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Basic Grey - Thoughts On a Merger

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9

June 01, 2008 – Comments (5) | RELATED TICKERS: BAS , GW , UBS

This value investment report considers the merger of Basic Energy Services, Inc. and Grey Wolf, Inc., currently scheduled to occur during the third quarter of 2008.

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Basic Energy Services, Inc. (NYSE: BAS) Financial statement data is based on the company’s latest 10-K filing dated December 2007.

What They Do
Basic Energy Services, Inc. provides a range of well site services to oil and gas drilling and producing companies in the United States, operating in four segments: Well Servicing, Fluid Services, Completion and Remedial Services, and Well Site Construction Services.

The Well Servicing segment provides services, including the drilling of a well bore; installation and removal of downhole equipment; elimination of obstructions in the well bore to facilitate the flow of oil and gas; and plugging and abandonment services. This segment operates a fleet of 387 well servicing rigs and 10 drilling rigs.

The Fluid Services segment provides oilfield fluid supply, transportation, and storage services, which include transportation of fluids used in drilling and workover operations; sale and transportation of fresh and brine water; and operation of company-owned fresh water and brine source wells. This segment operates a fleet of 645 fluid services trucks and related assets, including specialized tank trucks, storage tanks, water wells, disposal facilities, and related equipment.

The Completion and Remedial Services provides pressure pumping services, such as cementing, acidizing, fracturing, coiled tubing, and pressure testing; rental and fishing tools; cased-hole wireline services; and underbalanced drilling in low pressure and fluid sensitive reservoirs. It operates 118 pressure pumping units; 42 air compressor packages, including foam circulation units for underbalanced drilling; and 12 wireline units for cased-hole measurement and pipe recovery services.

The Well Site Construction Services segment engages in the preparation and maintenance of access roads; building of drilling locations; installation of small gathering lines and pipelines; and maintenance of production facilities.

The company serves oil and gas companies located in Texas, New Mexico, Oklahoma, Arkansas, Kansas, Louisiana, and the Rocky Mountain states, and is based in Midland, Texas.

Short-Term Investor (Hold of one year or less)
Based on a recent close of $28.77, the stock has First Resistance at $29.93, a 4% increase from recent levels, First Support at $25.21, a 12% decline from recent levels, and Second Support at $21.73, a 24% decline from recent levels.
 
Long-Term Investor (Hold of 3-5 years)
The stock is on my watch list with Reasonable Value Estimate of $68.87, a Buy Target of $34.44, a First Sell Target of $67.15, and a Close Target of $72.69. The stock currently has a Risk Reward Ratio of 6.4.

Investment Fundamentals (Based on annual financial data)
For its latest fiscal year, the company had Shareholder Equity of $12.77 per share, Earnings of $2.13 per share, and based on a recent close the stock has a trailing twelve-month PE ratio of 13.5.

Also for its latest fiscal year, the company had a Return on Invested Capital of 29%, Average Free Cash Flow of $0.79 per share, a Tangible Book Value of $7.12, and paid no dividend.

In addition, the company had a Cash Conversion Cycle of 50 days, an Enterprise Value of $36.84 per share, and an Equity Value of $20.74 per share.

Investment Ratios (Based on annual financial data)
The company ended its latest fiscal year with a Current Ratio of 2.9, a Quick Ratio of 2.78, a Cash Ratio of 1.00, a Flow Ratio of 2.34, a Debt to Equity Ratio of 0.81, an Acid Test Ratio of 2.52, and a Capital Efficiency Ratio of 0.31.

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Grey Wolf, Inc. (AMEX: GW) Financial statement data is based on the company’s latest 10-K filing dated December 2007.

What They Do
Grey Wolf, Inc., through its subsidiaries, provides onshore contract drilling services to the oil and natural gas industry in the United States.

It primarily operates in Arkansas, Louisiana, Texas, the Gulf Coast of Mississippi and Alabama, and the Rocky Mountain and Mid-Continent drilling markets.

The company serves independent producers, and oil and natural gas companies and at the end of fiscal 2007, the company operated a fleet of 121 land rigs.

The company was founded in 1978 and is based in Houston, Texas.

Short-Term Investor (Hold of one year or less)
Based on a recent close of $7.83, the stock has First Resistance at $8.63, a 10% increase from recent levels, First Support at $7.15, a 9% decline from recent levels, and Second Support at $6.27, a 20% decline from recent levels.
 
Long-Term Investor (Hold of 3-5 years)
The stock is on my watch list with Reasonable Value Estimate of $20.81, a Buy Target of $10.42, a First Sell Target of $20.32, and a Close Target of $22.00. The stock currently has a Risk Reward Ratio of 6.8.

Investment Fundamentals (Based on annual financial data)
For its latest fiscal year, the company had Shareholder Equity of $2.92 per share, Earnings of $0.56 per share, and based on a recent close the stock has a trailing twelve-month PE ratio of 14.0.

