It is common knowledge that the best time to consider exposure to a stock or industry is when sentiments are over bearish. The energy sector currently serves as the best example of this point, with several stocks delivering stellar returns from depressed levels. Patterson-UTI Energy (PTEN, Financial), which operates in the onshore rig segment, has surged by 131% in the last year and is a quality stock for value investors.
The company announced on Dec. 12, 2016, it is acquiring Seventy Seven Energy (SVNT, Financial). Patterson-UTI will acquire the company in an all-stock transaction that values Seventy Seven at approximately $1.76 billion. The deal is expected to close late in the first quarter of 2017.
There are several benefits for the merger. For Patterson-UTI, the major revenue contribution comes from contract drilling (61%) and pressure pumping (37%). For Seventy Seven, the major revenue contributors are drilling (54%) and hydraulic fracturing (38%). Seventy Seven also derives 8% revenue from oilfield rentals. Therefore, the combined entity will have a more diversified revenue stream.
Both Patterson-UTI and Seventy Seven have high-quality rigs, with Patterson already being a leader in walking rig technology for pad drilling applications. On the other hand, Seventy Seven has 28 high-specification rigs with 93% of them being pad capable. Therefore, the merger does not dilute the fleet quality for Patterson-UTI. The combined entity will be diversified from a revenue and rig type perspective along with maintaining the best standard rigs.
As a result of the merger, Patterson-UTI expects to achieve synergies in excess of $50 million that are primarily related to organizational, supply chain and corporate efficiencies.
The merger is also well timed with the onshore drilling industry witnessing early signs of recovery. The merged entity will see increasing fleet utilization that will be positive from an EBITDA margin perspective if this recovery sustains. A likely increase in spot market rates will also be positive for the merged entity. It is important to note that the combined company will have a strong presence in the most active basins in the United States.
Industry recovery is already having a positive impact on Patterson-UTI. The company has 71 drilling rigs operating in the U.S. and two rigs in Canada for December 2016. This is higher compared to the fourth-quarter 2014 average operating rig total of 66 in the U.S. and two rigs in Canada. The operating rig count is likely to increase in the coming months, positively impacting results and the stock trend.
From a balance sheet perspective, Patterson-UTI is well positioned with debt of $615 million as of Sept. 30, 2016. The company also had $37 million in cash, $500 million available under the line of credit and $150 million available under the unsecured bridge financing commitments. The liquidity buffer is more than sufficient in the near term for $336 million of Seventy Seven Energy's debt net of cash.
In the first nine months of 2016, the company’s adjusted EBITDA slumped to $168 million as compared to $484 million for the prior year comparable period. However, EBITDA interest coverage remains comfortable and EBITDA is likely to improve in fiscal 2017. Therefore, any additional debt resulting from the acquisition of Seventy Seven is not a concern.
In conclusion, Patterson-UTI Energy has navigated the crisis with strong fundamentals. With the merger, the company is well positioned to benefit from improving industry conditions. Even after the big surge in the last 12 months, I am bullish on Patterson-UTI Energy.
Disclosure: No positions in the stocks discussed.
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