We are back from a quick Dallas trip, but in keeping with the DEP model, we hit the road again this week. Half of the DEP team returns to the DFW area to speak at the DUG Permian Conference while others will roam around Oklahoma, catching up with our Sooner friends and attending another equipment auction. Importantly, we will host our annual OKC Steak & Baseball Outing on July 15th. The dinner table is now full, but we suspect there will be plenty of open baseball seats, so let us know if you are in town. Finally, we will drive over to Midland again on July 19th where we will spend the week conducting company updates. Again, please let us know if you are free and available to meet.
More Positive Rig Anecdotes. Hardly a huge sample size, but our Dallas trip revealed further upbeat rig anecdotes as one private E&P will increase its rig count from one rig to two rigs (+100%) and another private will purportedly increase its rig count from ~4 rigs to ~8 rigs (+100%). Both of these players are oil-directed E&P’s. Separately, this past week LPI issued its Q2’21 operational update which included a preview to 2022. In keeping with the positive rig theme, the company will add a rig in Q2’22, moving from 1 rig to 2 rigs. Again, a 100% increase. In another region, a private E&P shared it will increase its rig count anywhere from 30-60% in 2022 vs. today. The commentary is consistent with prior DEP reporting. Also, we were encouraged to hear PTEN report on the PES acquisition conference call the pending 2-rig increase in PES’ working rig count (going from 12 to 14 or +16% in Q3). Finally, we kicked off our land drilling update calls visiting with one private rig contractor on Friday who sees a 25-33% increase in its rig count between now and year-end. Increases for this player will largely be private E&P’s. Take all these anecdotes together and it paints a healthy picture for our land drilling friends. Two things to note. The bulk of the increases are with private E&P’s, thus one can’t simply extrapolate 100%-type increases to their public brethren. Two, if public E&P’s do intend to ramp their rig count, they might want to start locking up rigs now as the private players are accelerating. The next round of rig additions will come with higher pricing. Our private land drilling contact, for instance, is presently assessing further dayrate increases of $1,000-$2,000/day.
Near-Term Completion Activity. Diverging views on completion activity, but the majority of our field contacts see stable near-term completion activity. We point this out as we suspect some may look at the recent rise in drilling activity, coupled with the high commodity price, and conclude a sharp uptick in completion activity could unfold this quarter. We don’t think so. Instead, we envision a ~5-7% q/q gain in industry completion activity. The rig count, meanwhile, averaged ~439 rigs in Q2 (per BKR). We see the U.S. land rig count in Q3 averaging ~470-475 rigs, a +7% q/q improvement. Finally, we continue to believe today’s U.S. active frac crew count hovers in the ~215 vicinity. We know there are those who see the U.S. frac crew count north of 235 fleets, but we are still unable to find those extra 20 fleets. Our estimated count, although not perfect, is a bottom’s up approach and is “active” not “working” thus the effective fleet count would be lower than our ~215 active tally. We suspect the active fleet count ends Q3 somewhere in the ~220 vicinity as private companies, for the most part, are sold-out while public companies claim an unwillingness to deploy fleets at current pricing. Should this discipline fade, then perhaps the count could rise above our expectation, but that would require some explanation by industry leadership. Also, labor remains problematic which is a headwind for a rapid ramp in activity.
Sometimes you just have to ask. This week we caught up with a well service contact who shared a recent observation. Here’s the background. Inquiries for rigs are rising, including more unsolicited inbound calls for work. Not new news as we have chronicled the recovery in workover activity. However, field folks, according to our contact, remain a bit reluctant to test price, thus executive leadership has stepped in to encourage a bit more entrepreneurial vigor. Namely, if a call comes in, the new edict requires the yard manager to test price. Prior to the decree, the company’s hourly rates were hovering at $250/hour (base rig rate). In the past week, the company had three inbound calls. First quote was for $260/hour. No push back. Next call, rig contractor quotes $275/hour. No push back. Most recent call, rig contractor quotes $285/hour. Again, no pushback. All within the span of a few days. What’s this tell you? First, the company is probably still not charging enough. Second, does a $25-$35/hour increase really matter when oil prices exceed $70/bbl? Not a chance. Third, dare to be great and make some money for your company. There’s no guilt in this. Finally, look at the recent spate of M&A announcements discussed below. The industry consolidation process is beginning and the central message which typically is not discussed in the acquisition announcement is the potential benefit of upwards pricing. We get it. Trying to dictate a price to one’s customers doesn’t always jive with strong customer service, but the reality of running a capital-intensive business with gross margins sub-15% doesn’t make sense either, thus pricing needs to go up and it will as the industry consolidates. Our bet is we see service costs +20% higher one year today than where they are now, assuming of course no COVID resurgence, OPEC+ rational guardianship persists and continued global economic improvement.
