How to Make a Stock Pitch

How to Make a Stock Pitch

By Cameron Fen

How to Find Stocks?

• Look at Stock Spinoffs– http://www.stockspin

offs.com/– http://spinoffmonitor.

com/• Follow Famous

Investors– Go to SEC website and

look for 13HR filings of your favorite hedge fund

http://www.stockspinoffs.com/

http://www.stockspinoffs.com/

http://spinoffmonitor.com/

http://spinoffmonitor.com/

How Else to Find Stocks

• Read Blogs– Seeking Alpha– Reminiscences of a Stock Blogger– Alpha Vulture– Whooper Investments– Oddball Stocks– Wexboy (Great Britain Stocks)– Red Corner

Found a Stock! Now What!?!?

• Look at the Income Statement and Balance Sheet, Perhaps Peruse the Annual Report– Bad News: 90% of the

time, there is something wrong with the company

What could be Wrong with my Company?

• Over-Leveraged• Earnings too high (ie Cyclical Peak)• Lots of Preferred Stock• Untrustworthy Management• Not Cheap Enough

– Big reason not to invest

Coming Up with a Thesis

• Once you have identified that 1 in 10 stock that passes a quick analysis, now is the time to come up with a Thesis

• Thesis should write itself if you haven’t come up with one

Ex 1. Kenon

• Sum of the parts of this recent spinoff indicates upside of 100%– Kenon is made up of five segments– The money earning segment is overshadowed by

the other 4 money losing segments– On a P/E basis this one segment (electrical utility)

is trading at a 9 multiple and will increase capacity by 50% in the near term

Ex. 2 Third Federal Savings and Loans

• Mutual Holding Structure Hides Cheap Valuation; Company also buying back lots of shares– Trading at a P/Book of about .5– Buying back 15% of stock per year

Background of the Company

• Look over the Companies Risk Factors and Business Description in the 10-K

• Try to capture the essence of the background of the company that a.) either people want to know or b.) is important to the thesis

• In the case of Kenon, should talk about recent spinoff as well as the holding company structure

Example

Business Model

Paragon Offshore is a supplier and operator of low end “standard-spec” jack-ups and floating drilling platforms that

was spun off of Noble Energy on August 1, 2014

PGN Key MetricsMarket Cap $477MM

EV $2.67BN

12 mo Trailing PE 1.15x

EV/EBTIDA 2.86

EBITDA margin 44%

Select Customers Paragon’s Assets

34 Jack-ups5 Drill-ships3 Semisubmersibles

ChargesDayrate

Executive Summary

Valuation & Recommendat

ion

Market Overview

Industry Thesis

EBITDA Breakdown

Spinoff Details

Noble’s Reasons for Spinoff

• Separate newer high-spec assets from mature standard-spec assets• Raise $1.8B cash to pay off long term debt• Allow management of each company to focus on its own strategy

Spinoff Logistics

• The spinoff was completed on August 1st 2014• NE shareholders received 1 share of PGN for every 3 shares of NE

Average Fleet Age (years)

NE PGN0

10

20

30

40

13

34

Market Cap (millions) 2013 EBITDA (millions)

NE PGN0

500

1,000

1,500 1268

718

NE PGN0

1,0002,0003,0004,0005,0006,000

4900

485

Executive Summary


ion

Market Overview

Industry Thesis

Valued at adiscount to NAV

and NPV

Company Thesis

PGN is a victim of significant overselling

PGN’s rigs will remain competitive

Paragon has been oversold for reasons unrelated to the underlying business leading to a ~50% decline since being spun off

Paragon is currently trading below its net asset value, and the market does not fully appreciate the strength of their cash flows

Paragon’s low-spec rigs can maintain relevancy in current operating regions through their lean cost structure relative to their high-spec peers

