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Eric Fry, reporting from Laguna Beach, California...
The poet Jim Harrison once observed, "Modest dangers make you attentive,
while extreme danger can explode your equilibrium, sometimes permanently."
One illustration of this tendency, according to Chris Mayer, editor of
Capital & Crisis, is the growing pile of
cash on corporate balance sheets.
The credit crisis seems to have exploded the traditional equilibrium
between cash and debt. Of course, this "equilibrium" was no such thing, as
corporate cash levels have been perilously low for years...at least in the
finance sector.
But corporate chieftains are becoming attentive to danger, at least for
now.
"The credit crisis seems to have put fear back in their spines," Chris
remarks. "The 500 largest US companies - excluding financial firms - hold
the largest cash hoard as a percentage of assets since 1960. The Wall
Street Journal reports today that cash hoard is nearly $1 trillion,
or about 10% of total assets. That was in the second quarter, for which we
have full numbers. So far in the third quarter - with 248 of the 500 firms
reporting - cash has increased to 11.1% of assets.
"Cash is the financial equivalent of a big, soft pillow," Chris continues.
"It helps you sleep better at night. After the credit crisis turned small
balance sheet leaks into lethal holes, executive suites around the country
seem determined not to let that happen again. The Wall Street Journal
highlights the case of Alcoa, the big aluminum producer. It sits on $1.1
billion in cash, up 28% from a year earlier. It cut its dividend, even
though it is making money. The CFO said, 'We're just going to be extremely
prudent.'
"But there might be another reason why the bigwigs sit on all that cash,"
Chris reasons. "They might just not see many good opportunities to invest
in right now. In other words, the piling up of cash in America's corporate
treasuries may just mirror the weak economy."
But Chris suspects these corporations won't pile up cash forever.
Eventually, they will start itching to launch takeover deals. In fact,
Chris points out, "We are already seeing a pickup in takeovers and
mergers. Just last week, CF Industries, the fertilizer company, upped its
bid for rival Terra Industries. The new offer is worth $200 million more
and is mostly cash. Also last week, Denbury Resources offered $50 per
share for Encore Acquisition - about $15 in cash and the rest in stock."
So even though the overall market seems richly priced at current levels,
Chris has been setting his sights on a handful of names that look to him
like ideal takeover candidates. T3 Energy Services is one of his favorites.
He believes this leading oilfield services company would make a good fit
with the likes of National Oilwell Varco or Cameron Intl.
Tesco (TESO:nasdaq) would be another juicy target, Chris
believes. The stock trades slightly below book value, only 11 times
earnings, and also has a clean balance sheet. In today's edition of
The Daily Reckoning, Chris provides a few other scintillating details
about Tesco.
But first, a few words from the gang at The 5-Minute Forecast
about what Warren Buffett is buying...and selling:
"Wow... Warren Buffett just made the biggest acquisition in Berkshire
Hathaway history. In his words, "an all-in wager on the economic future of
the US." Undeterred by the moonshot rise in the S&P over the last eight
months, Berkshire Hathaway announced its acquisition of Burlington
Northern Santa Fe this morning. In spite of already owning $10 billion
worth of the railroad company, Buffett will have to pitch in another $26
billion and take on $10 billion of Burlington debt to seal the deal.
"Just as Chris Mayer has been predicting, 'There are simply too many
companies sitting around with too much cash. So takeovers are bound to
increase.'
"But that doesn't mean companies will buy any old piece of garbage, just
to spend their cash...especially not Berkshire Hathaway. In fact,
Berkshire just cut its stake in Moody's for the third time in three
months, a regulatory filing revealed yesterday. While Buffett has never
had the stones to admit Moody's and other major credit-rating agencies
produce less-then-honest research, he's letting his money do the
talking... Berkshire has cut its holdings of Moody's by over 20% this
year.
"If Buffett's purchase of Burlington is 'an all-in wager on the economic
future of the US,' what is his sale of Moody's?"
--- Chris Mayer's Capital & Crisis Research ---
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|
The Daily Reckoning
Presents: |
Today's headline kind of says it all...so,
let's dive right into the reasons behind it, direct from the pen of one
of our favorite stock pickers. Please enjoy...
Tesco is a "Buy"
By Chris Mayer
Gaithersburg, Maryland
Tesco Corp. (TESO:nasdaq) looks like a very cheap stock
to me. This oilfield services company is not merely cheap in relation to
its long- term growth prospects, but it is also VERY cheap in relation
to recent takeover prices in the sector.
Last summer, Cameron Intl. announced it would acquire Natco Group for
$780 million, or about 9 times trailing EBITDA. (EBITDA stands for
earnings before interest, taxes, depreciation and amortization. It's a
good rough measure of earnings power to use when comparing firms across
a sector.)
It's been a while since we've seen some headline-grabbing acquisitions
in this space. It's about time. Last summer, Precision Drilling bought
Grey Wolf, a clunky land driller with old rigs, for 5.1 times EBITDA.
