High Arctic Energy Services Quick Update - $HWO.to
Quick update after Q2 2023
HWO released Q2 last week and it gave some more detail on the proposed transaction.
If you haven’t read it yet, check out my prior post.
Q2 2023 was also the first quarter in a long time when a rig was fully utilized so it gave some confirmation on what PNG could contribute.
They also closed the sale of their Canadian nitrogen business for 1.35mil CAD (net 1.24mil). This was a gain of 550k.
PNG in Q2 2023
PNG provided 16.6 mil CAD in revenue in the quarter. 10.9 mil came from the rig, 2.6mil from equipment rentals and 3.1 in ancillary services. I am more confident on using history as a guide for the rig utilization and less so on rentals. Having said that, they are both tied to activity so this may be moot. They do give a more detailed break down PNG drilling services alone. The combined did 13.4 mil rev and about 3 mil in EBITDA for a margin of 22%. The ancillary services ebitda margin of 70% as reported. These do not include corporate expenses. In my high end estimates for PNG I had 25 mil per quarter in revenue and 5 mil in ebitda. So this activity level is below what I estimated for valuing PNG.
Transaction
We got a few detail on the proposed deal to be circulated in September.
From the call:
The reorganization is expected to result in. The payout to shareholders of $38.2 million, equivalent to approximately $0.75 per fully diluted share by way of tax-efficient return of capital distribution. The sale of High Arctic International to existing shareholders who opt to participate through issuance by the corporation of a right for shareholders to purchase from the corporation 1 ordinary share of High Arctic Energy Services Cyprus Limited for each common share held in High Arctic. A shareholder election process where shareholders can elect to do nothing and receive their return of capital distribution as cash. Elect to exercise their purchase rights in full or in part. Elect to use some or all of the funds to be received pursuant to the return of capital toward the exercise of any purchase rights and receipt by the corporation of the proceeds of the sale of ordinary shares of High Arctic International.
Through this reorganization, the corporation aims to completely divest its ownership of High Arctic International, an unlisted company incorporated and domiciled in Cyprus, that owns the corporation's interest in its foreign subsidiaries. The corporation expects to announce the exercise price for the purchase of High Arctic International and complete the information memorandum to be circulated to shareholders in September. The potential special shareholder meeting is anticipated to be held in October and the process concluded prior to year-end. I believe our customers and employees in both PNG and Canada will appreciate and benefit from a locally managed business.
As well on the Q&A some more details were provided:
Rights are proportional to ownership prior to the transaction.
There is no plan on having an exchange for the rights to trade on post transaction.
Existing CEO likely to stay on and run PNG.
New management to be recruited to run remainco (Canadian assets).
They intent to fully divest the PNG business and the business may buy any shortfall of shares.
Not specific on the exact strategy of PNG business. Although it did sound like if activity levels return to prior levels in (2017/18) they would be returning some capital to shareholders via dividend.
Majority of cash on the balance sheet (net 7mil after the distribution) is in Canada.
PPE listed at 41.4mil on the balance sheet is mostly PNG (about $0.85 per share).
Proceeds from sale of PNG business will go into the Canadian listed company.
At today’s price of $1.41 you are getting (if the deal is approved):
$0.75 per share in a distribution from prior sale of Canadian assets.
The right to purchase share in the PNG business (to be names High Arctic Energy Services Cyprus Limited).
Remaining listed company with Canadian assets.
The Canadian business will include:
Non-capital losses of 126.7 mil CAD expiring between 2027 and 2042.
Capital losses of 39.6 mil CAD.
Equity in Team Snubbing of 7.5 mil and Seh’ Chene of 150k. Total about $0.16 per share.
Convertible Note from Team Snubbing transaction of 2.7 mil ($0.06 per share).
Some of the existing cash on the balance sheet that isn’t needed for working capital purposes in the PNG business.
Small amount of PPE and land in Canada. If you take the listed non-current assets in Canada and remove ALL listed liabilities on the balance sheet I get about 10 mil or $0.20 per share.
Proceeds from sale of PNG business.
Without any value for the tax losses I have about $0.42 per share at book value. Apply whatever discount you think.
Risks and Thoughts on Them
Management is taking the PNG business private at a low ball valuation due to timing in the cycle.
The concern is that PNG is starting to ramp and the board is going to give the business away. The business will need an independent valuation in the transaction, so that should minimize this to some degree.
The timing is something we can’t control. At least we get an idea of what one rig utilized can produce for a couple of quarters.
No liquidity in PNG business post transaction.
Post transaction liquidity will be an issue. There is no way around it. I am used to no liquidity, but this is worse than typical for me.
This is the largest point of contention with shareholders. They want some sort of exit event. I was hoping there would be some sort of listing, but that doesn’t sound like the case.
PNG business value is way too low.
If they value of the PNG business is too low, you can purchase shares in the business (although it’s lacking liquidity).
Given that the current CEO said he intends to align his interests in PNG, at least we potentially get a strong operator. We also have a stated book value of above $1.00 per share to use.
Tax implications post transaction.
There are going to be tax implications of course, so this not exactly pain free from a tax standpoint.
The NOLs will have no value.
This is a risk if the Canadian business can’t find something to utilize them. I am not giving much value to these in my estimate of fair value. The good news is that the activity levels in Canada for O&G are strong and are looking to remain strong in the next couple years.
Activity levels in Canada drop off due to recession, housing crash, asteroid or some combination of all.
This is something I can’t predict so I don’t spend time doing so. All things come to an end - even recessions.
Closing Thoughts
This quarter gave some more clarity, but did not change my thesis to a large degree. At this price you are paying less than $0.75 per share (after the distribution) for the Canadian business and the right to buy the International business.
I am putting some money to work in HWO. Feel free to join me or not. Maybe we can commiserated over a drink or two if we lose money.
Thanks for reading.
Dean
*long HWO.to
I find the way management is presenting/structuring this spinoff transaction to be pretty self serving and manipulative. They are going out of their way to make it complicated instead of just doing a straight 1 for 1 spinoff and keeping the international business public. By structuring it as a right they are clearly hoping most retail investors won't participate and they can then increase their ownership in the PNG business at a very low price by backstopping the rights offering.
Hi Dean, have you seen the news that one of Cyrus's directors resigned from the board? I'm curious what it means? Thanks