Executive Summary


ion

Market Overview

Industry Thesis

Share Price Since Spinoff

50% decline

Executive Summary


ion

Market Overview

Industry Thesis

Institutional Ownership

Paragon has been oversold due to non-fundamental reasons

Noble Ownership

86%

16%

Paragon Ownership

Investment ManagersOther

Reasons for Selling

Tiny Market Cap

PGN’s 480m Mkt Cap makes it too small for many funds to hold

Indebtedness 2.4x D/EBITDA makes it appear too risky for many funds

Time CostNegative factors discourage investors from doing further research

Executive Summary


ion

Market Overview

Industry Thesis

Find information to Support Thesis

• Show graphs of revenue, earnings or expenses• Perhaps do a survey look at market conditions• Run a Monte Carlo simulation with different

possible events to get range of intrinsic values• I like to display backtested results of similar

companies• Market Analysis

Example

Future Supply

Deferred investment from 2008-2010 materializing in the next 4 years The market assumes newbuilds will hit the market immediately after they are

constructed

Executive Summary

Industry Thesis


ion

Market Overview

Jackup Supply and Demand

139 high-spec newbuild rigs coming on market between 2014-2017

We project utilization to fall to 87% during after the bulk of uncontracted supply hits the market in 2015 and stay around historical lows for the foreseeable future

International Jackup Supply/DemandBIG Projections

The jackup market will see significant decreases in utilization and dayrates

Executive Summary

Industry Thesis


ion

Market Overview

Varying Rig Cost Structures Standard Spec Rig(numbers in thousands/day)

Cash Operating Costs: $50Interest Expense: 8

Maintenance Capex: 12Allocated SG&A: 5

Break-even dayrate: $75

High Spec Rig(numbers in thousands/day)

Cash Operating Costs: $65Interest Expense: 10

Maintenance Capex: 15Allocated SG&A: 5

Break-even dayrate: $95

vs

High-spec rigs cannot compete with standard-spec rigs on price

Limited downside for standard-spec dayrates from newbuild rigs

All newbuild jackups will be high-spec

Executive Summary

Industry Thesis


ion

Market Overview

Floater Market Trends

•Market believes that PGN’s 4 floaters are next to be released by Petrobras•Petrobras faces severe supplier pressure with orderbook facing significant delays and litigation•Petrobras has huge DW reserves that it will be unable to access with current fleet and orderbook

• Large order book following financial crisis: 91 on order vs current fleet of 277• All major recent discoveries are in deepwater or UDW• Projected 8% demand CAGR• Forecast supply gap to reappear by 2018 0

100

200

300

400

500

600

Floater Market Demand

Floater Demand

Rig

Count

Brazilian and International floater demand will outstrip supply

Executive Summary

Industry Thesis


ion

Market Overview

Valuation

• Provide DCF and Comps in all situations– Use CapIQ for comps significantly reduces the

time required– Outline Assumptions

• Provide other valuations as needed– Company undergoing a transaction like a mutual

thrift conversion– Sum of the Parts Analysis if analyzing a

conglomerate

Example

NPV – AssumptionsAssumption Bear Base Bull

Jackups

• New supply immediately hits ME, GOM, WA and decreases dayrates ~37% by 2019

• N. Sea faces hardship, dayrates decrease 28%

• New supply hits ME, GOM, WA by 2018 and decreases dayrates ~31% by 2019

• N. Sea faces moderate hardship, dayrates decrease 23%

• New supply hits ME, GOM, WA by 2019 and decreases dayrates ~27% by 2019

• N. Sea faces moderate hardship, dayrates decrease 20%

Petrobras Floaters

• No contracts renewed• One semisub stacked• Dayrates decline 25%

• 2 contracts renewed • One semisub stacked• Dayrates decline 18%

• 3 contracts renewed• No floaters stacked• Day rates decline 10%

Other Floaters • Dayrates decline 19% • Dayrates decline 11% • Dayrates decline 8%

% FCF used for debt repayment 50% 55% 60%

Executive Summary

Valuation & Recommenda

tion

Market Overview

Industry Thesis

ME = Middle East; GOM = Gulf of Mexico; WA = West Africa

NPV – Returns

PGN Fair Value $8.80

(+57%)

15%

55%

30%

Day Rates Utilization Share Price

Jackups: 82

Floaters: 241

Jackups: 80

Floaters: 240

Jackups: 75

Floaters: 224

Jackups: 76%

Floaters: 67%

Jackups: 74%

Floaters: 56%

Jackups: 67%

Floaters: 56%

$11.46(+104%)

$8.70(+55%)

$3.82(-32%)

Stacked Rigs

3

4

4

Current Metrics

Share Price: $5.60Jackup Util: 91%Floater Util: 78%Jackup Dayrate: 113Floater Dayrate: 283Stacked Rigs: 3

