TOP CONTRIBUTORS

Imran Qureshi

TESO AT A GLANCE

P/E ► 31.3 HIGH EV/EBITDA ► 8.79 AVG ROA ► 3.1% AVG ROE ► 3.5% AVG Debt to Equity ► 0.287 LOW Current Ratio ► 3.92 HIGH Interest Coverage Ratio ► 6.81 AVG

 

 

 

 

 

 

Tesco Corporation (NYSE: TESO) is the third largest provider of global tubular services for the oil industry and the second largest manufacturer of third party oil drills known as Top Drives. ^[1] As an oilfield technologies company, Tesco Co. is responsible for designing, manufacturing and maintaining oilfield equipment used in drilling oil, gas and geothermal wells. It operates in 23 different countries providing three main business segments: Top Drive, Tubular Services, and the recently created CASING DRILLING portion.^[2] Its customers include drilling contractors, rig builders, major and independent oil and gas companies and national oil companies. ^[3]

Since Tesco's revenue streams are intimately tied to the energy industry, correlations such as falling oil prices or hazardous drilling installations have a negative impact on oil rig production. ^[4]. Also, Tesco Corp has been sued for its CASING DRILLING technology by National-Oilwell Varco (NOV) and Franks International for patent infringement.^[5] The financial crisis also has broader implications for the company, as tight credit could lead to unfavorable interest rates in the future. Coupled with lower operating margins, it will be difficult for Tesco to sustain its growth.^[6]

Company Overview & Business Segments

Not to be confused with the British retailer, TESCO Corporation was formed on December 9, 1993 as a result of a merger between Coexco Petroleum Inc., Tesco Corporation, Forewest Industries Ltd. and Shelter Oil and Gas Ltd.^[7]. The company provides drilling (Top Drives) and casing services to oil companies in order to extract natural resources from the earth. Although Tesco makes most its revenue from its Top Drive segment, it is working to promote its Tubular Services division. As a result, Tesco employs many proprietary technologies including TESCO CASING DRILLING® (“CASING DRILLING”), its Casing Drive System (“CDS™” or “CDS”) and its Multiple Control Line Running System (“MCLRS™” or “MCLRS”) to create structural support for both offshore and land-based wells.

Headquartered in Houston, Texas, Tesco Co. employs 1,834 ^[8] people to provide Oilfield technologies for drilling contractors, rig builders and equipment brokers, independent oil companies, and national oil companies

The chart represents Tesco's three main business segments and their percent contribution of revenue in 2008^[9]

Top Drive

A Top Drive system (TDS) is a hydraulic or electric motor that is suspended on a drilling rig's "mast". It's used to rotate a drill string (consisting of drill pipe that transmits drilling fluid and rotational inertia) with the drill bit (the part that cuts up the rock) into a well, breaking the Earth's crust to extract oil, gas, or geothermal resources. As opposed to conventional systems like a rotary table or kelly drives, top drives travel with the drill string into the well until the operator disengages the device's pipe handler (which connects the Top Drive to the drill string). The entire process, from the time setting the drill string, adding a new stand and reconnecting to the drive usually takes less than 90 seconds to perform which reduces the drilling crew's exposure to dangerous working conditions and adds to the speed and safety of the drive. With increases in well control and hole conditioning, the Top Drive Drilling System is recognized as one of the most significant advancements in drilling technology.

Tesco manufactures a range of portable and permanently installed top drive machines capable of delivering 400^[10] to 1,350 horsepower^[11], with a rated lifting capacity of 250^[10] to 650 tons^[11].