Also for its latest fiscal year, the company had a Return on Invested Capital of 40%, Average Free Cash Flow of $0.39 per share, a Tangible Book Value of $2.88, and paid no dividend.

In addition, the company had an Enterprise Value of $7.95 per share, and an Equity Value of $7.71 per share.

Investment Ratios (Based on annual financial data)
The company ended its latest fiscal year with a Current Ratio of 4.24, a Quick Ratio of 4.24, a Cash Ratio of 2.37, a Flow Ratio of 1.86, a Debt to Equity Ratio of 0.42, an Acid Test Ratio of 4.05, and a Capital Efficiency Ratio of 0.22.

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Merger/Investment Opinion (One investor’s conclusion)
At this time, I have no interest whatsoever in either company.

The main reason I have no interest in the stock at the present time is the pending “merger of equals” between Basic Energy Services, Inc. and Grey Wolf, Inc., a merger I think will end in divorce.

I took a look at the pending nuptialites to see which one was going to be wearing the white dress, and folks, the white dress winner is…Grey Wolf, Inc.

First of all, the new board is made up of nine members, five from Grey Wolf and four from Basic Energy, with Tom Richards from Grey Wolf being the Chairman of the Board and Ken Husemand from Basic Energy being the Chief Executive Officer.

Next in line was David Crowley from Grey Wolf who is gets to be President and Chief Operating Officer, followed by Alan Krenek from Basic Energy who gets to be Executive Vice-President and Chief Financial Officer. The rest of the board is made up of folks from both companies that I suppose know how to do board stuff.

This new board will manage the merged company named…Grey Wolf, Inc. The new stock ticker symbol, which is really the same ticker symbol just on a different stock exchange, will be (NYSE: GW).

The merged company will be a Delaware Corporation headquartered in Houston, Texas with an estimated 85 million shares outstanding, and an estimated value of the new enterprise of $2.9 billion, making the value of the combined shares about $34 each.

As to which shareholder gets what, here’s the deal.

Grey Wolf shareholders will receive $1.82 in cash and 0.2500 shares of new Grey Wolf for each share of Grey Wolf they currently own. Based on this exchange ratio, each stockholder of Grey Wolf will receive one share of new Grey Wolf for each four shares of Grey Wolf in addition to the cash consideration.

Basic Energy Services shareholders will receive $6.70 in cash and 0.9195 shares of new Grey Wolf for each share of Basic Energy Services they currently own.

So let’s see. At the moment there are 225.6 million shares of Grey Wolf, Inc. outstanding. The company is going to fork over $1.82 in cash for each of those shares, for a total of $410.6 million.

Also at the moment there are 41.1 million shares of Basic Energy Services, Inc. outstanding, and the company is going to shell out $6.70 in cash for each of those shares, for a total of $275.4 million.

That means between the two existing companies, they are going to pay the existing shareholders, $686 million, not a bad deal for the shareholders.

But in looking at the latest annual balance sheet for each company, I find that between the two companies they only have $339.6 million in cash.

So where is this $686 million coming from? Surprise, surprise, surprise, the new Grey Wolf is going to borrow it! Why didn’t I think of that?

Combining the new Grey Wolf debt of $686 million, with Basic Energy’s existing $423.7 million of debt, and Grey Wolf’s existing $275 million of debt, I figured out that the new company is going to be about $1.385 billion in debt when they open their doors for business.

Or put another way, not only is each shareholder going to get some cash, they are going to get shares of stock in a new company that are worth about $34 each, and contain roughly $16.29 of debt each.

Thanks to UBS Investment Bank and Goldman, Sachs and Company, the lender gods, for making that possible.

According to the joint press release of 04/21/08, the combination of the two companies will create an organization of 7,500 personnel, providing a broad range of drilling and oilfield well services utilizing 395 well servicing and 130 well drilling rigs.

The new Grey Wolf, again according to the press release, will have “pro forma sales and EBITDA of approximately $1,784 million and $632 million, respectively (for the full year ending 12/31/07). Pro forma sales (for the full year ending 12/31/07) would be approximately 53% from contract drilling, 19% from well servicing, 15% from fluid services and 13% from completion and remedial services.”

Folks, I am certainly not the sharpest pencil in the pocket protector, but I can add, sort of, and guess what? When I combine the numbers from both companies, I come up with the same numbers the press release gave to investors.

So using the same methodology, and looking just a little further, I come up with more numbers, numbers like $55.4 million in interest payments on the new company’s new debt, and $148.3 million in income taxes on that $1.784 billion in annual sales, leaving $419.7 million after Uncle Sam and the lending gods have received their offerings.

Since the financial wizards of the new company are just combining numbers, I assume that these wizards of business operation either have no idea what to do, or all of the folks currently employed by both companies are critical to the success of the new company and all will be kept.

In any event, looking at what both companies have spent in the past, and then using the mystic math of the future board of directors, the new company is going to spend about $318.7 million on CAPEX.

