CMG.TO - Computer Modelling Group

[bizaro86]

This came up recently in the "what are you buying thread" and its a company I know a bit about so I thought I'd start a thread. CMG develops and sells reservoir simulation software. The software solves equations of state numerically, and iterates the solutions to predict fluid parameters within a reservoir. Basically, reservoir engineers use it to make predictions about what will happen underground. Given that wells are expensive and reservoir engineers are expensive, it shouldn't surprise anyone to know that very complicated software used by reservoir engineers would be expensive. The company has been hurt badly by the ongoing weakness in oil and gas prices, but still has >40% EBITDA margins (47% last quarter).

 

They have very high fixed costs (typical software business) as the PhDs who write and support the software are expensive, but the cost of adding a few extra licensees is nominal. They mostly sell licences on a per-year basis, although they do sell perpetual licenses as well. However, almost all their perpetual clients (I spoke to a salesman who said he's never had someone not take this option) buy the maintenance option. Basically, they pay monthly fees to get all updates/latest versions added to their perpetual licence. That means their annuity/maintenance revenue is typically 80-90% of the total.

 

They are a strong number 2 in a duopoly market, where the market leader is Schlumberger. I like that they are focused and competing against a company where their competitor is a small, non-core division. The competing software is called Eclipse. It has more market share, but CMG is more user friendly (I've used both). CMG is also much, much stronger for thermal applications. That means that growth in the Canadian oil sands will benefit CMG.

 

They are trading at 22X earnings, although if you take out the excess cash its less than that. They are returning the cash through dividends, which exceed earnings at present. (Dividend rate is $0.40 Cad/year, TTM earnings are $0.28/year)

 

They are well below peak earnings, as they took in $0.71 in 2014. While I don't expect them to recover to that any time soon, they are growing earnings again. The year prior to the current TTM period they earned $0.25/share, so the trend is in the right direction.

 

I think this will grow earnings 10%/year with no oil price inflation, and if oil prices get back to $80ish they'll probably double in short order. I like it as a low risk, high upside play on oil prices.

[Foreign Tuffett]

Are you aware of a good source for market share data?

 

There are other competitors right, even if they are somewhat smaller + I think some of the supermajors have in-house proprietary software, although perhaps Shell working closely with CMG signals that supermajors are moving towards 3rd party solutions.

 

http://petrofaq.org/wiki/List_of_Reservoir_Simulation_Software

 

After some brief research, my overall impression is that certain software packages are better for certain types of projects. For example, maybe CMG's software is better for onshore horizontal drilling and fracking projects, while Schlumberger's ECLIPSE is better for deepwater development. There are also small outfits like ReservoirGrail that specialize in more niche applications like modeling waterfloods and other EOR techniques.

 

 

[bizaro86]

I'm not aware of any source for market share data, and doubt anything reliable exists. My former employer wouldn't even tell me what we were paying for eclipse or cmg seats when I worked there for contractual reasons.

 

I agree super majors (and even some large independents) have in house software. While licenses are expensive, I have to think it's less expensive than developing a whole suite in house, which isn't exactly a core competence. I don't think any of the other 3rd party developers have significant market share.

 

Some of the difference in markets is that the software has different capabilities (cmg STARS is better for thermal imo). For horizontal and offshore, I think the products are comparable and the different market shares are largely first mover advantage/high switching costs.

[Foreign Tuffett]

I think oil price cyclicality is obscuring the many good qualities of this business. Further, I think the industry is much closer to the bottom of the cycle than it is to the top. This is particularly true for the industry in Alberta (CMG is based in Calgary), which has been badly hurt by a lack of pipeline transport capacity.

 

I agree with everything bizaro86 has posted in this thread, so I'm only going to try and cover new ground instead of regurgitating the same info. In no particular order:

 

* This is a subscription-based software business that is moving towards cloud-based hosting. If CMG starts growing again I think we'll see significant multiple expansion as investors realize the business model is akin to SaaS.