PTEN/PES Deal. The following discussion is not a stock opinion. Rather, we simply offer our take on this week’s announcement regarding PTEN’s pending acquisition of Pioneer Energy Services. First, we like it from an operational perspective. The land drilling industry, like all other OFS segments, remains fragmented thus the ability to consolidate and slash costs is a welcome outcome. True, this isn’t a major land drilling consolidation play as PTEN, which is running 77 rigs or ~17% of the domestic market (per BKR), adds 12 working PES rigs or just ~3% of the domestic market. Nevertheless, each and every deal leads to a more normalized market. When one considers there are still several small land rig contractors competing in the space, some of whom have private equity / special situation interest behind them, it would seem reasonable other sellers may exist. In the press release and as discussed on the acquisition conference call, PTEN is likely to exit some of the legacy PES businesses. Specifically, PTEN commented about a potential sale of the PES well service unit. No specifics were made about the PES wireline business, but we’ll assume both could go as we see neither as core to PTEN’s land drilling business. We presume PTEN will keep the Colombian drilling business, however. So how should one think about values of what could be two non-core businesses for PTEN?
For the well service business, PES owns 123 rigs and reported a Q1 utilization rate of 35%. The perception from third-party well service players is positive with many placing PES at the top performer of the public well service companies (i.e. margin, utilization and rig quality all over time). When one considers the Q1 utilization rate of 35%, the natural assumption is roughly 40-45 working rigs. We know, however, Q1 results were hampered by weather. We also know field commentary from most well service contacts suggests a healthy q/q uptick in well service rig hours during Q2. Therefore, establishing a valuation using Q2 results for the PES well service business seems reasonable. Of course, we don’t know what those results are, but let’s make some bold assumptions. The BKR U.S. land rig count increased ~16% q/q in Q2. We believe industry well servicing activity/hours growth exceeded this, so let’s assume ~25% growth in the PES active fleet. That would put them in the 55-60 active rigs range. We know Q1 revenue for the PES well service business was $15M. Let’s continue with the ~25% q/q improvement and call Q2 revenue $18-$20M. Presumably, it’s a tad better given the Q1 weather gremlins. But let’s settle on $20M to keep our math easy. We also know pricing is now moving higher in well servicing (assume ~10%) and the DEP U.S. land rig count forecast calls for a ~7-9% q/q improvement in U.S. land drilling activity. We’ll simply call the activity/pricing uplift a 10-15% q/q improvement. Again, this feels conservative, but we’ll ballpark Q3 revenue at $22M.
As for margins, PES generated gross margins of 20% in Q1 (gross profit was $3M in Q1). If our revenue growth assumptions are reasonable and if PES extracted 40% incrementals, that would suggest Q2 gross profit might be in the $5-7M range with Q3 margins approaching $6-8M? Again, this is a guess on our part. Apply a modicum of G&A burden and could the Q2/Q3 well service EBITDA be in the $5-6M vicinity? Feels defensible. Thus, these collective guesses would imply the well service business may have an annualized EBITDA run rate EBITDA in the $15-$20M vicinity. So, what’s that worth? Good question and we fully acknowledge we’re not a banker, but a 3x multiple does not feel too aggressive. Therefore, could a strategic player value the business somewhere in the realm of $45-$60M? Again, feels defensible. But what about asset value? Recent auctions suggest good well service rigs garner prices in the $300k to $400k range with old crappy rigs securing prices in the $25,000 to $50,000 range. Remember, auctioned equipment isn’t working equipment. Those assets don’t have customers or employees, but let’s forget that for a moment. In this silly memory lapse, we apply a $400,000/rig value to an assumed active fleet of 60 rigs. That’s $24M of value on an estimated active fleet. This monkey math excludes the value of any real estate, the value of all the accompanying rental assets and gives zero value to the ~50 idle rigs. Excluding the ancillary assets would be foolish as these assets, we contend, are key reasons why PES generally reports a higher revenue/rig hour and why its margins exceed peers. There’s value to that equipment, but we don’t have an asset listing to quantify. Also, important to remember that we are simply trying to develop a framework which, for the well service business, would suggest a value in the $40-$60M range.
Turning to the wireline business, the two RNGR deals highlighted below suggest a value per wireline unit of ~$500,000. This is simply taking our estimated total transaction value of $28M and dividing by the 55 wireline units acquired. This, of course, is an overly simplistic methodology as it ascribes no value to the acquired cranes, pump-down units and real estate. Failure to account for those assets is clearly an error, but we’re trying to keep this quick and simple, so for now simply play the game with us. Taking that per unit value and applying it to PES’ total wireline fleet of 77 units would suggest the PES wireline unit has a value of $39M. Big and important difference, though, is the RNGR acquired businesses, while smaller in terms of total units, generated $30M in Q1’21 revenue vs. the $10M in revenue generated at the PES wireline unit. Also, the RNGR acquired businesses are “currently” generating gross margins in the 12-16% range while the PES business generated Q1 gross margins in the 4-5% vicinity. Not an exact apples-to-apples comparison as RNGR disclosed the PerfX/Patriot margins as “current” vs. the PES which were Q1. We also believe the assets acquired by RNGR had a greater concentration of completion-oriented work which probably carries a higher margin. That said, one would think the PES wireline business is doing better in Q2 than Q1 as we all know industry activity is up q/q. So, let’s continue with our simplistic analysis and call the wireline business a 10% gross margin business today and assume a modicum of G&A burden, thus we’ll peg EBITDA margins in the 5% vicinity. If we then assume the PES wireline business is growing in line the rig count, then quarterly revenue is somewhere in the $12-14M range. We’ll call this a $50M annualized business with annualized EBITDA in the $3-4M range. Using a similar 3x multiple, suggests a value in the $10M range. BTW – recent auctions of used wireline units fetched average prices in the $35k-$40k range. Assume $40k and 77 units and the collective value might be as low as $3-4M for that asset package. One would think a strategic might look at this business simply to avoid having ~77 units hit the auction block. Based on loose framework, it would seem a $5-10M valuation on the wireline business is reasonable.