Executive Summary


tion

Market Overview

Industry Thesis

Net Asset Value – Assumptions

Average Market Transaction Valuation: 4.7xBIG-assumed Valuation: 2.7x

Average Market Transaction Valuation: 5.3xBIG-assumed Valuation: 3.4x

Market Scrap Value

PGN’s Jackups

PGN’s Floaters

Cold Stacked

Executive Summary


tion

Market Overview

Industry Thesis

Rig Cohort/ Rig Name

EV/EBITDA

Mexico - 390' 3.0xMexico - 300' 2.5xMexico - 250' 2.2xMiddle East - 300' 2.5xMiddle East - 250' 2.2xMiddle East - 150' 2.0xNorth Sea - 350-390' 4.0xNorth Sea - 250' 3.3xWest Africa - 300' 2.5xWest Africa - 250' 2.2xMisc - 300' 2.5xMDS1 2.8xDPDS1 3.2xDPDS2 3.5xDPDS3 4.0xMSS1 3.3xMSS2 3.5xDPDS4 50,000 MSS3 30,000

Net Asset Value – Returns

Both rigs and floaters sold at a significant discount to current transaction comps of 4.7x EV/EBITDA to account for illiquidity

Two cold stacked rigs can be sold at market scrap value Assumed capital gains tax rate of 15% Liquidation value at a 30% discount to a third-party asset appraisal valuing PGN’s rigs

at $3.4 billion.

PGN’s downside is protected even in the worst possible scenario

Assumptions

Exit EBITDASales Multiple (EV/ EBITDA)

Liquidation Value

Drillships 217,947 3.5x 763,438 + SemiSubs 82,581 3.4x 281,880 + Jackups 566,920 2.9x 1,626,031 + Stacked - 0.0x 80,000 = Total 867,448 3.2x 2,751,487

Executive Summary


tion

Market Overview

Industry Thesis

Base Case ReturnsAfter-Tax EV 2,338,764 - Net Debt 1,730,000 = Implied Market Cap 608,764 Current Market Cap 476,310 ROI 27.8%

RecommendationCurrent Price

Purchase PGN below $5.70/share for an expected return of 100% in our upside case, 50% in our base case, and -30% in our downside case

Executive Summary


tion

Market Overview

Industry Thesis

Risks

• Pick two or three risks in your thesis and show why these risk are overblown or not potential problems

• Don’t put all the risks here if you have a short presentation, leave most in appendix if question gets asked

Example

● A 300 basis point increase in interest rates will reduce economic value of equity by 23%o This situation is mitigated by the fact

that the company trades at a huge discount to book value and is quickly becoming more asset sensitive

Worst Case Scenario: Rise in Interest Rates

∗Loans are gradually shifting away from Fixed Rate Mortgages to ARMs

Becoming more Asset Sensitive…

Appendix

• Should provide all the supporting details like the math that are too complex to go into the presentation

• Also should put in answers to potential questions

• Analysis of additional problems/risks • Analysis of transaction details if relevant• Definitions

Appendix (cont)

• Add details on commodity analysis when dealing with a relevant company

• Analyze management• Include sensitivity analysis• Look at competitors• Look at suppliers and customers• When in doubt, put it in

Example

Appendix Table of Contents

• Spinoff Mechanism 26• Breakeven Company Costs 27• Company Backlog 28• Floater Market 29• Petrobras 30-

32• Management 33-34• Seahawk 35• Debt Details 36-37• NAV Assumptions and Sensitivity 38-40• NPV Bear, Bull, and Base Case 41-45• Oil Price Analysis 46-50• Miscellaneous 51-53

Spinoff Mechanism

$1.7 billion Term loans

Company assets

$1.7 intercompany debt repayment

Back to Table of Contents

Breakeven Company Costs

Cash Operating Costs

Interest Expense

Maintenance Capital Expenditures

SG&A

Total

600mm

100mm

150mm

45mm

895mm

At 90% Utilization, 895mm in cash per annum requires a day rate of $82,500, down more than 20% from current levels. This

assumes zero income from floaters.


