What do fireflies, rollercoasters, and China's bull run on commodities have in common? They all play into my investment thesis for buying a 3% position in ION Geophysical (NYSE: IO ) , an oil-facing seismic technology company.
ION's stock, along with just about everything else, went into freefall in fall 2008. The ride was so bad that thanks to a horribly timed acquisition, ION almost went bankrupt. In China, the high-tech company found its saving grace – BGP – and struck a deal on a new joint venture. FireFly, ION's cableless seismic system to help oil companies solve some of their biggest problems, brought the deep-pocketed Chinese energy company to the table.
Three reasons to buy
1. The cycle is turning. In just two years, between January 2007 and January 2009, the price of oil skyrocketed from $55 a barrel up to nearly $150, and then promptly fell back below $40 a barrel. With oil now above $80 a barrel, companies like ExxonMobil (NYSE: XOM ) , Chevron (NYSE: CVX ) , and ConocoPhillips (NYSE: COP ) are just beginning to increase spending on exploration and development. That means the companies that provide the picks and shovels are starting to see an uptick in demand. ION's advanced seismic technology is a must when exploring challenging environments like deepwater drilling in the Arctic and unconventional onshore plays like the Marcellus shale.
2. BGP should bring a lot of business. Last year ION formed a joint venture called INOVA with BGP, the largest seismic land contractor in the world. Along with PetroChina (NYSE: PTR ) , BGP is a subsidiary of China's largest oil and gas company, CNPC. ION contributed its equipment and technology, while BGP forked over the cash and crew to form a premier land seismic equipment company. That means a heck of a lot of future business for ION in China and all over the world, thanks to BGP's global reach. Having at least one large stable customer alleviates some of the risk when assessing future cash flows.
3. It's cheap. We want to buy a cyclical company like ION when its earnings multiple looks ludicrous or simply nonexistent -- as is the case now. ION has returned to profitability over the last two quarters, and it's expected to earn $0.35 next year and $0.60 in 2012. By 2012, I expect ION to operate in a more "normalized" environment, with healthy spending from its customers resulting in EBITDA near $235 million. With a price tag of $6.60 and a market cap of $1 billion, ION provides plenty of upside levered to a rebound in exploration. ION is not the best company in its industry – heck even, its industry is less than stellar. But with a healthy balance sheet and a formidable new partner, I think this stock is just too cheap to pass up.
The business
ION has been around for 40 years, outfitting large seismic crews for both onshore and offshore oil exploration. But over the past decade, it has transitioned into a leading technology company led by the launch of Full-Wave sensors in 2003. Full-Wave improves on the 2-D and 3-D imaging primarily used in the industry, and positions ION well for the trend toward more unconventional oil and gas plays. Recent success in the Arctic, and its introduction of FireFly into the Marcellus shale, could make ION a leader in unconventional oil and gas space.
Risks
Onshore and offshore contractors have experienced a pick-up in demand, but for the most part, it has yet to flow to the seismic equipment makers. A decline in the economy or markets could prolong the delay in new equipment purchases, keeping a cap on the stock. This could slow the shift from cable-based seismic equipment to ION's cableless systems in the onshore market.
I could be overestimating the benefit from the BGP joint venture and its new 16% stake in ION. If the partnership is short-lived or less lucrative, I'll likely reduce my earnings expectations, and I may sell the stock.
The Foolish bottom line
ION currently has about a 3% market share in the $16 billion seismic market, while BGP boasts an 8% share. Together, the two companies are an excellent match, with ION's advanced technology and BGP's breadth and cost-effective operations. I expect demand for ION's FireFly technology to grow in the onshore market over the next several years as aging equipment gets replaced. ION should also grow its marine business, as deepwater rigs get rolled out and exploration activity in unconventional places like the Arctic heats up.
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