What’s all this mean? For one, if PTEN chose to exit these two PSLs, our Saturday-by-the-pool math suggests a value in the $50-$70M range. Keep in mind, we are making our loose estimates on current results. If PTEN seeks to exit these businesses after the close of the deal, which was stated as Q4 if we recall correctly, then one would hope a potential higher valuation could materialize if activity continues to march upward. But for now, forget that last thought and focus on the announced purchase price of $295M for the PES business. If our valuation framework is directionally correct, the implied value ascribed to the drilling business would therefore be roughly $235M. Allocating that purchase price to the 25 drilling rigs implies about $9M per rig. That doesn’t screen offensive to us as it creates industry consolidation at a fair price. Moreover, given the unfolding consolidation backdrop which is developing, we believe PTEN will find interested buyers for either the well service and/or wireline businesses should it choose to pursue a divestiture. Remember, we have recently seen (i.e. within past ~2 years) Brigade buy the NINE well service business; the BAS/CJES well service combo and most recently, the Axis/Forbes rig combination, thus consolidators in well servicing would appear to exist. We also just witnessed RNGR buy two wireline businesses in less than three months, thus a potential buyer in wireline exists. Now, do these companies continue their acquisition pursuit? Who knows. We’re simply trying to point out that a developing M&A market within two segments exists and that’s a good thing.
RNGR/PerfX Acquisition. Not a surprise to see RNGR announce another deal because the company previously disclosed a second deal was in the works. Nevertheless, deal #2 was finally announced on Friday and it represents a further consolidation of the domestic wireline space as RNGR picks up the assets of PerfX. When combined with the May acquisition of Patriot Completion Services, RNGR acquired 55 wireline trucks, 10 cranes and four pump-down trucks. Thus, RNGR now owns a total of 68 wireline units. As for financial metrics, RNGR noted the two acquired companies generated Q1’21 revenue of $30M with gross margins “currently” in the 12-16% range. Assume a G&A burden of 6% of revenue (RNGR’s is 9% in Q1, but RNGR is public, thus a higher burden) then one could guestimate current EBITDA margins may be roughly ~8%. Applying this margin to Q1 revenue leads us to believe current quarterly EBITDA would be in the $2.5-$3.0M ballpark.
As for deal valuation, RNGR issued a total of 2.256M shares and assumed $12M of leases/debt. For the Patriot deal, RNGR issued 1.256M shares. That deal closed on May 14th and the closing stock price that day was $6.15/share. We’ll assume that’s the issued price. For the PerfX deal, RNGR issued 1.0M shares and the stock closed on Thursday at $8.72/share, so we’ll use that price. Therefore, the implied value of both deals is ~$28M – we’ll double check our math once the 10Q comes out. Now, harken back to our financial statement math above and fully appreciate the fact our math represents a guess, but it would seem the combined deals represent a ~3x multiple of Q1’21 annualized EBITDA. If one further considers Q1 results for the domestic OFS complex were weather burdened and presumably a modicum of G&A savings will be achieved in this rollup, the transaction math would seemingly imply valuation is hardly offensive. Of course, we completely made some guesses and potentially run the risk of looking foolish once more deal specifics come out. That’s fine. The more important narrative, however, is the roll-up of the highly fragmented NAM OFS market is underway and that’s a much-needed step to help return to a more normalized supply/demand balance.
You Can Learn A Lot From Buccee’s. We confess – we are a Buccee’s addict, stopping four times this week on our travels to/from Dallas. The drink prices can’t be beat; the bathrooms are clean; and the BBQ is sufficiently edible. What’s also good about Buccee’s is the ability to assess certain economic conditions. For instance, evaluating store traffic or volume of cars getting gas. Another new metric is using Buccee’s as a barometer for the labor market and wage inflation. You see DEP takes photos on our road trips in order to log changes in market conditions. On this trip we noticed Buccee’s has raised wages – see photos below. The top photo shows wage advertisements from the Ennis location on April 30th. The bottom photo captures current wages at the same Ennis location on July 8th. Not only are wages up ~15-25%, but the company now offers an extra incentive to work nights. The extra evening pay at night versus none offered three months ago reaffirms the known fact that labor is hard to find. Recall from our May 2nd DEP Industry Observations, we commented on the pay differential between retail shops such as Buccee’s and the oilfield. With wages rising at relatively comfortable jobs which presumably offer stability, this creates a headwind for the oilfield.