed out on coal, but if you were watching the market back then, even if you didn’t invest in coal stocks, you should have learnt a fine lesson — a lesson that could be applied in the future to another sector that echoes what happened with coal.
We want to gain exposure to the offshore seismic survey sector so we’re buying CGG. There aren’t many stocks left within the sector which made the decision of what to buy rather easy.
We thought that CGG was the best of the bunch in terms of a risk vs. reward tradeoff.
There are four other offshore seismic survey stocks we considered but didn’t see them as having any unique competitive advantage or appear a bargain over and above CGG:
- Petroleum Geo Services (PGS, Oslo)
- Seabird Exploration (SBX, Oslo)
- SAExploration (SAEX, Nasdaq)
- Polarcus (PLCS, Oslo)
These stocks have high levels of debt which make them a little too risky. We want stocks that have huge upside but without the risk of running into bankruptcy (again).
However, if the companies listed above do survive, albeit without another debt reorganisation, then they will experience considerable upside:
We could have included PGS in the Trade Alert. It seems like a good company but we believe that CGG is way cheaper.
We wanted exposure to what no one else wants, the ships that actually conduct the surveying. There are companies, like TGS NOPEC Geophysical which have extensive data banks or surveys, great companies, but too expensive. We think they’ll still do well to be clear.
We believe it is the vessel owners who offer the most asymmetry as the number of available vessels is approximately half of what it was just three years ago. When demand for offshore seismic surveys picks up, there just won’t be the capacity (available ships) to conduct the surveys:
The Biggest Risk
It’s hard not to come to the conclusion that there is huge upside in these stocks, perhaps the most out of all oil and gas stocks. All we have to do is wait it out until offshore oil and gas capex spend starts to pick up again and not get stuck with stocks that wipe out equity holders again.
The good news is that there is evidence that majors are starting to spend again.
However, it is often the case that things take longer to play out than one thinks, perhaps the pickup in capex spend takes a lot longer. This is important to understand because it is the biggest risk that I see with these offshore seismic survey vessel stocks, which is why we want to limit downside as much as possible and buy what’s likely to survive.
CGG: More Detail
Best described as an integrated global geoscience company offering geological, geophysical and reservoir products and services primarily to the global oil and gas industry.
Originally called Compagnie Générale de Géophysique, it’s French listed but operating globally in the geophysical services market. Founded in 1931.
It has three complementary businesses:
- Acquisition and geology,
- Geophysics and reservoir (GGR).
CGG engaged in a number of mergers and acquisitions from 2006 to 2013 (Veritas DGC 2007, Wavefield Inseis, Quest Geo Solution, Optoplan 2009, Fugro Geoscience Division 2013). It took on way too much debt which ultimately led to its bankruptcy in 2017.
Actually, a quick side note here. Most of these companies in this sector appear to have been really horribly run. Management are clowns. As such, we’re largely not really betting on management (most look mediocre to outright thick).
In any event, emerging from bankruptcy in January this year, much of the cost of acquiring these companies has been written down. Debt was swapped for equity and additional equity raised and a new CEO appointed in April.
This company now has some serious competitive advantages with its geographical exposure, equipment and services, and comprehensive data library.
We think the bankruptcy of CGG is a huge positive for those investing after the reorganisation – investors now are getting a well capitalized company, new management and very, very cheap assets.
The company is now cash flush, earning a profit, cash flow positive, and it still trades well below book value.
Commentary from recent earnings reports suggest that activity is picking up quite quickly on most of it business segments.
Execution: CGG can be traded on the IB platform in Paris or the ADR in the NYSE.
Allocation: 1% of risk capital.
Timeframe: As with most of our trades, we are looking at a 5-year time frame.
Founder & Editor In Chief, Capitalist Exploits Independent Investment Research
Founder & Managing Partner, Asymmetric Opportunities Fund
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