 

* CMG has a consistent history of generating strong cash flows + it doesn't capitalize any of its software development costs.

 

* CMG resembles a university-affiliated research institution more than it does a typical publicly-traded company. While this means we'll probably never see a leveraged recap or a sale of the company, it also means that we are also unlikely to see value-destroying acquisitions. It also means management is unlikely to lose focus on the core business or stray from its dividends-first capital allocation policy.

 

* CMG benefits from its close relationship with the Energi Simulation non-profit

 

* Most oilfield services companies have large capex expenditures. Cyclical industry + high capital intensity = bad. CMG's capex budget for this FY is $1 million, which is all of 1.33% of FY 2018's revenue. CMG finished outfitting its new HQ in FY 2018, so it's unlikely to have large capital expenditures for many years.

 

* Very clean balance sheet 

 

* This is a highly technical niche business that builds on 40+ years of R&D. User switching costs are high.

 

Risks:

 

* If oilfield spending stays low, the dividend could be reduced, or even eliminated

 

* While I think it would be excessively costly and time consuming for a new market entrant to improve on ALL of CMG's software, it's possible that someone builds a better mousetrap for a particular application. For example, a physics professor and his grad students might devise a way of simulating thermal recovery processes that is inherently superior to CMG's STARS.

 

* Schlumberger could use its much greater resources and vertical integration to, over time, out compete CMG. I think this is unlikely though, as other industry players almost certainly don't want to see SLB monopolize the reservoir simulation segment.

 

 

Anyway, I like this idea and bought some yesterday. I might buy more if it drops further. Thanks bizaro86 for the idea. I hope you chime in if you agree/disagree with any of the above.

 

 

[Foreign Tuffett]

I found this article very helpful, despite its age:

 

https://uk.reuters.com/article/computermodelling-growth/interview-software-firm-cmg-takes-on-schlumberger-unconventionally-idUKL4N0BL3Z720130222

[tenyearsout]

Does anyone know how their new product ‘Coflow’ is being thought of in the industry? 

[bizaro86]

Does anyone know how their new product ‘Coflow’ is being thought of in the industry?

 

I haven't been able to find anyone who uses CoFlow. I'm not optimistic about it as a market for reasons I'll get into, but I'm pretty sure they had a customer pay for most of the development, which reduces the risk. And developing coflow is a high-risk, high-reward endeavor.

 

The potential market here is huge - right now CMG sells software to only the reservoir engineers of a company. There are almost always more production engineers, and they're in charge of generating revenue right now, so they were less affected by layoffs in the downturn.

 

On the other hand, the production engineers already have software that performs these functions. For silo reasons, they may not be politically interested in using software that will be perceived as coming from the reservoir group. On the other hand, coflow will integrate the reservoir model into the production forecasts. That should make the production engineers materially more efficient, and could improve their ability to optimize the wells. So IN THEORY, this software should get taken up if they get it working well.

 

But my experience as a production and a reservoir engineer is that while those groups are collegial and work together, neither wants the other to be in charge. So I'm not totally convinced this will work out. But if it does, the market size would be very significant relative to the size of CMG.

[tenyearsout]

Bizaro86, thanks again for the insight.  Do you know how well, relative to their competition, CMG software is for shale-gas reservoir simulation?

[bizaro86]

Bizaro86, thanks again for the insight.  Do you know how well, relative to their competition, CMG software is for shale-gas reservoir simulation?

 

I don't have any basis for an opinion on that.

[bizaro86]

One factor that could be depressing the price here is that the company was removed from the S&P TSX Composite Index last month, which means Canada's big index funds have sold.

 

https://us.spindices.com/documents/indexnews/announcements/20190308-887958/887958_2019-03-08compositereview-pr.pdf?force_download=true

[Foreign Tuffett]

One factor that could be depressing the price here is that the company was removed from the S&P TSX Composite Index last month, which means Canada's big index funds have sold.

