Why debt is a serious problem for Tuscany International Drilling
Tuscany International Drilling, Inc.: Financial snapshot
Tuscany has a short operating history, but based on the previous few quarters and discussions with management, we have a sense of what the company can do in terms of EBITDA (earnings before interest, tax, depreciation, and amortization), cash flows, and debt reductions. Between 1Q2011 and 1Q2013, average revenue per day was roughly $31,000. Management has stated that 2012 had the worst utilization metrics to date and expects a return to the +85% range by end of 4Q 2013. Operating at 100% utilization would produce around $22 thousand EBITDA per Q, given the 37 rigs available. Assuming 80% utilization, we are looking at $17.7 thousand EBITDA. Given quarterly maintenance CAPEX and depreciation assumptions of $6 thousand, working capital needs of $1.5 thousand, and a tax rate of 20%, we break down cash flows and equity values below. Note, assumptions are somewhat generalized in nature but have been confirmed by management.
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2013 YE debt reduction assumptions are based on 80% utilization, and include an after-tax amount of $20 thousand from the HRT lawsuit and $8 thousand in free cash flows generated between Q3 and Q4 that will be applied to debt. Applying a 5X EBITDA multiple provides a number of equity values, the lowest of which is roughly 100% higher than current price of $0.17. Additional implemented strategies such as asset sales, debt restructuring, or joint ventures could enhance value further.
It’s important to note that Tuscany does not operate in a dying industry. The company realistically should be able to achieve these numbers with time.
The market for contract drilling services is quite fragmented, with very large and very small players. North America is dominated by larger firms, and contracts are often short-term in nature. Emerging markets are a little different. The size and scope of competitors can vary and contracts are often longer-term than those found in North America due to lack of infrastructure.
Longer-term contracts in untapped markets with an ability to scale quickly provide an attractive opportunity for those who understand emerging markets, and this is exactly what Walter Dawson saw when he decided to create Tuscany. It’s worth noting that Dawson’s vision does not come without risk, and in the past North American firms who have attempted to grab market share in emerging locations have closed operations unsuccessfully. For those firms who do understand the nuances of foreign operations, the rewards can be satisfying; consolidation has been a recent theme, as larger players such as Ensign Energy have publicly stated intentions to grow in these areas via acquisitions, further strengthening the argument of a healthy industry and demand for foreign market share.
The contract drilling services industry will be around for quite a while and exploration companies are increasingly moving into foreign markets so demand for services should be healthy going forward.
Current public competitors include the following:
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A few metrics for comparison:
It’s apparent where Tuscany has problems: debt. This is the main catalyst for Tuscany’s troubles and it cannot be overlooked. As mentioned above, the company has fallen into a liquidity trap; management has publicly stated intentions to make the issue a primary focus and this is an important point to our investment thesis. The distinction between illiquid and insolvent is important to determine, as Tuscany’s fate rests on its operational abilities. We personally believe that the firm needs time to work through its debt burden, can do so under normal circumstances, and with support from strategic initiatives to lift some of the weight the company will be able to operate just fine.
The Market Realist Take
Tuscany said it’s experiencing delays in the collection of accounts receivable balances from two customers in South America, aggregating to $29,358, as well as a VAT receivable from the Gabonese government for $10,788. The company is involved in various legal claims and actions arising in the course of its operations. Management believes it will be successful in its claims and defense of counter-claims, so no provision against these claims and counter-claims has been recorded.
The company has a total credit facility debt of $253,000 as of June 30, 2013, which has restrictive financial covenants and a substantial repayment schedule that begins on December 15, 2013. If the accounts receivable balances aren’t collected on a timely basis (or if the current credit facility isn’t refinanced prior to principal repayments in December 2013), based on the historical cash flow from operations generated by the company, it will likely not be able to comply with the debt repayment schedule in 2014.