You would expect this given the company is in the early stages of a profit recovery and it will take time for investors to get a grip on the likely projectory of earnings, and the implications on the valuation. Having appraised last week’s results, I still feel there is significant untapped value in the company and believe that my 60p a share target price is a realistic goal, assuming of course the earnings recovery takes hold.
I was first attracted to the company after SeaEnergy acquired R2S, a profitable, cash generative and growing business, around 20 months ago. The purchase has gone to plan and in last week's full-year results SeaEnergy confirmed that R2S achieved cash profits "in excess of £2.5m" in the 12-month trading period to end-February 2014, ahead of target. That triggered the final earn-out payment of £4.6m to the vendors and means SeaEnergy has in effect purchased a fast growing and highly profitable business for a bargain basement total consideration of £10.1m.
In my opinion, the robust growth is set to continue because R2S's core service - Visual Asset Management - is proving as popular as ever. The VAM technology involves taking 360 degree spherical photographs of locations and then building up three-dimensional (3D) models. Data can then be embedded, indexed and managed. R2S initially provided these services to Police Forces and Courts across the UK, to model crime scenes and to index and manage associated evidential data. But it is the oil and gas sector where the real profit potential lies. That’s because VAM enables oil rig operators to keep a visual record of all key parts of an oil rig, monitor its condition and any changes to the fabric, with a view to carrying out maintenance. It’s cost effective too because the technology can be operated remotely, so it cuts overheads and reduces the need for trips out to the oil rigs.
As one would expect, R2S's core market is in the North Sea, where many oil & gas installations are reaching the ends of their design lives and the importance of maintaining asset integrity is increasing. Revenues are generated from both the "asset capture" project of initially setting up the 3D models and from ongoing software licensing fees charged to the operators of assets which have been captured. Since entering the oil & gas sector market, R2S has developed a strong market presence, and is now finding that clients, who have successfully utilised the company’s service on UK installations, are replicating the cost savings they have achieved in other geographies.
In turn, this is creating additional opportunities to grow the business. Chief executive John Aldersey-Williams "expects to see an increasing range of projects undertaken this year, as assets previously captured are recaptured, and in the case of new facilities, R2S provides services from the design and build phases all the way to decommissioning". In order to capitalise on this, the company set up an office in Houston, Texas to target the Gulf of Mexico market. It's a sensible move given that oil majors Chevron, BP and Nexen are among SeaEnergy's clients in the UK, so there is potential for them to utilise the company's service overseas too.
Recurring revenue stream
Importantly, R2S is creating a recurring and growing revenue stream for SeaEnergy. In terms of the income generated, a fifth of the £4.7m revenues earned by R2S last year came from software sales and the balance from data capture. The growth potential of R2S also gives credibility to Edison Investment Research's prediction (subject to review post last week's full-year results) that SeaEnergy's total revenues will rise by 50 per cent to £7.4m this year to produce pre-tax profits of £1.8m and EPS of 3.1p.
True, SeaEnergy reported a pre-tax loss of £230,000 in the second half of 2013, and a loss of £804,000 for the year as a whole, but it's worth noting that this was after accounting for restructuring costs of £311,000 and start-up costs of £222,000 on its ship management business. Furthermore, those are one-off items, the benefit of which have cut annual operating expenses by £900,000 to £2.2m, and set the platform for growth in the ship management business. This unit is focused on operations and maintenance vessels to service offshore windfarms and oil and gas platforms. The division should also enable SeaEnergy's marine service business to win tenders for wind farm support operations vessels of the type designed by the company over the past three years. I also understand that the marine business is "in advanced discussions with a vessels owning and operating company to form a joint venture for the provision of ship management services to third parties and for ships owned by the joint venture partner". Expect revenues from this source this year too.
It's also worth noting that SeaEnergy's consulting business secured its first project last year, working with an international operator of European offshore wind farms, to develop and implement an approach for the inspection and maintenance of operating assets. Not only are there benefits for the client in reducing costs and maximising turbine efficiency, but there is an obvious cross over with R2S too.
Value in SeaEnergy's balance sheet
Clearly, prospects for a higher share price rating will be driven by the profit growth at R2S and a pick-up in revenues and fall in losses at the consulting and marine services businesses. However, it's also worth flagging up that the investment risk is mitigated significantly by SeaEnergy's valuable legacy assets.
These include a UK royalty interest in Block 21/8a, located adjacent to the Forties field in the Central North Sea and which contains the Scolty discovery. Last October, FTSE 250 company EnQuest acquired a 50 per cent interest and operatorship in the Greater Kittiwake Area fields. As part of this agreement, it also agreed a contingent consideration to be paid in the event of the Scolty field achieving Field Development approval. The acquisition was driven in part by EnQuest's aim to develop the Scolty and Crathes fields and, according to Mr Aldersey-Williams, "has significantly enhanced the likelihood of these discoveries moving to production". As a result, SeaEnergy's royalty interest has been enhanced by the Enquest transaction and is likely to increase further once the Field Development Plan is approved.
SeaEnergy also owns a 21.4 per cent stake in Aim-traded North Celtic Sea-focused oil and gas explorer Lansdowne Oil & Gas (LOGP: 14.5p), a company with a market value of £21m and one that has a 20 per cent holding in the Barryroe licence, where Providence Resources (PVR: 180p) is the operator with an 80 per cent interest. The license area is located in 100 metre deep water in the North Celtic Sea Basin around 50 km off County Cork, Ireland. The field has 346m barrels of oil equivalent of recoverable 2C resources, but will need substantial capital to develop, possibly as much as £1bn to reach first oil. That's well beyond the means of the two companies. So advised by Rothschild investment bank, Providence Resources is seeking a farm-out deal on behalf of its partners.
Admittedly, there is no guarantee of a farm-out deal being concluded, but in the event of one, you would expect both Landsdowne and Providence Resources to have a carried interest to first oil and be reimbursed for their costs incurred to date in exchange for cutting their stakes in the Barryroe license. I understand that Landsdowne has invested £12m to date, a sum equating to 60 per cent of its market value. It's also realistic to assume that if any farm-out deal is concluded then shares in both Providence Resources and Lansdowne will re-rate with an obvious read through to SeaEnergy given its 21.4 per cent stake in Lansdowne. In turn, it would enable the company to offload this legacy asset.
And the best part is that SeaEenrgy can afford to await a conclusion of Rothschild's discussions since it has no pressing financial concerns. In fact, even after paying the final deferred consideration of £4.6m on the R2S acquisition post the December year-end, the company is still in a small cash-rich position.
Target price
In my opinion, fair value for the company is far closer to £33m rather than the current market capitalisation of £20m. In fact, there is case to be made that the R2S acquisition is worth the current share price alone, based on a multiple of eight times cash profits, leaving the UK royalty interest in Block 21/8a, the stake in Lansdowne Oil (worth 8p a share), and all SeaEnergy's other businesses in the price for free. Trading on a modest 10 per cent premium to a conservative book value of 32p a share, I continue to rate the shares a buy on a bid-offer spread of 34.5p to 35.5p and maintain a target price of 60p on a 12-month basis.
Please note that I am working my way through a long list of companies on my watchlist which have reported results or made announcements recently. These include: IQE (IQE), Pure Wafer (PUR), LMS Capital (LMS), Communisis (CMS), Eros (EROS), Inland (INL), Safestyle (SFE), Sutton Harbour (SUH), First Property (FPO), API (API) and Record (REC).