This is Tesco's "cash cow" so-to-speak since it provides almost 65% of its revenue stream.^[12] The firm also rents these machines to oil companies on a day-rate basis and provides after-market support to add to their income. Tesco Co, as stated in its 10-K, expects these services to grow since revenues from top drive rental activities increased $2.3 million to $112 million in 2008. ^[13]

On December 31, 2008, the company announced a renovation of its rental top drive fleet, adding 34 HXI machines (Tesco's hydraulic top drive line, used for both offshore and land based wells^[14]) to its fleet in addition to selling them to its traditional customer base. ^[15]

A Top Drive System already mounted on a rig's "mast"

Tubular Services

While Top Drives are used to break into the fuel sources, Tubular Services involves laying a support structure within newly drilled wells This is called casing and essentially consists of deploying a series of pipes designed to withstand underground pressure. Although casing can be performed manually with a drilling crew, it is dangerous. As a result, Tesco developed its Casing Drive System which automates the running of tubing into the wellbore. ^[16]. Sold under the brand Azimuth Tubular Services™, Tesco's casing mechanism has been used to run more than 650 strings or four million feet of casing.

In order to continue growth in this sector, Tesco purchased the assets of Tong Specialty and Cheyenne Services on Nov 2, 2005 for $50MM. More recently, the firm acquired Lightning Casing, Inc.for $12.0 million and Hill's Casing Service Ltd. for $5.7 million on August 2, 2007. Each company formerly provided conventional casing running for their respective local areas. ^[17]

CASING DRILLING

Although once a part of the Tubular Services segment, CASING DRILLING has recently formed into its own separate entity effective December 31, 2008.^[18] Basically, Casing Drilling is the name of a proprietary technology that combines both drilling and casing in extracting natural resources. While conventional rigs usually drill using one kind of pipe and then case it with another, casing drilling combines these two steps into one. The process not only increases the safety of the process, since there is less exposure to the drill crew, but makes it possible to speed up drilling 20 to 30 percent by eliminating drill-string tripping and the problems associated with it. ^[19]

Despite its relative superiority, CASING DRILLING is still an operating loss for the company. Losses increased by 110% to $14.1MM in 2007, but decreased 11% to $12.6MM in 2008^[9] as Tesco continues to establish a market base for its Casing Drilling services. ^[20] Litigation has also been an issue for the technology as Tesco Co. has been sued by National-Oilwell Varco (NOV), Franks International, and Weatherford International (WFT) for copyright infringement. ^[18](see "Array of Lawsuits Threaten to Cripple Tesco" below)

Tesco has agreements with ENSCO International (ESV) and Transocean (RIG) to provide Casing Drilling for their offshore rigs, including operation support. ^[17]. As of December 31, 2008, the technology has been used in drilling 500 wells. ^[18]

Business and Financial Metrics

Tesco's revenue breaks down as follows:

TESCO generates 64% of its revenue from its Top Drive technology which provided $341.4MM (revenue) in 2008 as opposed to $166.5MM from Tubular Services and $27MM from CASING DRILLING.^[9] On a year to year basis, Tesco's revenue growth fell from 1.9% in 2007 to 1.5% in 2008. ^[9]. However, Tesco also holds a significant rental base (i.e. machines are borrowed by drilling companies) and provides aftermarket support which adds to their operating income:

Tubular services and Top drives generate the most for the company's operating revenue. Tesco's CASING DRILLING segment represents a major operating cost to the company which rose 88.1% from 2006 as Tesco establishes a market presence within the industry.^[9] Also, Tubular services is down 32.9% since 2006 and continues to plunge despite increased global demand for energy. However, due to a spike in orders for its top drive technology^[18], Tesco's net income soared 62.6% in 2008:

Key Trends/Forces

"Volatile Operating Environment" Limits Growth

Since the energy industry is subject to a high amount of variability, it is difficult to forecast net income from quarter to quarter.

