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Here it is:

CVEO

CVEO is an underfollowed spinoff, which recently fell 50+% on a refusal to convert to a REIT. Civeo provides workforce accommodations, mainly in the oil sands in Canada, coal mines in Australia(They have a tiny operation in the US as well). Civeo is a strong cash flow generator and benefits from multi year contracts. The key point however is the depressed valuation at which Civeo trades currently. Civeo currently trades at around 5.75x run-rate EBITDA, a low valuation already, but even more so when you consider the strength of the business. There are some cyclical factors which will also depress earnings for a while, and will slowly rerate back to normal, driving earnings growth.

Business Overview:

Civeo has operations in Canada, Australia, and the US. The company develops, owns and operates villages and mobile camps for oil, gas, coal and other mineral resource extraction sites. Civeo is less sensitive to commodity price fluctuations due to forming 1-3 year contracts to take away some of the volatility associated with commodity exposure. The model basically takes away the downside volatility associated with swings in commodity prices as the hotels are contracted out on 1-3 year basis, and new developments are backed by longer contracts to derisk the new building. On an unrelated note, the terms lodgings and work camps sound really spartan and hovel-y, but the facilities are really nice actually and have tons of furnishings. I personally would not mind living in one, going by the pictures.

Canada: Civeo operates approximately 13,000 rooms in Canada, driving 69% of their revenue and 63% of their EBITDA from the region. Canadian lodgings are mostly due to the oil sands, and will grow along with increasing investment in the area.

Australia: Civeo operates approximately 9000 rooms in Australia, driving 24% of their revenue and 33% of their EBITDA. Australia has a wider variety of projects compared to Canada, and has gold and LNG but mostly coal projects.

US: Not really much to say, the US makes up too small of a section of Civeo’s operations to be given too much thought.

Commodity factors:

Coal: Coal prices are at an all time low in the world, and many producers are currently unprofitable. Australian producers sit at the lower end of the cost curve, however, and many analysts have called the bottom of metallurgical coal prices, and project a 30-50% increase over the coming years. So there is definitely a macro tailwind in place to set floor in how badly the operating conditions can deteriorate. Most of the decreased earnings are from some losses in Australia, and should normalize if prices rise again.
Oil: This shows that the expansion pipeline is quite large, and this shows that the employment pipeline is quite large as well, providing favorable growth outlooks for Civeo’s Canada operations. Oil sands are also extremely long term projects, and should be operational for generations, as opposed to short term tight oil projects. There are also many pipelines that are under construction to bring the heavy crude that comes from the oil sands to refineries, which should tighten the spread between Western Canada Select, and WTI. Also, contrary to many street expectations, oil sands actually have a lower breakeven than many US plays like the Niobrara, Permian, and Eagle Ford, which should lower even further when transportation bottlenecks are resolved and the spread tightens(Mexican heavy oil trades at only a tiny slight discount to WTI due to better transportation). Oil is a commodity though, and it will always be impossible to truly forecast the price with any measurable degree of certainty.

Future potential:

Civeo has land banked a lot of land, and has the potential to add over 15000 rooms. This allows Civeo to gain an early mover advantage and Due to not converting to a REIT, Civeo has greater operational flexibility and can fully realize the potential associated with a market like the one it operates in.

Civeo also has the potential to expand its leverage by a little. It currently sports a 1.5x Net Debt/EBITDA ratio, and even adjusting for the fact that it is a cyclical commodity influenced company, it can expand this to 3-4x EBITDA. Other alternative REIT-like comparables like prisons certainly have a lot of political risk, but sport a much higher leverage ratio.

Also due to the fact that CVEO has very high fixed costs, any increase in occupancy would basically flow straight to the bottom line. In 2012, EBITDA was at 500M due to higher occupancy rates from higher mineral prices.

Civeo also has the potential to pay out a much higher dividend, as it currently only pays out approximately $55M a year. This could be easily doubled or even tripled, although management has not given clear confirmation of this(they have made statements about better capital allocation though). This may also cut into Civeo’s growth plans, however, there is a good argument to be made to raise the dividend to put it more in line with REIT comps.

Key point:
The main factor in this situation is Barry Rosenstein’s Jana Partners. Jana holds approximately 12% of CVEO right now, and was obviously hurt extremely badly by the recent 50%(!) drop. Greenlight Capital also entered into a position(10%) of similar size, and they will also likely be unhappy. So ultimately, there are 22% of very smart, very motivated, angry investors who want to get their money back, and have the capability and credibility to do it. Civeo is working with both of them to create value and we all know Jana and Greenlight are pretty smart.

Valuation:

2Q14 EBITDA was approximately $70M, and management has guided similarly for 3Q14. Due to the cyclical factors covered above, this should not stay permanently, and I would like to say once again that in 2Q13 when commodity prices were better, EBITDA was $130M. This opportunity should eventually drift back up to 13-16x, as given by public alternative REIT comps CXW, CBOS, and GEO, and hotels(not the best comparables but only non-reit ones) CHH and STAY. Possibly, maybe lower due to the still present levels of commodity exposure and probably higher maintainence capex due to the lodges being in harsh weather, however, CXW and GEO have a lot of political risk as well, and they trade well.