• Backlog is concentrated in floaters due to longer contract length (~5 years vs 1 year)

Company Backlog

Jackup Backlog Floater Backlog0

400

800

1200

1600

Contracted Backlog

Pre 2015

42%

14%

7%

5%

4%

28%

Backlog by Customer

PetrobrasPemexTotalADMA-OPCONexenOther


Floater Market

Floater demand is expected to outpace floater supply by 2018


Petrobras

Petrobras is Key to PGN’s Future

• 4 Floaters Contracted: MSS2 (2015), DPDS1 (2015), DPDS3 (2017), and DPDS2 (2017)

•Dayrates at 270,000-340,000 vs ~120,000 for jackups

•PGN bears assume inability to hold on to these contracts

•Majority of oversupply in UDW and presalt segment

•Problems with local supplier solvency have put newbuild order book at risk

•SBM corruption investigation threatens largest supplier

•Cost overruns and political climate will cause focus on more efficient standard specs

•Long term floater supply gap will ensure new customers

Petrobras Risk is Overstated

Jackup Backlog Floater Backlog0

400

800

1200

1600

Contracted Backlog

Pre 2015

Petrobras42%

Backlog by Customer


Floater Exposure – Petrobras

Petrobras is Key to Floater Market 4 of 6 Floaters Contracted: MSS2 (2015),

DPDS1 (2015), DPDS3 (2017), and DPDS2 (2017)

Dayrates at $270,000-340,000 vs ~ $110,000 for jackup

Bears Assume inability to hold Contracts

Petrobras has let go 10 standard-spec rigs in the last two years

Petrobras ordering 52 floaters, to come online in the next decade


Floater Exposure – Petrobras

Majority of oversupply in UDW and presalt segment Problems with local supplier solvency have put

newbuild order book at risk SBM corruption investigation threatens largest supplier Cost overruns and political climate will cause focus on

more efficient standard specs Long term floater supply gap will ensure new customers

Petrobras Risk is Overstated

Valuation Considerations

Assume MSS2 is cold stacked after end of contract in 2015

Assume 15% drop in dayrate and 20% drop in utilization for DPDS1 and 2017 rigs


Steven Manz

Current: CEO of ParagonPast:• Managing Partner of SEH Offshore Ventures (2011-2014)• President and CEO of Seahawk Drilling (2008-2011)• President and CEO of Hercules Offshore (2004-2008)

Current: CFO of ParagonPast:• CFO of Prospector Offshore Drilling (2010-2013)• CFO of Seahawk Drilling (2008-2010)• CFO of Hercules Offshore (2005-2007)

Randall Stilley

Management

Management Incentives

Management is incentivized to meet certain EBITDA targets (yet to be released) and safety standards.


Seahawk Story

• In August 2009, Seahawk was spun off of Pride International but declared bankruptcy in 2011. While both look similar, they are actually quite different:

Qualities of Seahawk:• Old fleet: average rig age was 28 years• Customer Concentration: 58% of

revenue from Pemex• Declining business: only had 1 rig on

contract at time of spinoff• BP Oil spill made it extremely difficult

to operate in the gulf

Qualities of Paragon:• Much more geographically

diversified• Much more diversified in

customers as well• Much larger backlog• Much more diversified fleet

types


Debt

800

650

580

500

Secured Term Loan, Matures 2021LIBOR + 2.75%1% annual repayment

6.75% Senior Unsecured Notes due 2022• Non-call for 4 years7.25% Senior Unsecured Notes due 2024• Non-call for 5 years

Revolving Credit Facilitiy, Matures 2019• Undrawn• LIBOR + 2.00%

2015 2016 2017 2018 2019 2020 2021 2022 2023 2024$0

$100

$200

$300

$400

$500

$600

$700

$800

$900

$7 $7 $7 $7

$800

$7

$609

$500 $580

Covenants for Revolver• Maximum Net Debt to EBITDA of 4:1• Minimum EBITDA to Interest Expense

of 3:1

Ratings• Revolver: BBB- (S&P), Baa3

(Moody’s)• Term Loan: BBB- (S&P), Baa3

(Moody’s)• Senior Notes: B+ (S&P), Ba3

(Moody’s)

Despite high debt load, PGN can meet all its obligations and is not at risk of defaulting.