Just as oil reached its all-time high in May 2008 at $133 (West Texas Intermediate), it quickly dropped to $39 a few months later^[21]. Tesco, as an oilfield services company, is particularly affected by the lowering demand for oil and increased pressure from its competitors. Simply put, the oilfield services industry works under contracts made when oil prices were high and continue to bring in revenue because of them. These agreements carry heavy penalties if violated so oil companies continue to operate under them and the production makes them little revenue or profits, potentially endangering Tesco's own contracts with ENSCO International (ESV), Transocean (RIG), and ConocoPhillips (COP). ^[22]

As of March 24, 2009, the industry has already seen declining demand for drilling. Since September, the U.S. rig count, or the number of active oil and natural-gas rigs, has fallen by 47% to 1,085. Citigroup analyst Robin Shoemaker expects the count to drop as low as 600 by the second quarter of 2009.^[23] This poses a significant risk for Tesco since almost 52% of its revenue is generated within the United States ^[24]

Array of Lawsuits Threaten to Cripple Tesco

Despite its proprietary technologies, Tesco Co. is involved in at least two lawsuits involving patent infringement which will serve to hamper Tesco's growth. As of December 13, 2008, the firm's just settled with Fluid Design Solutions, Inc for its Top Drive technology, but continues its suit against VARCO I/P, Inc. (“Varco”), Franks International, Inc. (“Franks”), and Weatherford International concerning Tesco's CASING DRILLING patent.^[25]

In 2005, National-Oilwell Varco (NOV) filed suit against Tesco for violating two of its patents. In 2007, the company was sued again by both Franks Intl and Weatherford International^[26] concerning 12 patent infringements for the Casing Drilling technology. Although Tesco filed countersuits against all three companies, the patents are still under reexamination. ^[27]. Tesco's suit with Franks Intl. is scheduled to proceed in May 2009, with an estimated $5.4 million in damages. ^[27]

Weatherford International and National-Oilwell Varco, which generate around 2500% more net income than Tesco, have a significantly greater presence in the Oilfield Technology industry. Lacking the same resources, it will be hard for Tesco to protect its future patents.

The Financial Crisis may Exacerbate Losses

As of December 31, 2008, Tesco Co. held $29.6 MM in debt securities.^[28] increasing their exposure to the 2008 Financial Crisis.

The crisis weakened the banking system due to massive losses on many subprime loans that had high interest rates, but also a lot of risk. Before 2007, ratings agencies gave the securitized form of these loans investor-grade status. Basically, they said putting money in these assets was just as good as an investment in a Fortune 500 Company. Naturally, when investors realized how dodgy these loans were, it was already too late; most people under the category of 'subprime', had defaulted on their loans and the CDO's (the subprime securities) became worthless. Without capital flowing to banks, credit is hard to come by, affecting many industries that rely on expensive machinery to operate. While Tesco's debt is small in comparison to other companies', oilfield services generally operate in a high-cost environment that makes them rely on banks for funding. A deteriorating economic climate could set very high interest rates for future loans.

There are also indirect effects. As the financial crisis spills into the real economy, more liquidity - printed and provided by the Federal Reserve and the U.S. Treasury - increases the risk of inflation. This poses a real threat to Tesco, since most of Tesco's revenue is made in the U.S., yet a considerable portion of its manufacturing is done in Canada. ^[28] Therefore, if the US dollar falls against the Canadian dollar, production costs will soar, but revenues will fall.

Competition

TESCO has different competitors between its two main business segments. In manufacturing top drives, it competes with National-Oilwell Varco (NOV) and Canrig Drilling Technology Ltd, a subsidiary of Nabors Industries (NBR) . Tesco's primary competitors for Tubular Services are Weatherford International (WFT), Franks International and BJ Services Company (BJS).^[1]

Tesco is a relatively small company, with $ 534.9MM revenue in 2008, compared with the billions earned by its competitors:

National-Oilwell Varco (NOV) is the leader in oilfield services with $13.4 billion revenue in 2008; its name can be found on the majority of oil rigs around the globe. The company pursues an aggressive acquisition strategy, spending $7.87 billion to acquire five different companies, all in one year. Size may not be such a boon for Varco, however, since it makes the company sensitive a vast array of problems. This was evident when a decline for domestic land rigs helped to offset gains from booming demand for offshore drilling equipment.

