Citi Upgrades Superior Energy On Deal Accretion Potential

Citi has upgraded Superior Energy Services, Inc. SPN to Buy from Neutral as it sees upside to shares on potential accretive acquisition due to the supply of excess frac equipment potentially available at depressed prices.

Possible M&A Activity

The brokerage said a deal could also improve the balance sheet of the oil service company and ease discussions with lenders, benefiting the current multiple.

"We believe consolidation within the domestic frac industry currently offers one of the best valuation creation routes. This reflects the current stress in the marketplace, the likelihood of a robust rebound over the medium term and the benefits of scale," analyst Scott Gruber explained.

Gruber noted that Superior Energy Services' shift in strategy to expand their frac business offers a material catalyst for the stock, especially "if we're right and they're under-selling the opportunity."

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According to the analyst, "assuming SPN buys a 420 k hp fleet at 60 percent of newbuild cost," EBITDA margins could increase to 15 percent resulting in 15 percent upside in shares even under an all-stock deal. If Superior Energy Services buys 1.1 mm hp fleet, then shares could see 21 percent upside.

Potential Targets

Meanwhile, Gruber said ProPetro and Weatherford's pumping assets could be potential targets.

"ProPetro may make sense as Superior has discussed the benefit of scale in a particular basin," said Gruber noting that ProPetro is the thirteenth largest pumper in the United States according to PacWest.

But, the entire fleet of ProPetro is located in the Permian. The analyst highlighted that If Superior buys ProPetro, it would be the largest pumper in the basin with about 50 percent more capacity than the next largest, RPC, Inc. RES and Halliburton Company HAL.

In addition, the analyst said an acquisition of Weatherford's pumping assets "may work as the simplicity of the transaction may offset the larger size."

Gruber noted that Superior could buy Weatherford's pumps without involving the lenders, while the asset sale would free up the liquidity for Weatherford without sacrificing any of its current EBITDA.

"A deal would shift SPN further towards onshore, with potentially 2/3 to 3/4 of company revenues being derived from onshore US by 2018. Growth Onshore US should prove more attractive compared to SPN's other geographies," Gruber said.

Gruber said since pressure pumping currently accounts for less than 20 percent of Superior Energy Services' revenue, an acquisition could push it to 25–40 percent of the total and could act as a cushion against lower growth segments.

"Onshore Completion & Workover revenues could become up to 70 percent pressure by 2018 if SPN opts for a large acquisition," the analyst added.

Possible Financing

Gruber highlighted that the potential deal could be done via equity financing that improves the net debt to EBITDA ratio.

"Late this year, we believe Superior is likely to be in violation of its current credit facility covenants and there's risk that the company could need to issue equity to satisfy lenders and fund growth opportunities, especially if the credit facility is pulled (a low probability event)," Gruber elaborated.

Shares of Superior Energy closed Monday's regular trading at $16.89. Gruber raised the price target on the stock to $20 from $14.