Capital Structure Debt Maturity Profile

Debt servicing and coverage

Bear CaseDebt Balance 1,730,000 1,383,307 1,138,079 1,019,575 926,873 889,421 868,369 Debt / EBITDA 2.16 1.73 1.75 2.24 2.35 3.00 3.23 Interest Coverage 8.50 8.42 6.57 6.26 4.90 4.55 Interest (expensed+capitalized) 94,065 77,389 69,331 63,027 60,481 59,049

Bull Case

Debt Balance 1,730,000 1,383,307 1,124,485 992,130 888,554 824,815 752,548 Debt/ EBITDA 2.16 1.73 1.68 2.04 2.09 2.27 2.02

Base Case

Debt Balance 1,730,000 1,383,307 1,124,485 968,056 846,673 767,064 677,740 Debt/ EBITDA 2.16 1.73 1.68 1.86 1.82 1.91 1.65


Third-party Asset Valuation

Prior to the spinoff, an unaffiliated third-party appraised Paragon’s assets. That appraisal value was reflected as PP&E on the company’s

10-12B filing submitted on 5/23/2014

49

We believe that the appraisal value of PGN’s rigs is aggressive, but supports the conservativeness of our valuation methods

Source: Deutch Bank

10-12B valuationAfter -Tax LV 2,894,065 - Net Debt 1,730,000 = Implied Market Cap 1,164,065 Current Market Cap 476,310 ROI 144%


Comparable Transactions – Jackups

Jackup Transactions January 2012-May 2014 Qualitative

Rig Sold Day Rate Utilization Revenue EBITDA Margin EBITDA Sale Price EV/ EBITDAEnsco 85 130 80% 37,960 30% 11,388 64,000 5.6xGSF Monitor 136 81% 40,061 30% 12,018 85,000 7.1xVicksburg 116 95% 40,100 52% 21,000 55,400 2.6xBen Avon 105 94% 36,120 34% 12,281 55,000 4.5xOcean Heritage 120 90% 39,420 30% 11,826 45,000 3.8xOcean Columbia 90 80% 26,368 34% 8,965 40,000 4.5xAverage 116 87% 36,671 35% 12,913 57,400 4.7x

Description of Jackups Sold 2012-2014Rig Sold Date of Transaction Year Built Last Upgraded Water DepthEnsco 85 4/ 24/ 2014 1981 2012 300GSF Monitor 2/ 1/ 2014 1989 N/ A 350Vicksburg 10/ 1/ 2013 1976 1998 300Ben Avon 2/ 1/ 2013 1980 N/ A 250Ocean Heritage 4/ 1/ 2012 1981 1981 300Ocean Columbia 3/ 1/ 2012 1978 N/ A 250


NAV Assumptions & Returns

Jackup Sale Multiple

Flo

ate

r S

ale

Mu

ltip

le Realistic Realm of Possibilities for ROI

28% 2.5x 2.7x 2.9x 3.1x 3.3x3.3x -21.7% -1.5% 18.8% 39.0% 59.2%3.5x -8.3% 11.9% 32.2% 52.4% 72.6%3.8x 5.1% 25.3% 45.6% 65.8% 86.0%4.0x 18.5% 38.7% 59.0% 79.2% 99.5%4.3x 31.9% 52.2% 72.4% 92.6% 112.9%

Base Case ReturnsAfter-Tax EV 2,338,764 - Net Debt 1,730,000 = Implied Market Cap 608,764 Current Market Cap 476,310 ROI 27.8%

Rig Cohort/ Rig Name

Multiple/Scrap Val

Mexico - 390' 3.0xMexico - 300' 2.5xMexico - 250' 2.2xMiddle East - 300' 2.5xMiddle East - 250' 2.2xMiddle East - 150' 2.0xNorth Sea - 350-390' 4.0xNorth Sea - 250' 3.3xWest Africa - 300' 2.5xWest Africa - 250' 2.2xMisc - 300' 2.5xMDS1 2.8xDPDS1 3.2xDPDS2 3.5xDPDS3 4.0xMSS1 3.3xMSS2 3.5xDPDS4 50,000 MSS3 30,000


