Polarcus Revisited

Has a special situation presented itself?

I went into some detail on Polarcus three weeks ago (https://hammerinvesting.wordpress.com/2014/11/18/polarcus-a-short-analysis/) when the price was NOK 0,99. Now, following the OPEC meeting on November 26th, it is at NOK 0,64. A loss of 35%, while competitors Dolphin (0%), PGS (-5%), TGS (+8%), EMGS (+20%) and CGG (+1%) have pretty much stayed put. Has Polarcus become that much more risky in comparison with their competitors in that short time period or can the reason be found elsewhere? I believe the latter to be the case.

Forced selling?
This post is not about the longterm value of Polarcus. Instead it is born out of what seems to me a special situation that has developed. The newest major shareholder list, http://imgur.com/xrF3q9p, reveals an interesting fact: Since Nov. 14th there has been heavy selling, possibly forced selling, by two Finnish Pension funds, Elo Pension and Varma Pension. None of the other major shareholders have reduced their holdings in the same period. Pareto Securites has sold 19 million shares since November 14th and so it seems to me the only possibility is that they are selling on behalf of Varma Mutual Pension fund and that they now have fewer than 7 million shares left.

For an investor this is significant for two reasons. One, they are soon out of shares, most likely within a few days (Pareto sold 2,8 million shares on Friday) – and there have been no other heavy sellers at these price levels, which makes a near term upwards rise in the share price quite likely in my opinion. Two, if a fund sells large amounts of shares without regards to valuation and estimates of risk/reward, great opportunities can arise.

Why would a fund sell at large discounts?
Possible reasons:
Risk profile. Being pension funds their risk profile may be such that they are forced to avoid companies where risk is seen to have increased without regards to price and an overall judgment of risk/reward.
Market cap considerations. Some funds are known to have internal rules that require them to sell stocks in companies when the market cap of the company falls below a certain threshold.
Tax/window dressing. At the end of the year some funds are known to sell their loser stocks for tax or for window dressing reasons. Some managers don’t want to be seen investing in stocks that underperform significantly for job security reasons or fear of customers withdrawing funds, so they erase the loser stocks from their listed investments before the end of the year.

There is of course the possibility that the two Finnish pension funds have found a hole in the case that other investors, such as JP Morgan, Goldman Sachs, BlackRock and Erik Henriksen, have not. Personally, I view that as highly unlikely. Pension funds are typically not considered to be the sharpest knives in the industry.

While it is not at all certain that Polarcus will make it through the current turmoil in the oil business without new infusion of capital when the USD 104 million bond expires in April 2016, I question if this as catastrophic as the current market price indicates.

Market cap NOK 428 million, equity NOK 4 billion!
Suppose the expired bond cannot be refinancied with a new bond at an attractive interest rate and the company needs to issue new equity that will see a 50% dilution, the Price-to-Book will still be in the neighborhood of the 0,20-0,25 range (currently 0,11) – in other words, still very cheap. Consider also that the largest shareholder, One Equity Partner, owned by JP Morgan, is financially strong and has put up NOK 78 million only two months ago along with NOK 26 million by other insiders.

The current price also makes a takeover bid for the company by a capital strong competitor or a private equity fond a very real possibility, especially considering the recent bid on CGG by Technip and the merger between Halliburton and Baker Hughes. Curiously, CGG is traded at P/B 0,54, while Polarcus is traded at P/B 0,11, even though Polarcus’ EBIT-margins are much healthier. CGG’s equity ratio is slightly better than Polarcus’ at 45% vs. 42%.

I believe the market has made a serious probability misjudgment based on irrational fear in relation to upside potential. However, it is never wise in these above normal risk/high reward situations to put too much of one’s capital at risk. Staying in the game should always have the highest priority.

As for the oil price, with a sharp downward move like we have seen in the past few months, I am betting on mean reversion in the not too distant future rather than a prolonged downturn – even though it may decline further in the near term. China and India are still growing rapidly and the low oil price ought to raise demand.

10 thoughts on “Polarcus Revisited

  1. It is not at all certain that the investment in Polarcus by One Equity Partners was made on and behalf of JP Morgan Chase. I refer you to the statement issued by JP Morgan on June 14, 2013 concerning future investments made by OEP.

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      1. In Addition:

        Updated Aug. 11, 2014 5:16 p.m. ET

        J.P. Morgan Chase JPM reached a long-awaited deal to sell roughly half its stake in the portfolio of its buyout arm, One Equity Partners.

