Stock Review

The latest float from Macquarie Bank is expensive, cyclical and far from compelling.

‘All the oil service company personnel operate from bases surrounded by high walls with razor wire on top and armed guards on duty twenty-four hours.’ So wrote Paul Carter in his book Don’t Tell Mum I Work on the Rigs, She Thinks I’m a Piano Player in a Whorehouse. It’s a story of hard men working in a hard game under some pretty tough conditions. Life on a rig, running rods and lifting core samples, is not for the faint-hearted – and neither is the latest offering from the suits at No. 1 Martin Place.

Founded way back in 1890 as a subsidiary of South African diamond miner De Beers, Boart Longyear’s main business is the operation of onshore drill rigs. Drill rigs are used by resource companies to drill deep into the earth and extract core samples. These samples then help miners work out what valuable minerals lie under their patch of land, and to build three-dimensional maps of the ore body like those you might have seen in mining annual reports. Drill rigs are also used to extract earth samples to test for environmental contaminants such as lead, benzene and mercury, as when the Homebush site was rehabilitated for the Sydney Olympics.

Drill bits are forever

The drilling operation comprises 62% of Boart’s business by revenue, whilst the other 38% comes from a products division that manufactures drill rigs, rods and bits. Interestingly, many of the drill bits are diamond encrusted, which is where the link to De Beers comes in.

Enough of the history, though, what about the float? Here at The Intelligent Investor, we tend to be more interested in companies undertaking a public offering to raise money for the expansion of their business. But lately, this approach has taken a back seat, with most floats being from knowledgeable sellers, such as private equity investors, liquidating their investment and collecting windfall profits.

The float of Boart Longyear follows this model. The prospectus states: ‘The Company will not retain any of the proceeds of the Offer, other than an amount to pay the costs of the Offer and to repay a portion of the Company’s debt balance.’ So the Boart Longyear business doesn’t need the money, it’s just that the current owners want out, and a float has been deemed the most profitable way to leave.

The score boart
Retail offer closes	28 March
Allocation	4 April
Shares start trading	5 April
Indicative price range	$1.76–$2.10

The offer is hoping to raise between $2.25bn and $2.65bn from investors, for 85% of the company. The other 15% will be held by a subsidiary of Macquarie Bank and some (but not all) of the existing owners.

Assuming a price in the middle of the $1.76 to $2.10 per share offer range, about $1.3bn will go to the existing owners, more than $1bn will go to paying down debt, and a whopping $93 million will cover the costs of the float – going as fees to the ubiquitous Macquarie Bank amongst others.

Investors will be buying into a company that has forecast revenue of US$1.46 billion and earnings before interest, tax, depreciation and amortisation – or EBITDA – of US$320 million. After accounting for the I, T, D and A, though, the forecast net profit is just US$149m, which translated to A$193.2m at the time the prospectus was put together. At the top end of the float range, this amounts to a PER of 16, and at the bottom end the PER comes to about 14. That compares to Ausdrill – a smaller competitor – which trades on a PER of about 10.

Thanks but no thanks

That looks expensive for a cyclical business operating in the top half of the cycle. Most oil and mineral exploration bosses have spoken about the difficulties of getting access to drill rigs in recent years, and this has shown itself in an increase in Boart’s utilisation rate (the percentage of available time its rigs are actually working) from 70% to 90%.

There are low barriers to entry in the drilling business, so as new players enter the field or existing companies expand to meet demand, we expect these utilisation rates to fall back. Boart itself has increased its number of rigs from 728 in 2003 to a forecast 1,080 by the end of 2007. There will be a lot of rigs out there looking for work when the cycle turns one day.

This growth in rig numbers raises an interesting point about the prospectus. The reported maintenance expenditure seems quite low for what one would imagine is quite a capital-intensive business. Management claims it is due to a maintenance program that allows the company to get twenty years’ use out of each rig with minimal cost. But we suspect it’s more a case of the sheer number of new rigs artificially lowering average maintenance costs. As any farmer will tell you, it doesn’t cost much to keep a new tractor on the go. But, as the fleet gets older, more money will have to go into maintenance. That may affect profits and cash flow at some stage.

There’s always a patsy

Another note of interest is that the revenue figures quoted in the prospectus are in US dollars. The prospectus says this is because the largest portion of the company’s revenue is US dollars. So why list in Australia and not the US? The probable answer is that the existing owners believe they can make more money out of a listing here than they can over there. Remembering that the owners are taking the money and running, do you really want to be their patsy?

In a nutshell, the prospectus offers a ‘resources supercycle sales pitch’. But if the owners really believed that, they probably wouldn’t be selling. For a price of around 15 times forecast earnings to be justified for Boart Longyear, India and China would need to grow uninterrupted for years, and yet not come up with their own solution to a global shortage of drilling equipment. Our doubts about the ‘supercycle’ are well reported. The existing owners have decided to cash in, and we don’t want it to be at our expense. AVOID.

Brendon Johnson

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