Assuming, just like the new Grey Wolf directors are doing, that the CAPEX number is correct, the new company is left with $101 million from which to pay down debt, meaning if everything stays the same, and the new company uses all of that money to pay down the new company’s debt, it will take almost 14 years to pay off the debt created by the merger of these two companies.

But the press release says…“The combined company intends to dedicate a substantial amount of its free cash flow to the repayment of the debt while at the same time fully funding and implementing its significant, value-adding growth initiatives.” which to me is the same thing as telling the existing stockholders what they want to hear just so long as the deal gets done.

After the deal is done, my feeling is that management will careless about their shareholders, at least until the class action lawsuits start.

Look, let’s get one thing straight from the start. I have no submarine in this race, so it really doesn’t matter to me who does what to whom, I simply don’t care.

But I know folks that own shares of the merging companies, folks that are nearing retirement, folks that if they hold on to the shares of the new Grey Wolf, Inc., may not be happy campers in a few years.

I have to wonder, when the world demand for oil falls off of a cliff because the regular people like me simply can’t afford to pay for all of the things that are made from oil, which today is almost everything, what will happen to the new Grey Wolf?

Will they remain in business? Will they still have any business to remain in? Aside from perhaps the major oil companies, what firms will be able to afford to drill for oil?

I wonder just what the crack management team of the new Grey Wolf, Inc. is going to tell their shareholders when the value of their investments has fallen off to something less than what their cost basis is because the oil business has priced itself out of work? Did I mention class action lawsuits?

I can hear it all now, management singing the blues about how they are sorry that the value of the shareholder’s investment has fallen, but reminding shareholders that management is also a shareholder and that the value of their investments has fallen as well, and all of the other typical rhetoric.

Meanwhile, the forgotten lender gods, standing in the shadows, will be smiling, shaking one another’s hands, slapping each other’s backs, aware of the misery caused by the merger of these two companies…and thankful for it.
 
Wax

5 Comments – Post Your Own

#1) On June 11, 2008 at 9:22 AM, Delwin (< 20) wrote:

Thanks for a good post, Wax.  The only  thing I question is the combined annual sales of 1.784 b.

GWs core earning come from drilling activities.  The way to significant way to increase income is to increase drilling activity by acquiring more rigs.  Not just the 10 rigs from BAS since these are already contributing to combined revenue estimate.

 Also, BAS income is primarly from well servicing and the way to increase their revenue from this area would be to increase service be acquiring more service-rigs and people.

I'm not very experienced in the arithmetic of mergers, so I don't understand how revenue would likely be this high after the merger.  How would a merger, in itself, create so much additional income?  Any ideas?

 Delwin 

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#2) On June 11, 2008 at 6:12 PM, wax (97.33) wrote:

Delwin;

Thanx for the kind words and great question.

In reading through the press release one thing I noticed was that the majority of the numbers presented were actually a combination of the individual numbers from both financial statements. It was that "logic" that I followed in putting together part of my post, including EBITDA. I'm not saying I believe what was released that's for sure.

I had to spend a bit of time figuring out all of the mumbo jumbo to determine what the new debt levels would be, and based on my understanding of what was in the release, and then coupling that with the existing debt levels of both companies, I was able to finally get a handle on just what the merged company's debt would probably be.

I have to say that I think a merger of the two companies  is going to take a very very long time to reward investors, and as time goes by, servicing all of that debt should become more difficult.

At the moment, oil prices are extremely high. But I believe that the markets are discounting just how much pull the consumer has, and frankly, have left them out of the equation all together.

Which is another reason, I think this merger is going to be a bit doomed from the start.

Wax

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#3) On June 12, 2008 at 10:43 AM, Delwin (< 20) wrote:

Wax

I could tell you spent a good bit of time in your analysis of the merger. I followed your math with no problem, and it  seems reasonable as to debt.

 My son owns a few shares of GW, and I was wondering about the new GW as to its ability to service the post-merger debt.  The combined revenue of the GW and BAS from the Income Statments is 907 million which is quite a bit less than the 1.784 billion.

My question  is really whether the merger would generate enough additional revenue to service the debt, given that the additional revenue would seem to have to come from an increase in cap-ex as opposed to a reduction in cost.

Thanks again for your thought provoking post.

 Delwin

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

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#4) On June 12, 2008 at 5:29 PM, wax (97.33) wrote:

Delwin;

My feeling is that at first the company will be able to service the debt. What I find hard to believe is that the company will be able to continue to service the debt.

As to the revenue, here is the joint press release of 04/21/08. Hope it will help you.

Wax

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#5) On June 12, 2008 at 7:04 PM, Delwin (< 20) wrote:

Wax or who ever reads my last comment, please disregard it.

I had made a composite soreadsheet of the two companies assets and simply misread it.

Sorry about that.  I did enjoy the discussion, however. 

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