FTK - Flotek

[writser]

Has anybody ever looked at Flotek (FTK) recently? Was a somewhat fashionable short in 2015 / 2016 if I remember correctly. The company has since then sold most of their divisions. Only the 'energy chemistry technologies segment' remains. Basically they sell chemicals that increase productivity of oil and gas wells. Pro forma (link) the company has ~$100m in net cash, ~$17.5m in escrow. Market cap is ~$200m for an EV of ~$90m (all ballpark). Revenue of this segment has been around $200m the past few years.

 

Mgmt doesn't appear very competent and there's way too much overhead. But a shareholder (David Nierenberg from D3 Family Funds) is on the board since 2018, is now chairman and leading a 'strategic capital committee', determining what to do with the excess cash. Also, the company has hired a new CFO last December with a history of short stints and strategic transactions. She's also on the strategic capital committee.

 

I have a hard time judging how attractive / profitable the ECT business is but it seems like shareholders finally have a place at the table and that a sale and/or return of capital is a distinct possibility. Pro forma the company seems cheapish on a few simple metrics. Any thoughts?

 

VIC writeup that piqued my interest: https://www.valueinvestorsclub.com/idea/Flotek/9761947981 .

[Foreign Tuffett]

Weren't the short cases correct in that FTK's core fracking chemicals ("stimulation chemistry") business line is commoditized? I think part of the reason this was (as you mention) a battleground stock several years ago is that, with lots of new technologies and variables, onshore E&P companies didn't have great insight into how to maximize hydrocarbon recoveries (lateral lengths, proppant levels, etc). FTK was able to convince some industry players (and investors!) that their products deserved a premium price due to higher levels of effectiveness, but it was only a matter of time before the industry as a whole figured out that this was not, in fact, the case.

 

http://brontecapital.blogspot.com/2016/12/flotek-some-new-research.html

 

https://www.fourworldcapital.com/ftk-supporting-materials

 

Is this cheap on asset basis: Yes (@ a $3.41 stock price I came up with a $82 million EV #)

 

Is it a low quality business: In my opinion, yes

 

Nierenberg as Chairman is a positive development, but he has been long and wrong here for an extended period of time.

 

It's an interesting idea, but it's probably a pass for me.

[writser]

Is it a low quality business: In my opinion, yes

 

Sure, but, despite that revenue from the segment was $188m in 2016, $243m in 2017 and $177m in 2018, with a gross margin of ~24% the past nine months (down from ~40% in 2015, 2016). Not superb but apparently the product is not totally b.s. either. Remainco is probably too small as a standalone entity, especially given the ridiculous overhead costs, but currently it is priced at ~0.5x EV/revenue or something like that. Shouldn't it be a very attractive acquisition target at that multiple?

 

Not saying I'm completely convinced either. But story might be worth following.

[SnarkyPuppy]

I own some for the reasons described.  Part of it is just a short term rare info arb (maybe I'm the one being info arb'd?) where the price is clearly ridiculous and should rerate as the VIC author describes.  VIC author also talks about recent Saudi deal which likely was the result of significant due diligence by knowledgeable people in the field vs desktop jockeys playing with excel. 

 

Let's just say that I don't intend to hold forever.

[writser]

Glad I avoided this one so far. Q2 another ~15m net loss on 35m of sales. Gross margins were actually negative. Shares down ~30% today for a market cap of ~$125m. EV is basically zero. Cheap, but it will go down in flames quickly this way.

 

“Finally, our Strategic Capital Committee continued to make important progress in the second quarter in its detailed review that began with a deep-dive into the business and later moved into an evaluation of the alternative possible uses for the significant amount of cash on our balance sheet as a result of the sale of Florida Chemical Company.”

 

The deep-dive .. I don't see any urgency to sell this PoS as soon as possible. Maybe the conference call will bring up something interesting.

[writser]

Conference call snippets:

 

we are in a buyers' market today for energy businesses. Therefore, we should recognize the very considerable opportunity costs of using cash merely for financial engineering.

 

Next, because we are in a buyers market for oilfield services, have $100 million and are protecting it vigilantly, the Strategic Capital Committee is evaluating inorganic growth opportunities, which could grow revenue and profit. Our valuation of these with Citi has already considered approximately 40 possibilities. Our acquisition criteria include these goals: Buying immediate positive EBITDA in a buyers market; therefore, not buying a start-up, not buying a bleeder, but a well-managed partner with scale and profits.

 

if a company has a very weak balance sheet and isn't performing well, then it may need to sell itself. But we have a lot of opportunities to add value to what we have here, and we have -- I think all of us come to the conclusion that the better thing to do is to keep our head down and make those good things happen.

 

If 'buyers' market' was on your conference call bingo card you'd have had a great time. Phrase of the day .. Seems like these guys are pretty much focused on growing scale by acquisitions. Maybe that's the smart thing to do, but I don't think I want to get involved with that.

[kab60]

Haven't followed the Company but that management sounds like a structural short.

[Homestead31]

one can certainly argue that there are real execution risks here, but I think criticism of "management" here is mis-placed.  The shots are being called by the Chairman of the board, who is guy that has run a concentrated small cap portfolio for 30 years.  Before that, he was Mitt Romney's right hand man at Bain.  He owns a decent sized position, and bought stock in the open market about 6 weeks ago at prices that are 80% higher than the current stock price.

 

again - you can argue about the execution risks - but the credentials and incentives of the guy running the show are impeccable in my opinion.

 

"buyers market" definitely got punched on the bingo cards, but so did "time arbitrage."  The simple fact is that this company has a ton of cash, and when capital markets are closed to most industry participants, each of those dollars is worth more than a dollar.

