SLB - NexTier And Patterson Merger Creates Oil Service Player With Discount Valuation

2023-06-15 11:44:29 ET

Summary

• NexTier Oilfield Solutions Inc. and Patterson-UTI Energy, Inc. are merging to create the second largest North American oil service company after Halliburton Company.
• The combination will create a high margin, strong balance sheet oil service company focused on efficiency and value.
• The pro forma valuation is severely discounted vs. their natural large cap peer comparison.

NexTier Oilfield Solutions Inc. ( NEX ) and Patterson-UTI Energy, Inc. ( PTEN ) to combine in merger of equals - WSJ broke the rumor earlier this week, and today the companies have made the rumor a reality.

Favorite Quote Watch:

"This merger unites two top-tier and technology-driven drilling and well completions businesses, creating a leading platform at the forefront of innovation. As one company, we will have a significantly expanded, comprehensive portfolio of oilfield services offerings across the most active producing basins in the United States, along with operations in Latin America. With our combined strong balance sheet, ample liquidity and greater free cash flow, we will be well positioned to continue to invest in technology, innovation and people, while delivering strong cash returns to shareholders." ~ Andy Hendricks, CEO of PTEN .

"Our agreement to merge with Patterson-UTI brings together two complementary organizations to create a premier North American drilling and completions company. We believe offering a comprehensive suite of solutions on one integrated platform will position the combined company as the partner of choice for a greater number of customers across geographies and throughout the full well life cycle. We're confident that together, we will be able to drive efficiencies across the portfolio and unlock more value for shareholders and customers than either organization could achieve on its own." ~ Robert Drummond, CEO of NEX.

The Primary Assets:

• 172 super spec rigs in U.S., with 120 of them considered Tier 1 super spec rigs.
• 45 active frac spreads (majority from NEX), almost 2/3 dual fuel capable.

The Deal:

NEX shareholders to receive 0.752x PTEN shares, resulting in a 6% discount in NEX based upon yesterday's close.

The combined management team expects to generate synergies of $200 mm over the next 18 months and sees this as not only achievable, but beatable. Synergy savings are expected to come from three buckets:

1. The combined company will use NEX's frac integrated offering across Patterson's existing 12 frac fleets. This well-honed system will help reduce fleet maintenance costs and via predictive part failure aid in fleet uptime.
2. They expect to use their scale to leverage cost savings across the supply chain.
3. While both names are lean, there is always some organizational overlap in a deal like this.

Given the savings, they see deal as being accretive to both earnings and free cash flow in 2024, as they expect a 4Q23 close. Key here is the move to reaffirm their commitment to return of "at least 50%" of free cash flow to shareholders.

The Pro forma Metrics:

• #2 in NAM Revenue. Pro forma 1Q23 revenue of $6.9 B, putting them second only to Halliburton Company ( HAL ) in terms of North American oil service. Notably this puts them ahead of Big 3 Oil Service stalwarts Baker Hughes Company (BKR) and Schlumberger ( SLB ), as well as frac company peers Liberty Energy ( LBRT ) and ProFrac Holding Corp. ( ACDC )
• Strong Balance Sheet. At close, they expect to have a low net debt to EBITDA multiple of 0.5x, and on 2024 this falls below 0.5x.
• Strong Margins. The combined company is likely to sport EBITDA margins near 30%.
• Low valuation. On a combined basis, as of last night's close, the deal puts them down at a TEV/pro forma 2024 EBITDA (with savings) of about 2.5x.

Nutshell: In our view this creates a sizeable, high tech, efficient, slightly smaller HAL (unowned), albeit with a significant lower valuation, better margins, and a better balance sheet.

• HAL TEV/ 2024 E EBITDA is 5.4x (or more than double this deal).
• HAL EBITDA margin of 22% vs a pro forma NEX+PTEN near 30%.
• HAL Net Debt to Annualized 1Q23 EBITDA was 1.2x (or 3x higher).

We've not been big in drilling for some time, and with rig counts having slumped and our last review of PTEN about a year ago near $14, it doesn't seem like we've missed out on much. But we have been keeping an eye on this well-run company. Meanwhile, we've written on NEX a couple of times, and the name is the 3rd largest holding in our portfolio. If the rig count decline moderates in 2H, as we expect, then we suspect we would have expected pressure on a standalone PTEN to have abated and for the name to have lifted with higher oil and natural gas prices (also our expectation) into the second half. We note that both management teams speaking on the conference call were really upbeat on the NAM drill and complete macro, viewing the current period of soft oil and gas prices as temporary.

Over the years, we have learned to like "no premium deals" relative to short-term deals that offer quick pops but leave the combined name in a weaker position going forward. Instead, we see this as creating a < 2.5x TEV/2024 pro forma EBITDA company with a TEV of $5.4 B and a strong balance sheet. We see the cross selling opportunities here as likely to be initially underestimated. We would like to hear more about the plans for free cash flow ("FCF") next year once the deal is done. Given the current valuation, our thoughts would definitely skew more towards a buyback post deal close, with only a modest dividend bump from PTEN's perspective.

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