I also expand on some comments in a discussion on reddit:

http://www.reddit.com/r/SecurityAnalysis/comments/2iwrc7/einhorn_takes_999_stake_in_civeo_wants_ceo_gone/cl6dvrq

So anything wrong? Holes in the argument? Things I forgot to take into account? etc? I admit I'm just learning.

Comments (13)

 
Nov 27, 2014 - 1:05pm

Decent summary of the core issues but you could go a lot deeper. Not familiar with the name, but here are some things I would think about before investing:

First off, how badass was Einhorn's trading on this? Then...why was CVEO spun off? Will the cost structure of the spinoff be the same as it was under the parent? Are spinoffs still even under-followed nowadays? What are management's incentives? Why did they elect not to convert to a REIT? Is a REIT multiple still appropriate? Other than "wanting their money back", what do activists want the company to do differently? Are you sure Jana will create value? What is the right "normalized" level of EBITDA/earnings power for this business? Is this a good time in the cycle to own the business? What would be the effect of a prolonged downturn in commodity prices on occupancy rates? Could the company still be overleveraged given high fixed costs if occupancy rates fall further? (This business is much more cyclical than prisons). What is the land bank worth? What would the business look like in liquidation - do you have downside protection from asset value?

 
Nov 28, 2014 - 12:56am

By the way, managed to screw up and not include the links in the post, that's why some of it sounds weird because links were supposed to be there. I link to most of them in my comments on reddit though.

You're right, probably should have covered these in the main article, and I'll respond to them mostly question by question.

Einhorn was already a owner I think before the drop, and I think he was in the same position as Jana, who came in as activists during the spin off from Oil States.

Civeo was spun off because it was a completely different business from Oil States. Oil States made equipment for the oil drilling and other stuff like that, which is quite obviously different from a lodgings business.

The cost structure will be essentially the same as there were no synergies under the parent.

Civeo only has 3 analysts covering it, and none from a large BB(Howard Weil, Sterne Agee, Susquehanna Financial Group)

The Civeo website has a pretty good presentation on why they didn't convert, and I'm sure they know more about it than me, (http://ir.civeo.com/events.cfm) but basically, REITs only reduce taxes on repatriation on money to the US, and doesn't affect Austrailian and Canadian earnings at all, there's limited operational flexibility, and upfront taxes have to be paid.

A REIT multiple may not be appropriate as yes, commodities are really cyclical. However, a lot of hotels go for a little lower on the multiple scale(HOT, 12-13x, H, 12.5x, CHH and MAR actually go for way higher, 17x and 22x). Even if we apply a 10x multiple on this, it's a fair bargain, and really around what people were willing to pay before the REIT conversion announcement.

The activists have already appointed new board members and have made a value creation committee(not sure how effective that will be but meh). They've also pushed for a better dividend policy and capital allocation, etc. Normal activist stuff I guess. I have no real clue to be honest, but I don't think they'll hinder value creation. If they're successful, Civeo might be start to be valued on dividend yield, and that could lead to value creation.

The last large commodity bust was in around 2008 and they managed to grow revenues and operating income then based on year level data. The data's spotty though looking through their S-1, and all I have is the yearly revenues, operating income and net income. This also might not be representative because they were about half the size back then, and they were still picking lower hanging fruit, but I think they'll do ok.

On whether it's a good time to own right now, I'd say it depends on how oil looks to you. If you think oil will drop more, then don't buy obviously, but if you think it'll rise again, then by all means do. Civeo is really like a call option on oil(and coal) to be honest, with a strike price around 60-70ish WTI, and met coal around 80ish. Below that, it's worth almost nothing, because the oil and the coal won't be economical and nobody will be mining or drilling. However, as we've seen, a huge amount of value can be made if oil and coal are above the strike price.

If commodity prices were to fall for a prolonged period of time, I'd imagine that there would be some margin compression. However, by 4th quarter, oil prices had already been falling for some time, and they're still guiding for 30% EBITDA margin on 210M in revenue, on top of holiday slowness. I got to my 5.75x multiple based on the guidance, as I think it provides the best view of the business now, TTM, it's around 4.5. I still think Civeo will manage to hang in there as long as oil stays above $70ish(no real basis, just a gut feeling though). Met coal prices are at their lowest in a long time, and the people Civeo are contracting with are the lowest cost producers, so they'll do fine.

As for leverage, I guess they could be, however, their margins and moat are a lot better than say prisons, so there's room to give if need be. Corporate level EBITDA margins are guided to be 30+%.

No idea what it's worth in liquidation, nor the land bank. Can't find transactions, although I might not be looking hard enough.

 
Nov 28, 2014 - 7:43am

Just another comment, there's also been a lot of FX headwinds, as both AUD and CAD have declined against USD a lot, so that's another contributor to earnings weakness. In 2012, EBITDA was $500M, and CAD/USD was 1:1, and AUD/USD was 1:1.05. Now they're 1:0.88, and 1:0.85 respectively, so not a small impact at all. Depending on how macro looks there(I know I'm not smart enough think too deeply about about this), it could potentially turn into a tailwind.

 
Nov 29, 2014 - 10:44pm

don't follow commodities at all so i can't really judge. however, the comment about jana being 'smart' made me lol.

 
Dec 31, 2014 - 10:30am

rip

Disclaimer for the Kids: Any forward-looking statements are solely for informational purposes and cannot be taken as investment advice. Consult your moms before deciding where to invest.
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