No. of Recommendations: 32
SeaEnergy (SEA)

AIM-quoted SeaEnergy (‘SEA’) is a £16 million market cap business operating primarily in the oil services and renewable energy sectors. It also holds a significant legacy investment in AIM-quoted Lansdowne Oil and Gas (‘LOGP’), a small Exploration and Production (E&P) business.

My analysis suggests that the market is currently mispricing the value inherent in the business, specifically its fast-growing and highly profitable software division. The investment case is underpinned by a solid balance sheet and significant unrealised investment gains which together offer a reassuring margin of safety.

The shares currently trade at 29/30p.


Background

SeaEnergy was formerly known as Ramco Energy and was involved in oil exploration. It also developed an offshore wind farm business which was sold to Repsol to generate proceeds (net of transaction costs and debt repayment) of around £30m in June 2011. The former founder and Executive Chairman, Steve Remp, stepped down as CEO in January 2012 and was replaced by the current CEO, John Aldersey-Williams. Later that year £6.9 million was returned to shareholders through a tender offer at 36 pence per share. My understanding is that there were corporate governance issues in the past, with a high level of director remuneration. This no longer appears to be a major concern with a new line-up of Executive Directors and the introduction of a new Long Term Incentive Plan (LTIP), details of which can be found at http://www.seaenergy-plc.com/faq.html


What does SeaEnergy do?

The new team’s strategy is “to build a group of complementary and innovative businesses.” Currently there are three activities :

- Consulting : specialising in offshore energy and renewables
- Marine : offshore wind farm operations and maintenance, and ship management
- Return to Scene (R2S): this is described in detail below.

Consulting and Marine are at the early stages of development. Whilst revenues are not broken down by division it appears that these two activities accounted for a very small proportion of the £2.2 million in revenues generated in the first half of 2013. I consider them to be peripheral to the investment case and will therefore focus on R2S, a fast-growing, high margin business which was acquired by SeaEnergy in August 2012.

For the current year Edison projects revenues of £5 million and a small loss, increasing to £7.4 million in revenues and £1.8 million in Pre-Tax Profit for next year, equivalent to EPS of 3.1p. (This research can be accessed from SeaEnergy’s website at http://www.seaenergy-plc.com/investors.html )


R2S (Return To Scene - www.r2s.co.uk )

R2S was founded in 1992 as a digital media and corporate communications business and has since developed its own ‘VAM’ (Visual Asset Management) software. This technology involves the taking of 360 degree spherical photographs of locations and the building of three-dimensional models. Data can then be embedded, indexed and managed within these models. This enables users to experience a virtual walk-through of any location and remotely view any scene that has been captured. You can think of it as ‘Streetview on Steroids’, though offering far higher definition images and a wide range of additional functionality. The software was initially developed and deployed for use at crime scenes as a ‘powerful investigative, briefing and Court presentation tool.’ It was also used in security preparations for the G8 conference of world leaders in Enniskillen, Northern Ireland.

More recently it has been deployed in the Oil and Gas sector, allowing remote inspection of facilities for the purposes of training, planning of maintenance and other activities which might otherwise require a physical presence for close-up inspection. Given that facilities are often in remote offshore locations accessible only by boat or helicopter, VAM offers its clients major savings in both time and money. In the words of R2s’s Managing Director, Brian Dillon : “Travel to and from offshore assets for asset management, or maintenance reasons can be hindered by a shortage of flights, bed space, HSE issues, climatic or security reasons. Using R2S reduces the need for travel to assets for a range of purposes and is a useful training tool in its own right. At R2S we have proven to save our clients' money and provide a visual asset management tool with multiple applications.” ( http://tinyurl.com/nrosg86 )

A video presentation of the product can be found at www.r2s.co.ukhttp://vimeo.com/48458292/ This is essential viewing to gain a better understanding of its capabilities.

SeaEnergy acquired 100% of R2S in August 2012, initially paying £5 million in cash with further payments of £0.5 million in 2013 and up to £4.6 million in 2014, dependent upon meeting post-acquisition performance targets. In the year to 29 February 2012 R2S had reported a turnover of £2.0 million and a pre-tax profit of £0.5 million.
The following is taken from SeaEnergy’s 2013 interim results ( http://www.seaenergy-plc.com/news.html ) released at the end of August 2013:

“… R2S has continued on a strong growth trajectory, and is now active in US markets as well as in the UK and Northern Europe. Earlier this year, we opened an R2S office in Houston, Texas, to target the Gulf of Mexico market and this has already generated our first photographic capture and R2S model build of a Gulf of Mexico platform.

Since the acquisition, the technical scope of the R2S offering has expanded to include the full life cycle of captured assets. R2S now provides "pre-visualisation" in which spherical images are constructed of platforms and other structures which have yet to be built and for major modifications of existing structures, by interpreting 3D construction drawings. These pre-visualisations allow for collaborative working, the planning of building and commissioning tasks and for early familiarisation of new assets, before they are built.

At the opposite end of the life cycle R2S has also, for the first time, started providing support for decommissioning operations, in which R2S spherical images allow for safe and efficient planning of the tasks required in safely disassembling retired assets.

In the near future, we expect to capture our first wind turbines with the R2S process, and we continue to broaden the business across the oil & gas sector as well as entering other sectors.”

