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Equity research: Tuscany International Drilling, Inc.

Part 2
Equity research: Tuscany International Drilling, Inc. (Part 2 of 4)

Why investors are reanalyzing Tuscany International Drilling

Tuscany International Drilling, Inc.: Catalyst overview

Investors are recommended to reanalyze the Tuscany situation for a number of reasons. First, Tuscany seems to have a liquidity problem, not an operational or solvency problem, and should be able to work thorough the current crunch. Given that the company operates in a healthy industry and in markets that many firms see as growth opportunities, although currently overleveraged, operations should be able to support the capital structure and provide enough to pay down debt if the company can return to a more normal utilization rate. With a relatively young fleet in emerging operational markets, the severity of setbacks looks closer to one-time events than recurring, normalized problems.

Tuscany International Drilling (TID.TO) Revenue and UtilizationEnlarge Graph

Second, operations are beginning to return to a more normal level. Utilization rates are expected to improve over the next two quarters, operational areas are showing additional signs of interest in exploration activity, and contract durations are lengthening.

Third, management is now focused on strategic initiatives to enhance shareholder value. The founder and previous CEO has returned to the helm and Tuscany has hired two firms to act as strategic advisors, with mentions of debt restructurings, asset sales, and partnerships. Management is also working towards the completion of a lawsuit that should provide around $20 thousand after tax that can be applied to debt, which is expected in 4Q2013 or 1Q2014.

Catalyst overview

Utilization

Management has confirmed that 2012 is expected to be a worst-case scenario and by 3Q/4Q2013, investors should see dramatic improvement in key areas. The table above shows where utilization will be attributed and what percent of revenue each area contributes. You can see that Brazil remains the problem child, but improvements are expected from the current rates of 44% to 74%, and there are other signs that suggest further improvements throughout 2014, such as land sales and letters of interest.

Contracts

According to management, some areas are starting to see contracts lengthen, with two-year durations coming on versus previous timeframes of six month to one year. Longer durations are common in emerging markets, in contrast to North America, due to lack of infrastructure, and this will help provide a consistent stream of cash flows.

Cost-cutting initiatives and restructuring debt

This is now a focal point at Tuscany. Annual CAPEX is expected to be for maintenance only, so no additional asset purchases are coming online, and management has identified cost-cutting opportunities to lower overhead and lean operations. The company has engaged two firms to act as financial advisors in an effort to enhance shareholder value. Financial strategies have been divided into a debt and equity side, with the debt area focused on restructuring debt to add flexibility and the equity side focused on asset sales and similar opportunities such as joint venture or an outright sale.

Insiders

Founder Walter Dawson is taking over as CEO. Dawson operated as CEO of Tuscany before separating the roles of CEO and Chairman. Prior to Tuscany, Dawson created a very similar firm called Saxon Energy Services, an interesting study discussed further below. Director Jeff Scott recently resigned to avoid conflicts of interest, which may suggest a sale or similar event. Aside from Dawson’s recent purchases, most insiders, including Maurel & Prom, are significantly underwater on share purchases and options. With insiders owning over 40%, there is significant incentive to work in shareholder best interests.

Partner support

M&P recently exercised its warrants and continue to avoid writing down their investment in Tuscany. The warrants had roughly one year remaining and the average price is around $0.83. Based on M&P’s industry calculations, their holdings are not impaired, further strengthening the argument of a healthy industry.

HRT lawsuit

A significant contract between HRT and Tuscany was canceled and Tuscany is vigorously pursuing damages. HRT comments very little on the subject and the tone of HRT’s financials suggests the suit will be in Tuscany’s favor. Credit Suisse has commented on the Tuscany claims and subtracted it from its analysis of HRT’s financials, suggesting they expect a payment to Tuscany. Payments are expected to be $20 thousand.

The Market Realist Take

Revenues decreased in the first quarter of 2013 compared to the fourth quarter of 2012, as the company had no further demobilization revenue to record in Brazil relating to the two rigs whose contracts were terminated early by HRT, and in Colombia from several non-traditional contracts that resulted in lower day rates compared to rigs of similar capacity (albeit with minimal operating costs). Revenues in the second quarter of 2013 increased compared to the first quarter of 2013 due to significant mobilization fees on two rigs in Africa and increased rig utilization (from 65.9% in the first quarter to 69.6% in the second quarter).

As noted in Management’s Discussion and Analysis for the year ended December 31, 2012, Tuscany has two large receivables with two separate customers in South America. In Ecuador, Tuscany has been providing drilling and completion services to a joint venture operated by CYA. CYA has been providing integrated drilling services to PetroEcuador, the Ecuadorean national oil company, through this joint venture. Under the terms of the agreement with the joint venture, Tuscany isn’t entitled to receive payment until all drilling and workover services have been completed. As of April 21, 2013, all drilling and workover services contracted from Tuscany have been provided, and management is expecting payment of the outstanding accounts receivable in due course. Management understands that the drilling program operated by CYA on behalf of PetroEcuador has been successful and PetroEcuador is fully committed to making all payments to the joint venture. However, to date, only minimal payments have been received, and Tuscany is owed $16,525 from CYA as of June 30, 2013.

In Brazil, in June and July 2012, Tuscany’s customer HRT terminated early drilling contracts on two rigs. The contracts provided early termination penalties in favor of Tuscany, which haven’t been accrued into the consolidated financial statements, and are currently subject to arbitration. HRT is delaying all payments regarding demobilization fees due to Tuscany until the arbitration resolves. Included in accounts receivable at June 30, 2013, is $10,423 related to demobilization fees recorded by Tuscany during the second half of 2012.

In Gabon, Tuscany has five rigs operating. Gabon has $10,788 of VAT recoverable. Currently, VAT returns are being filed with the Gabon government. But the Gabon government isn’t refunding the VAT amounts that are due to the company. In 2010, a new government came into power in Gabon. Since that time, the new government has stopped refunding VAT—including VAT owing to Tuscany—while the VAT laws and administration haven’t changed. All the oilfield services companies in Gabon have been affected similarly. Oilfield service companies have organized a committee, including Tuscany, to lobby the government to begin refunding VAT again on a timely basis. Tuscany is expecting payment in due course.

The delay in collecting the amounts due from CYA and HRT and the delay in the refund of VAT from the Gabonese government have limited the amount of cash available to the company. This has resulted in Tuscany stretching its accounts payable. Plus, this strain on cash has limited the company’s ability to spend money on capital assets that would reduce the rental expenses it currently incurs, which reduces its adjusted EBITDA. The company said it’s actively pursuing refinancing alternatives, which, if successful, will allow the company to significantly improve its liquidity and allow it to enhance its gross margins.

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