FMC Technologies (FTI) manufactures technology for many different industries including energy, food processing, and airport technology. Since Tesco only provides services to the oil industry, it only competes partially with FMC. Nevertheless, almost 64% of FMC's revenues in 2008 came from its energy systems.

Cameron Corporation (CAM) is one of the world's leading suppliers of subsea "Christmas Trees" - valves that control the flow of resources to the surface, preventing them from leaking into the environment. Unlike Tesco Co., Cameron focuses on large, expensive orders, meaning it is easily affected if a deal does not go through. This was the case when when FMC Technologies outbid Cameron for a major contract with Total S.A. (TOT)

BJ Services Company (BJS) focuses on providing casing solutions such as pressure pumping which includes cementing to support the physical structure of oil wells. Naturally, BJS competes with Tesco's tubular services portion.

Weatherford International (WFT) is another large oilfield services company whose revenues in 2008 exceeded $9 billion. The company focuses on expensive drilling and extraction technologies, making it reliant on high energy prices.

References

1. ↑ ^{1.0 1.1} TESCO 10-K SEC Filing, Page 7
2. ↑ TESCO 10-K SEC Filing, Page 2
3. ↑ TESCO 10-K SEC Filing, Page 6
4. ↑ TESCO 10-K SEC Filing, Page 10
5. ↑ TESCO 10-K SEC Filing, Page 16
6. ↑ "Drilling into Tesco" - Fool.com
7. ↑ MarketWatch TESO Profile
8. ↑
9. ↑ ^{9.00 9.01 9.02 9.03 9.04 9.05 9.06 9.07 9.08 9.09 9.10 9.11 9.12 9.13} Tesco 10-K SEC Filing, Page 23
10. ↑ ^{10.0 10.1} 250 EMI 400 Top Drive, Bottom Table
11. ↑ ^{11.0 11.1} 500/650 ECI 1350 Top Drive, Bottom Table
12. ↑ Tesco 10-K SEC filing, Page 35
13. ↑ Tesco 10-K SEC filing, Page 30
14. ↑ 250 HXI 700 Top Drive, Bottom Table
15. ↑
16. ↑ Tesco's 10-K SEC Filing, Page 3
17. ↑ ^{17.0 17.1}
18. ↑ ^{18.0 18.1 18.2 18.3} Tesco's 10-K SEC Filing, Page 4
19. ↑ Tesco Corp - What is Casing Drilling?
20. ↑ Tesco's 10-K SEC Filing, Page 32
21. ↑ [2008-2009 West Texas Intermediate]
22. ↑ Oilfield Services - Bears
23. ↑ Patience seen as a virtue in oil services - Fidelity.com
24. ↑ Tesco's 10-K SEC Filing, Page F-36
25. ↑ RFC Express - Tesco Co v. Weatherford Intl
26. ↑ RFC Express - Weatherford v. Tesco Co.
27. ↑ ^{27.0 27.1} Tesco's 10-K SEC Filing, Page 19
28. ↑ ^{28.0 28.1} Tesco's 10-K SEC Filing, Page 12]
29. ↑ "National Oilwell Varco Announces Fourth Quarter and 2007 Earnings"
30. ↑ "FMC Technologies Reports Fourth Quarter Diluted Earnings per Share from Continuing Operations of $0.70, up 49 Percent"
31. ↑ ^{31.0 31.1} Cameron: News Releases, "CAMERON FOURTH QUARTER EARNINGS TOTAL $0.54 PER SHARE; REVENUES UP 25 PERCENT, ORDERS AND BACKLOG REACH NEW HIGHS"
32. ↑ ^{32.0 32.1} BJ Services Annual Report, Page 3
33. ↑ ^{33.0 33.1} Weatherford Ltd. Google Finance
34. ↑ "National Oilwell Varco Announces Fourth Quarter and 2007 Earnings"
35. ↑ "FMC Technologies Reports Fourth Quarter Diluted Earnings per Share from Continuing Operations of $0.70, up 49 Percent"