Deal Creates a Gusher for Oilfield Water Services

 | Jul 20, 2017 | 1:00 PM EDT
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amzn

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The big news in the oil patch yesterday was the merger of Select Energy Services (WTTR) and privately held Rockwater Energy Solutions. I've written extensively about oilfield water services for Real Money and first mentioned WTTR (which IPO'd on April 20) positively in my column of June 9. The market obviously liked the deal, as Select shares gushed to a 20% gain in yesterday's trading. 

It's rare to see the stock price of an acquirer in a stock-for-stock deal jump that much, and investors clearly believe water services for the oilfield are ripe for consolidation. It wasn't quite Amazon (AMZN) -Whole Foods (WFM) , where the one-day jump in the acquirer's share price covered the cost of the deal, but by my calculations, the move in WTTR shares covered 34% of the net cost (including assumed debt) of the deal, so that's a nice bonus for WTTR shareholders. 

Together, the two companies are a water-services behemoth, with pro-forma annual revenues of $1.25 billion, annual Ebitda of $176 and a pro-forma market cap of $1.6 billion. There is no doubt that the combined Select-Rockwater is the leading oilfield water services company in North America, and Select's improved public market valuation gives the company the currency to continue to acquire privately held competitors. 

The industrial logic for the deal is clear, but financially the metrics show that energy still has a long way to go to return to previous peaks of profitability. As per Select's presentation, Rockwater generated about $17 million of Ebitda in the second quarter, but reading the fine print shows that $16 million of that was depreciation and amortization. So, on an Ebit basis, Rockwater was barely profitable in the second quarter. 

As the cadence of well completions continues to increase throughout 2017, Rockwater's profitability will improve, according to Select's projections. Annualizing projected Ebitda for the second half of 2017, Select is paying 5.6x Ebitda for Rockwater (assuming Monday's closing price for WTTR shares; the multiple is obviously much higher at today's level) and using a more conservative method of annualizing Rockwater's second-quarter actual Ebitda, the pre-announcement acquisition multiple was 7.4x Ebitda. 

The most interesting data point from the slide presentation accompanying Select's conference call yesterday, though, was the geographic breakdown of the combined company's pro-forma income. As always in the oil patch, business areas are grouped by "plays" rather than strict geography. Select and Rockwater are very strong in the Permian Basin, widely believed to be the most economical of all North American shale plays. Larger market share will allow Select and Rockwater to more efficiently amortize fixed costs in the Permian, although the possibility for substitution will limit the opportunity for better pricing, in my opinion. Really, though, if one analyzes the combined Select-Rockwater, the revenue mix is almost perfectly aligned to the relative economic attractiveness of the individual plays. 

Permian 32%

Mid-Con (Oklahoma) 18%

Eagle Ford (South Texas) 14%

Bakken (North Dakota) 13%

Rockies 11%

Northeast 8%

Haynesville (Ark-La-Tex) 4% 

Clearly, this revenue mix is by design, and Select and Rockwater's combined composition of revenue by plays is perfectly suited for a "lower for longer" oil price environment. This deal cements WTTR's status as a leading oilfield services company, and I believe the shares are attractive at these levels.

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