 

https://us.spindices.com/documents/indexnews/announcements/20190308-887958/887958_2019-03-08compositereview-pr.pdf?force_download=true

 

That's interesting, thanks.

 

Has Burgundy Asset Management made any comments on why they like this name so much? Looks like they own almost 20% of the company.

[bizaro86]

One factor that could be depressing the price here is that the company was removed from the S&P TSX Composite Index last month, which means Canada's big index funds have sold.

 

https://us.spindices.com/documents/indexnews/announcements/20190308-887958/887958_2019-03-08compositereview-pr.pdf?force_download=true

 

That's interesting, thanks.

 

Has Burgundy Asset Management made any comments on why they like this name so much? Looks like they own almost 20% of the company.

 

You're welcome. I couldn't find anything on why Burgundy has such a big stake. Maybe they are just highly polished, successful, and scholarly investors like all CMG owners?  ;D

 

Seriously though, I went through some of their writings https://www.burgundyasset.com/library/ and didn't find anything on CMG, although I thought they were interesting. It is a value shop.

[Foreign Tuffett]

Solid results from CMG this morning.

 

https://www.cmgl.ca/sites/default/files/sites/default/files/uploads/docs/CMG_Q4_19_Results_Press_Release.pdf

 

Also, here's an article from last month about how CMG is using AWS to move to the cloud.

 

https://aws.amazon.com/blogs/apn/solving-technological-limitations-of-complex-reservoir-simulation-with-cmg-and-aws/

 

 

[bizaro86]

Solid results from CMG this morning.

 

https://www.cmgl.ca/sites/default/files/sites/default/files/uploads/docs/CMG_Q4_19_Results_Press_Release.pdf

 

Also, here's an article from last month about how CMG is using AWS to move to the cloud.

 

https://aws.amazon.com/blogs/apn/solving-technological-limitations-of-complex-reservoir-simulation-with-cmg-and-aws/

 

I've been out of the simulation game for a few years now, but if that AWS article is accurate, CMG has had a significant breakthrough. Historically parallelization has worked for simulation, but only to a certain extent. When I ran simulations, my company had a group of virtual machines I could use for parallel processing of complex simulations. However, if you run with too many processors it hurts the accuracy of your results. I don't claim to understand this exactly, but it has to do with the math. By splitting the process of solving a very big matrix into too many processes, the rounding inherent in any computer solver affects the results. That limits the effectiveness of using many cores at the same time.

 

However, if they've come up with a more elegant/AI based method for dividing up the solver between multiple cores, then massively parallel computing becomes an option. With the much lower cost of renting processing from cloud providers, that could be a game changer for the cost/effectiveness of simulation.

 

I realize I'm doing a poor job explaining this, but I'm very excited about it. I haven't been able to find anyone in my network who has used this yet. Unfortunately companies aren't exactly spending money on upgrades right now, but I think this has the potential to be very material.

 

Their historical pricing has been based on the number of licenses, with each processor requiring one license. My work was almost never restricted by the number of computers available, but we had an internal process to prioritize  how many licenses one engineer could use depending on the priority of the project. This will increase internal demand for licenses among engineers, and if the cost of computing falls and productivity/value goes up, I could see companies significantly increasing the number of licenses purchased per simulation/reservoir engineer.

[Jurgis]

I have looked at this. I see zero revenue growth in past couple years, zero income growth, and zero change in shares outstanding. It looks like all CF (and more) is paid out as dividends. So is the future going to be the same as past and there will be no growth + all CF paid out as divvies gonna be the only source of return? Why would the future be different from the past?

[bizaro86]

I have looked at this. I see zero revenue growth in past couple years, zero income growth, and zero change in shares outstanding. It looks like all CF (and more) is paid out as dividends. So is the future going to be the same as past and there will be no growth + all CF paid out as divvies gonna be the only source of return? Why would the future be different from the past?