And before that, we had a spate of deals north of 10 times EBITDA,
including Hydril's purchase of Tenaris.
In the same view, we can buy Tesco - a quality oil field services
company known for its cutting-edge technology - for under 3 times
EBITDA. If Natco went for 9 times EBITDA, this one ought to go for no
less. And that would mean a gain of 226% from here. Even without the
acquisition, though, there is lot to like. Let's talk technology for a
minute to understand just what Tesco does so well.
Tesco designs, makes, sells, rents and services top drives. A top drive
is a motor that sits on top of rig and spins the drill. I don't want to
get too geeked up in the technical aspects of this - if you're
interested, there is plenty of detailed information on the company's Web
site. The key thing to know is that top drives power the directional and
horizontal drilling rigs that access unconventional natural gas reserves
- all those shale plays. As more and more supply comes from shale plays,
unconventional wells will grow much faster than conventional ones.
Hence, a nice backdrop of demand for Tesco's top drives.
This is a big market with an installed base of over 3,000 top drives
around the world. As time goes by, more and more rigs will have top
drives, which provide some growth opportunities even if the total number
of rigs stays flat. In particular, there is more opportunity in the land
rigs than offshore.
Most of these existing top drives are from National Oilwell Varco. Tesco
is No. 2. And Canrig, a division of Nabors, is No. 3. Tesco also rents
top drives. In this business, it is top dog, with a rental fleet of
about 126 top drives.
As for casing services, Tesco has a proprietary service that allows a
driller to drill and case a well simultaneously. Casing a well means
putting steel pipe down the well bore so the thing doesn't collapse on
itself. The ability to drill and case at the same time cuts in half the
number of days needed to complete a well. It's a big timesaver, and many
expect the industry to adopt Tesco's technology, which would be a big
boon to Tesco.
This casing technology really makes Tesco stand out from the pack. There
is no other company with Tesco's technology. Tesco thinks that the
market for this technology is in the billions. Currently, it's only
about $50 million and growing. We've got a long runway here, though I
think someone will buyout Tesco before too long.
I want to emphasize that these products are highly engineered and
complex. Tesco owns a portfolio of over 80 patents and is developing
another 120 patents to protect its proprietary applications. This is why
I think of Tesco practically as a tech stock. And it's why Tesco
deserves a premium valuation and remains a great acquisition for
somebody. A much larger company, like a National Oilwell Varco, could
take this know-how and apply it more widely over a larger customer base
and push these products through its bigger distribution network.
About half of Tesco's business is from outside the US, which is holding
up better than the US market in this mess. This recession also plays
well to Tesco's strengths, because its tools cut the time needed to
drill and complete a well, and help its customers make more money.
Also, Tesco's customers are mostly large firms - BP, EnCana, Petrobras,
Occidental and the like. They are not the little guys who are going
belly up. Tesco's customers are likely to remain active even in a
relatively low-price environment.
As far as the financials go, there is not a lot to worry about here. The
company has a strong balance sheet. Cash was $20.4 million at the end of
the second quarter and debt was only $44 million. Tesco produces good
cash flow and has low capital spending requirements - and most of that
is discretionary. Management intends to finish the year with zero debt.
So we have a company able to build cash even in this tough environment.
There are 38 million shares outstanding, and the stock trades for $8.50
as I write. That's a market cap of $319 million. Add in the net debt of
$24.6 million and you can have the whole company for $345 million today
(enterprise value, or EV). This year, the company will generate EBITDA
of about $75-100 million. (Last year, EBITDA was $109 million). On a
trailing EBITDA basis, Tesco trades for about 3.2 times EBITDA.
Comparable companies would include Weatherford, Cameron, National
Oilwell Varco and Natco, among others. As I pointed out earlier, Cameron
bought Natco for 9 times trailing EBITDA. That kind of multiple gets you
a $25 stock price for Tesco.
But you don't need the acquisition to make money when you buy at 4 times
EBITDA or better. Cameron, for example, trades for 6 times EBITDA today.
Even just getting back to a more normal historical multiple would put
Tesco's stock closer to $15. It's just very cheap, especially when you
consider the bright future ahead of it. It wasn't that long ago when
people were talking about Tesco as a $40 stock.
This is not the retail sector, in which we have to figure out whether or
not Tesco's next hot bluejeans are going to sell or whether customers
will like the new store formats. We're talking about stuff you need to
produce the oil and gas that keeps civilization a going concern. We're
talking about highly engineered products that save customers a lot of
dough. We're talking about a company that benefits from one of the great
stories of our time: going ever deeper to reach untapped reservoirs of
hydrocarbons once thought inaccessible. It's a heroic effort and the
companies that can do it are going to make a lot of money - and so are
their shareholders.
An added bonus: The executives and directors own 18% of the stock. So
they have every incentive to maximize the value here. I'm betting they
will.
Regards,
Chris Mayer,
for The Daily Reckoning
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