        The largest U.S. bank by assets agreed to sell part of its stake to investment firms Lexington Partners LP and Carlyle Group LP’s AlpInvest Partners, the firms said Monday.

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  2. I think you cannot the take the book vakue directly :
    1/ you have 33M in assets which are the consequences of the WesternGeco. Liquidation value=0
    2/ you have to discount by 50% the MC libray > another 50M off
    3/ now the big question : what is the value of the vessels? one was sold to Turkey for 120M in beginning 2013. But WesternGeco/SLB just writeoff the value of its own fleet from 1.9 B to 1.1B (last week). This 800M write off is mainly on vessels from the EasternEcho aquisition. So vessels not so different of the Polarcus ones.
    Charles (Luxembourg)

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    1. Hi monot, thanks for your comment.
      1) Can you eloborate on that. I don’t know what you are refering to.
      2) Yes, the library is probably not worth 100% of book value, but as Polarcus library is quite new compared to many competitors (they have previously been almost exclusively focused on contract work and ony recently started building the MC-library – on 31/12-2011 it was at USD 10 million and now it is at USD 115 million).
      3) Yes, in the current market they will be difficult to sell at book value, but this is part of my reason for investing: The recent violent downturn in oil price ought, in my opinion, not to be considered the norm. If we return to a more normal situation in H2 of 2015, they could easily be worth around book value, especially now when so many competitor vessels are retiring.
      I don’t think you can compare the WesternGeco vessels leaving the market as they are older low end 8-10 streamer boats, while Polarcus fleet is a high-end fleet that consists of 6 14 streamer boats (one them only at 12 now, but it is upgrading at the start of 2015) and 1 8 streamer boat (which is on a non-cancellable lease until August 2016). So I don’t really see a big write-down in the horizon as there ought to be enough work for this kind of fleet – which seems to be reflected in the large backlog, unless there are cancellations in the horizon.
      There are 3 new competitor 16 streamer boats coming into the market in 2015 and 1 in 2016 and apart from that no new builds (see Polarcus September 2014 presentation, page 17: http://www.polarcus.com/en-us/presentations/presentations.php), so to me it seems like Polarcus is one of the better positioned companies in the seismic market, apart from their balance sheet being more strained than some of their competitors.

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  3. I presume monot is referring to the following.

    On 03 October 2013, the Company entered into a settlement with WesternGeco concerning the lawsuit filed by WesternGeco against Polarcus Limited and Polarcus US Inc for alleged patent infringement through a paid worldwide license for WesternGeco patents relating to steering marine seismic streamers and arrays. The license fee has been agreed at USD 40 million, payable over 2013-2015 in equal amounts. The settlement involves no admission of liability or the correctness of WesternGeco’s allegations in the case. The license will be recognized in the Group’s consolidated statement of financial position in Q4 2013 and accounted for as an intangible asset and amortized over the lifetime of the patents.

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  4. Hi,
    yes Patrick is right on the WG case. I dont think it can be considered an asset. Also on PLCS, the risk now is liquidation value : they just bought back a convertible, secured on a vessel, for 75% of par value. I have not been yet through this deal but basically the seller had a different vue on the vessel value. I do agree that if they manage to survive this crisis, multiple will be high. And one good point on this is the alignement of interest with the founding family : they put 100M $ at a price of 1$, and I think in the last capital increase they added 13/15M. Another good point is, as you said, Technip bid on CGG : you have some industrial players who want to take profit of these levels of prices. On negative side : a lot of debt !

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    1. Thanks for pointing this out. I was not aware this post in the balance sheet was the result of the lawsuit. The value of it is unclear to me and you may very well be right that it may not be worth the stated value.

      With regards to the bond purchase, yes the seller seems to either see considerable risk in the value (most probable) or they may simply be in need of liquidity due perhaps due to being too exposed to the sector.

      Do you know the approximate board share ownership? In case of pressure from lenders could there be a situation where management would be able to take a course unfavorable to the major shareholders and in favor of the lenders?

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      1. No idea but it s a Dubai company and subsidiaries owning vessels are in Norway : liquidation would not be easy. I know also that the family has some related business in Norway because in 2008 they took back some vessels from PLCS to release pressure on the balance sheet.

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  5. Thanks for your thoughts on Polarcus. Tomorrow comes the Q4 results, just took a small position this morning at the price of 0,61 kr.
    It seems there is quite much resistance on the ~0,60kr level.

    Have a nice day, we will make money on this stock πŸ˜‰

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