 

It might not be. But there end market has had a brutal cyclical downturn. Presuming that downturn doesn't last forever, I think they're well positioned to grow after it ends.

 

I would incidentally note that they will probably trail the commodity on the recovery, perhaps substantially. The market for software is proportional to the number of reservoir simulation engineers. Companies won't hire for that until they are sure they will have sustained increases in capex. And then they won't add licenses until it's a consistent shortage.

 

But I don't think their business is impaired.

[tenyearsout]

Also mentioned was that they had two more (short term) contracts with different companies for Coflow.  This is promising in that industry is at least trying out their new product.

[Foreign Tuffett]

I have looked at this. I see zero revenue growth in past couple years, zero income growth, and zero change in shares outstanding. It looks like all CF (and more) is paid out as dividends. So is the future going to be the same as past and there will be no growth + all CF paid out as divvies gonna be the only source of return? Why would the future be different from the past?

 

1) CMG has actually been a long term winner. IPO'd in 1997 at $3.50 per share. Once you adjust for 2-for-1 stock splits in 2008, 2011, and 2014 + dividends, the stock has performed very well.

 

2) Building on bizaro86's point: look at the train wreck formerly known as the four largest oilfield services companies:

 

SLB -- $104 to $37

NOV -- $81 to $22

HAL -- $65 to $23

Weatherford -- recently filed for bankruptcy

 

I think we will see the cycle turn at some point.

[DooDiligence]

I have looked at this. I see zero revenue growth in past couple years, zero income growth, and zero change in shares outstanding. It looks like all CF (and more) is paid out as dividends. So is the future going to be the same as past and there will be no growth + all CF paid out as divvies gonna be the only source of return? Why would the future be different from the past?

 

1) CMG has actually been a long term winner. IPO'd in 1997 at $3.50 per share. Once you adjust for 2-for-1 stock splits in 2008, 2011, and 2014 + dividends, the stock has performed very well.

 

2) Building on bizaro86's point: look at the train wreck formerly known as the four largest oilfield services companies:

 

SLB -- $104 to $37

NOV -- $81 to $22

HAL -- $65 to $23

Weatherford -- recently filed for bankruptcy

 

I think we will see the cycle turn at some point.

 

Those guys did big buybacks at the top of the cycle too.

 

Couldn't have planned it worse.

 

It was almost as if they didn't understand their markets at all.

 

---

 

Can someone explain the difference between the modeling CMG does & that which is done by Core Labs?

 

Isn't CLB's production enhancement pretty similar with the inclusion of hardware & field service techs?

[Spekulatius]

Yep, these buybacks from SLB, HAL and others were quite nonsensical. I suspect is more benefiting management to push up stock prices  on the top of a cycle, so they can sell at even better prices than would’ve possible without buybacks, then to buy back stock when it actually makes sense forma perspective of adding intrinsic value to shares. I recall SLB having an great balance sheet with net cash in the 80‘s and 90‘s - then they spent the dough on low margin acquisitions ( pressure pumping and similar) and stock buybacks and now this company looks like a low quality operation with a matching balance sheet. I will guess the will take some dividend investors with it when they finally cut, because it does not look like they cannot afford to pay they $2/ share much longer.

[DooDiligence]

I just listened to the last CLB earnings call.

 

Demshur opens up with a welcome to everyone, “especially to our employees”.

 

Projecting lower completions but intensity of perforations should be up which provides a revenue opportunity.

 

If tight onshore activity drops & deepwater offshore increases, Core Labs will garner higher margin opportunities due to the increased complexity of these operations.

 

Touting pre-assembled guns. It’s all about the high margin charges. The gun is just a delivery vehicle.

 

Focusing on a wide range of energetics (explosives/charges) efficiency as used across a variety of rock formations. Talks about competitors offering closed system guns where the client doesn’t have the option of changing out energetics at the well site. Core Labs gun systems are pre-assembled but packaged with multiple energetics packages which can be swapped out onsite.