NPV Valuation – Bear

Key Assumptions

Jackup utilization by 2019: 67%

Jackup dayrates by 2019: $75,000

2019 Floater utilization: 55% 2019 Floater dayrates: 195 Cash flow is used to pay down

debt MSS2 floater is coldstacked

CDS = Contract Drilling Services

Total CDS EV 1,543,414 Debt Balance 2019 1,373,507 Cash Balance 2019 30,000 Scrap value of stacked rigs 75,000 Total CDS Market Cap 274,907 Current Market Cap 433,930 ROI -37%


NPV Valuation – Base

Key Assumptions



2019 Floater utilization: 57% 2019 Floater dayrates: 203 Cash flow used to pay down

debt MSS2 floater is coldstacked

Total CDS EV 1,823,230 Debt Balance 2019 1,257,686 Cash Balance 2019 30,000 Scrap value of stacked rigs 75,000 Total CDS Market Cap 670,544 Current Market Cap 433,930 ROI 55%


NPV Valuation – Bull

Key Assumptions



2019 Floater utilization: 67% 2019 Floater dayrates: 241 Cash flow used to pay down

debt No currently active floaters

stacked

Total CDS EV 1,965,150 Debt Balance 2019 1,182,878 Cash Balance 2019 30,000 Scrap value of stacked rigs 60,000 Total CDS Market Cap 872,271 Current Market Cap 433,930 ROI 101%


Management Capital Allocation Valuation is driven by company’s

aggressive cash flow generation in 2014, 2015, and part of 2016.

We believe debt repayments are the most tax-efficient way to provide value to shareholders

Added optionality of repurchasing debt at around a 10% discount to par


WACC Schedule

2014 2015 2016 2017 2018 2019Beta 2.5 2.5 2.5 2.5 2.5 2.5Risk-free rate 2.5% 2.5% 2.5% 2.5% 2.5% 2.5%Expected market returns 8.0% 8.0% 8.0% 8.0% 8.0% 8.0%Cost of Equity 16.3% 16.3% 16.3% 16.3% 16.3% 16.3%Cost of Debt 7.0% 7.0% 7.0% 7.0% 7.0% 7.0%Value of debt 2,268,613 2,034,890 1,801,168 1,567,445 1,333,723 1,100,000 Value of equity 507,700 507,700 507,700 507,700 507,700 507,700 Total Value 2,776,313 2,542,590 2,308,868 2,075,145 1,841,423 1,607,700 WACC 8.7% 8.8% 9.0% 9.3% 9.6% 9.9%

Assume that debt is paid off with excess cash flow Cost of equity significantly higher than street assumptions


Oil Consumption and Supply: Past

Increase in petrol production between 2005 and 2014 can be entirely attributed to Canadian oil sands and U.S. Fracking.

60% of the increase in petrol consumption during the period attributed to China. 25% of the increase is attributable to South East Asia.


Oil Consumption and Supply: Future

OPEC seeks to regain market share by increasing supply to match world demand

North American “tight oil” production doubles during projection period

90% of future consumption increase driven by South East Asia, India, and China

Partially offset by steady to decreasing demand from the West


Conclusion: Market will Remain Tight

OPEC still represents 41% of the world’s liquids production and will continue to be able to tighten a slack market or inject supply to match demand.

The North American energy boom is almost entirely attributed to tight oil which is 50% more expensive to extract compared to conventional sources.


Cost/bbl by Production Method

Shallow water drilling done by jackups is the cheapest extraction method outside of the Middle East

The spot price for oil would have to approach $40/bbl before demand for offshore jackup contracting is threatened

Note: white lines refer to average production costs for each production method


Additional Support of Breakeven Costs


• PGN’s tax rate was 44% in Q4 2014 due to restructuring provisions resulting from the spinoff

• As debt obligations from Noble and other provisions expire, the tax rate will return to normal.

Tax Rate


Time to transport jackups and semisubs

“wet tow” = 4 knots“dry tow”= 14 knots

Middle East to W. Africa

Distance: 9,620 mi Dry tow: 25 days

Source: http://www.offshore-technology.com

North Sea to W. Africa


Gulf Coast to W. Africa


Distance 14,850 mi Dry tow: 42 days

S.E Asia to W. Africa


http://www.offshore-technology.com/features/featurebig-rigs-how-to-move-the-worlds-largest-rigs-4265775/

Standard vs. High-Spec Rigs

PGN – Form 10-12B


Economy & Finance

How to Make a Stock Pitch