R2S has delivered an impressive financial performance since it was acquired. The following is taken from Note 7 in the June 2013 Interim Results :

“Additional Earn-out consideration of up to a maximum of £4.6 million may become payable in March 2014 subject to the achievement by R2S of certain profit targets (and not linked to continuing employment of directors). For the maximum Earn-out consideration to become payable R2S would have to report annual earnings before interest, tax, depreciation and amortisation in the year to 28 February 2014 in excess of £2.5 million. .. As at 30 June 2013, given the performance of R2S over the first half of 2013, the Directors believe that it is probable that the profit targets will be achieved.”

In two years R2S is therefore expected to go from a pre-tax profit of £0.5 million to EBITDA of £2.5 million. Whilst this is not comparing like-with-like (Pre-Tax vs EBITDA), it’s clear that R2S has delivered exceptionally strong profit growth and means that the company was acquired on a very undemanding EBITDA multiple of just over 4. This suggests that SeaEnergy’s management are shrewd dealmakers.

I believe that R2S offers significant potential for continued, rapid growth in revenue and profits. I find the following features of the business particularly attractive:

- R2S delivers an innovative software solution which saves its deep-pocketed client base both time and money. As a result it has rapidly gained traction in the oil and gas sector and is growing fast. The client base includes a wide range of blue chip names including Chevron, BP, Total, Centrica and BG. (You can find a full list of clients at http://www.r2s.co.uk/clients.asp)
- Although I have no hard data on the potential size of the potential market, it is clearly very large, potentially comprising all offshore oil and gas facilities worldwide. The opening of the Houston office should help R2S develop its client base in The Americas.
- The barriers to entry are high – once a facility has been photographed there will be little incentive to have this work repeated. I am not aware of any directly competitive products.
- In common with many software businesses, operational gearing is high. Once a client signs up for VAM a recurring revenue stream is generated in the form of support fees. As far as I’m aware there is no available breakdown of initial and recurring revenue streams, but every new licence sold should generate ongoing, incremental revenues at little or no cost.

The interims state that “in the six months to 30 June 2013, R2S contributed nearly £1 million to Group earnings.” Given that revenues across all division were £2.2 million, this implies an operating margin in excess of 40%! To deliver this level of profitability R2S is clearly providing a very valuable service to its clients and has considerable pricing power. It appears to be an exceptional business.


Downside Protection

SEA owns a 21% stake in AIM-quoted Lansdowne Oil & Gas plc (LOGP). At the time of writing this holding has a market value of just under £12million, equivalent to approximately 75% of SEA’s £16 million market cap. It is management’s stated intention “…to realise the value of our legacy oil & gas assets over time and to return a proportion of that realised value to shareholders.” (2013 Interim Results Statement.) Note that there is likely to be some corporation tax charged on the £7m gain over book value.

The balance sheet is solid. As at 30th June this year there was £5.4 million in cash and no debt. Assuming that R2S performs as expected a further £4.6 million of earn-out consideration will be payable in March, 2014. However, note that “The Earn-out consideration can be settled through the issue of shares in SeaEnergy, subject to certain restrictions, at the sole election of SeaEnergy.” (2013 Interim Results Statement.) Should the share price remain at its current low level I imagine that management would prefer to pay cash, but share-based payment is available if the share price climbs and/or cash needs to be conserved. Bear in mind that R2S should generate significant free cash-flow over the coming months, assuming it hits the earn-out target.


Valuation

SeaEnergy’s market capitalisation is currently £16 million. This is for a business which has :

- An investment in Lansdowne Oil and Gas worth just under £12 million at today’s market price.
- Zero debt and a cash balance of £5.4 million. (However, note that a £4.6m R2S earn-out payment will be payable in March 2014.)
- A fast-growing software business expected to generate EBITDA of at least £2.5 million in the 12 month period to 28 Feb 2014. I would expect this to be valued on an EBITDA multiple of at least 7, perhaps very substantially higher given its growth potential. This implies a minimum value of around £17 million for R2S alone.

At today’s share price of 29p I believe that the business is significantly undervalued.


What’s the Catch?

At this point I’m asking myself why the attractions of this stock have been overlooked. I’ve identified the following negatives but would appreciate feedback on any other gremlins which I may have missed :

- SEA is currently loss-making and as such will have been ruled out of consideration by a significant proportion of potential investors. (However, this is in the context of growing two divisions organically from scratch.)
- The stock is illiquid and trades on a wide spread, often over 1p.
- The business has a number of strands including renewable energy-related divisions and its holding in Lansdowne Oil and Gas. These activities obscure R2S, the jewel in the crown and the reason why I’m interested in this stock. On top of this both renewables and small cap E&Ps are very much out of favour with the investing public.
- The Marine and Consulting divisions may take up management time and suck in working capital as they establish themselves.
- As yet, management have not been particularly active in communicating the potential offered by R2S.
- My understanding is that Ramco Energy, SeaEnergy’s previous incarnation, generated a lot of negative sentiment as a result of its corporate governance and executive remuneration. Investors have long(ish) memories so there may still be a legacy of mistrust despite the new Executive team. It’s perhaps because of this that there’s very limited institutional following, with Ruffer the only institution holding a disclosable stake.
- There is a $2.2m contingent liability arising from a 2009 joint Venture in Iraq. (The details can be found in note 10 of the Interim Results statement.)

Given the profitability and growth potential of R2S and the strength of SeaEnergy’s balance sheet I don’t think any of the above delivers a knockout punch to the investment case. In my opinion the market is failing to recognise the intrinsic value of the business and I’d be surprised if this anomaly persists for very long. SEA offers investors a highly asymmetric payoff, with very limited downside and the potential to multi bag to the upside over time.


For the avoidance of doubt I hold shares in SeaEnergy.

Steve
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