Helix Energy Solutions Group, Inc. (HLX)

ValueArbitrage (98.85) Submitted: 10/2/2008 7:34:06 AM : Start Price: $36.03 HLX Score: -48.45

HLX is simply to cheap for a (primarily) capital light, competitively advantaged company with above average growth prospects and a long paper trail of earning above average returns for its shareholders.

Reasons for my conviction stem from its ludicrous current undervaluation (based on almost any metric, relative and absolute) as well as the variety of levers management has at its disposal to improve profitability and grow the top and bottom line over the next few years.

For one, HLX is emerging from a heavy investment phase and should hit an inflection point regarding it's free cash generation capabilities at some point over the next year. A few additional levers that mangement may utilize to drive returns over the next few years include...

1. The spin-off or outright sale of its more capital intensive E&P business (in the case of a spin-off I believe both companies would warrant higher valuations as independent pure plays rather than continuing as a combined entitiy).

2. Execution of revenue and margin enhancement strategy. I believe this likely for a variety of reasons, a few of which include...

On the sales side of the equation...

Future sales growth should be achieved through continued growth within its rapidly growing contracting segment. Underlying business drivers here include the addition of 3 new upgraded vessels (during the 4th quarter) with the ability to lay pipe under water. Demand for such vessels is considerable, and likely to only get stronger (at least for awhile). I expect additional top line growth on the E&P side as well. 3 new oil fields are scheduled to come online during the fourth quarter, with full production by the second half of '09 (which should roughly double HLX's current run rate). Higher oil prices and the tight services market should provide a decent tailwind here.

On the margin side of the equation...

Margin expansion should be driven by a combination of increasing asset utilization, reduced costs (less maintence capex), and a mix shift to its faster growing, higher margin business going forward (to name a few).

On the contracting side...the addition of the 3 new upgraded vessels (with enhanced capabilities) should allow HLX to deploy these ships at new, more profitable rates going forward. Considering these vessels are expensive, difficult to replicate assets, as well as HLX's formidable (proprietary) expertise working with these type of assets in the deep water realm...I believe shareholders should benefit from large and rising margins within this segment for the foreseeable future. i.e. I don't expect serious competition to drive down margins and hence returns for quite awhile (I expect the opposite).

Also previous investments in their E&P properties should bolster margins over the near to medium term. With 3 new fields coming online shortly (consider these fields ability to ramp up to full production relatively quickly as well), it doesn't take a genius to realize significant margin expansion within this segment is likely. Due to the natural operating leverage of the E&P business, this segment should begin to drive profitability considerably higher over the next year or so as new production kicks in (as sales increase while fixed and variable costs decrease, causing margins to expand) and profitability explodes.

Lastly, a longer term mix shift to the faster growing, higher margin services segment (currently 70% of revenues) and ongoing improvements in HLX's cost structure should make future growth meaningfully more profitable than what a careful study of historical results would indicate. For instance, Capex for the E&P segment is much larger than capex for HLX's service's segment. Therefore, as management begins to focus their attention more on the growth of the service segment (over time representing more and more of Helix's revenues), capex will grow at a slower and slower rate.

I believe the market is likely to reward any visable improvement on these fronts, which should begin to manifest themselves in relatively short order. Now that Owen Krantz is back at the helm, I believe execution here is likely, as this is a man who historically has consistently underpromised and overdelivered. Why should I expect the future to be any different.

3. Value added capital allocation (paying down debt, buying back stock, etc.). Management has a variety of non-core assets to divest if the price is right, which if monetized would bolster HLX's cash position and increase their flexibility to add value in this area.

The bottom line...

Considering HLX's historical profitability and future outlook, its savvy and shareholder friendly management team, and the positive underlying business dynamics currently underway...this misunderstood and underfollowed company is grossly mispriced. When examined through a normalized margin and profitability assessment, HLX in my opinion is screamingly cheap. Investors who purchase shares at or around today's price should reap outsized risk-adjusted returns of 50-100% over the next 2-3 years