 

Wireline operator takes ownership but operator makes the decision regarding configuration & deployment.

 

Noticing a slight uptick in proposed deepwater projects.

 

Still maintaining great FCF & leveraged.

 

I'm down 20ish% on this & doubled up in my retirement account today.

 

I expect to have to hold this for at least a decade.

 

(Living up to my signature...)

[Foreign Tuffett]

Did anyone else catch this nugget in the recent proxy/management information circular filing?

 

"The Corporation’s GEM simulator is industry-recognized as the only commercial simulator capable of modelling all of the applicable physics associated with GHG [greenhouse gas] sequestering processes. In such operations, GHGs are injected deep underground into saline aquifers where they can be safely and permanently retained."

 

 

[Jurgis]

Did anyone else catch this nugget in the recent proxy/management information circular filing?

 

"The Corporation’s GEM simulator is industry-recognized as the only commercial simulator capable of modelling all of the applicable physics associated with GHG [greenhouse gas] sequestering processes. In such operations, GHGs are injected deep underground into saline aquifers where they can be safely and permanently retained."

 

Do you think this is positive or negative or just infoporn?

 

I can see both positive and negative interpretations for this:

 

Positive: New/additional business for GHG modelling. ESG funds invest in shares (if you want the shares to go up).

Negative: Management just added ESG promotional tidbit which generates no business, but promotes shares to ESG suckers investors.

Neutral: "Let's add this sentence and see if Foreign Tuffett anyone notices".  ;)

[Foreign Tuffett]

Did anyone else catch this nugget in the recent proxy/management information circular filing?

 

"The Corporation’s GEM simulator is industry-recognized as the only commercial simulator capable of modelling all of the applicable physics associated with GHG [greenhouse gas] sequestering processes. In such operations, GHGs are injected deep underground into saline aquifers where they can be safely and permanently retained."

 

Do you think this is positive or negative or just infoporn?

 

I can see both positive and negative interpretations for this:

 

Positive: New/additional business for GHG modelling. ESG funds invest in shares (if you want the shares to go up).

Negative: Management just added ESG promotional tidbit which generates no business, but promotes shares to ESG suckers investors.

Neutral: "Let's add this sentence and see if Foreign Tuffett anyone notices".  ;)

 

A management team that doesn't do earnings call or IR presentations inserted two sentences on page 48 of the annual proxy because it's trying to promote the stock to "suckers?" That isn't even plausible.

 

* Edited for clarity.

 

 

[Jurgis]

Did anyone else catch this nugget in the recent proxy/management information circular filing?

 

"The Corporation’s GEM simulator is industry-recognized as the only commercial simulator capable of modelling all of the applicable physics associated with GHG [greenhouse gas] sequestering processes. In such operations, GHGs are injected deep underground into saline aquifers where they can be safely and permanently retained."

 

Do you think this is positive or negative or just infoporn?

 

I can see both positive and negative interpretations for this:

 

Positive: New/additional business for GHG modelling. ESG funds invest in shares (if you want the shares to go up).

Negative: Management just added ESG promotional tidbit which generates no business, but promotes shares to ESG suckers investors.

Neutral: "Let's add this sentence and see if Foreign Tuffett anyone notices".  ;)

 

A management team that doesn't do earnings call or IR presentations inserted two sentences on page 48 of the annual proxy because it's trying to promote the stock to "suckers?" That isn't even plausible.

 

* Edited for clarity.

 

OK. How about this then: the company is described above as nerd/Ph.D. heaven. So perhaps they added two sentences because they thought it was cool from physics/engineering perspective, and they have the feature, and they are proud of it, but it's quite possibly not gonna add any significant business (anytime soon).

 

It would be interesting to hear if any customers are buying their product because of the GHG modelling capabilities.