 

i recommend reading the transcript of the last call - or the last 3 calls - before passing judgement.  i think much of the selling was just from people who were playing for a quick buyback, and who were disappointed.  i get it - i am certainly disappointed - but the guy who knows the most about what is going on is not someone who  is career management and just trying to protect their own job.  he is someone whose real job is doing what alot of the people on this board do - investing in small cap stocks - and insider buying from someone like that right before a huge sell off should make people think a little deeper in my opinion.

 

 

[Foreign Tuffett]

one can certainly argue that there are real execution risks here, but I think criticism of "management" here is mis-placed.  The shots are being called by the Chairman of the board, who is guy that has run a concentrated small cap portfolio for 30 years.  Before that, he was Mitt Romney's right hand man at Bain.  He owns a decent sized position, and bought stock in the open market about 6 weeks ago at prices that are 80% higher than the current stock price.

 

again - you can argue about the execution risks - but the credentials and incentives of the guy running the show are impeccable in my opinion.

 

"buyers market" definitely got punched on the bingo cards, but so did "time arbitrage."  The simple fact is that this company has a ton of cash, and when capital markets are closed to most industry participants, each of those dollars is worth more than a dollar.

 

i recommend reading the transcript of the last call - or the last 3 calls - before passing judgement.  i think much of the selling was just from people who were playing for a quick buyback, and who were disappointed.  i get it - i am certainly disappointed - but the guy who knows the most about what is going on is not someone who  is career management and just trying to protect their own job.  he is someone whose real job is doing what alot of the people on this board do - investing in small cap stocks - and insider buying from someone like that right before a huge sell off should make people think a little deeper in my opinion.

 

I get what you're saying, but there's such a thing as sector-specific knowledge, and Nierenberg appears to have little. He's owned shares since 2015, right? Most of what you are saying could have been written back then.

 

While I basically agree that the oilfield services space is a buyer's market right now, I don't see any indication that I want this management team to be buying anything on my behalf. Small cap oilfield services is a space filled with junk companies (like this one), that can become impaired faster than you can say "what happened here?"

 

I think this is suitable for a quant basket of net nets, but other than that no thanks.

 

 

 

 

[Homestead31]

[

 

Most of what you are saying could have been written back then.

 

 

 

Back then they were heavily indebted, preparing to sell assets, they had not yet gone through cost cutting exercises, the CEO had not yet agreed to a pay cut to stay on, Nierenberg was not an insider, there was no strategic capital committee, the CnF technology had not been validated by Saudi Arabia and others, they were relying on HAL for most of their distribution.

 

Now they are cash heavy, and preparing to buy assets, and all of those other things have changed as well, so I think the situation is markedly different.

 

that being said, i agree that Nierenberg is not a domain expert (probably a good thing given how much value destruction there has been in the space), and as i said previously there is certainly execution risk. 

[writser]

Artko capital has a 10% core position in Flotek (gutsy) and shares his thoughts on Flotek in his latest letter: https://www.hvst.com/organization/art-capital-lp/posts/artko-capital-3q-2019-partner-letter-EvrTnLGB .

We believe at these prices we are well compensated for this risk and in return we are getting free optionality on a number of potential positive external and internal scenarios within the next few years such as a return of stronger oil and gas markets; CnF product and the new technically oriented salesforce being as good as management claims it to be and receives customer recognition in form of higher revenues as a result; a profitable revenue layer acquisition and further cost  cutting  efforts  create sustainable profitability  for  the  company;  at the  current  stock price  the strategic committee changes its mind and initiates a share buyback; a successful sale of the company at  a price higher than the zero value  the market assigns to it today  and so on. In a nutshell, Flotek represents  the  type  of  investment  we tend to get  excited  about:  a stock with  extreme  negative sentiment,  industry  and company  specific;  with  low  permanent  capital  impairment  risk,  high uncertainty  and  free  optionality  for  potential  returns  in  the  100s  of  percent  from  these  levels.

 

Can't say I'm quite convinced but a decent read nonetheless.

[Foreign Tuffett]

Artko capital has a 10% core position in Flotek (gutsy) and shares his thoughts on Flotek in his latest letter: https://www.hvst.com/organization/art-capital-lp/posts/artko-capital-3q-2019-partner-letter-EvrTnLGB .

We believe at these prices we are well compensated for this risk and in return we are getting free optionality on a number of potential positive external and internal scenarios within the next few years such as a return of stronger oil and gas markets; CnF product and the new technically oriented salesforce being as good as management claims it to be and receives customer recognition in form of higher revenues as a result; a profitable revenue layer acquisition and further cost  cutting  efforts  create sustainable profitability  for  the  company;  at the  current  stock price  the strategic committee changes its mind and initiates a share buyback; a successful sale of the company at  a price higher than the zero value  the market assigns to it today  and so on. In a nutshell, Flotek represents  the  type  of  investment  we tend to get  excited  about:  a stock with  extreme  negative sentiment,  industry  and company  specific;  with  low  permanent  capital  impairment  risk,  high uncertainty  and  free  optionality  for  potential  returns  in  the  100s  of  percent  from  these  levels.

 

Can't say I'm quite convinced but a decent read nonetheless.

 

Several things I disagree with in that letter about FTK:

 

* One of the few times I've seen someone lump in restricted cash in with unrestricted cash balance ($97.5 + 0.7 = his $98.2 million #). It's not meaningful difference, but seems like an odd thing to do.

 

* The land and buildings they own are really only liquid if the company (1) liquidates or (2) does some sale-leaseback transactions, which would immediately cause it to start burning even more cash. Also, they may or may not be worth the ~$40 million they are carried at on the balance sheet.

 

* The real risk here isn't a "10 - 20% permanent capital impairment loss." This could be a zero in a couple of years if management blows most of the cash hoard on a bad acquisition and the core business continues to burn cash. Cyclicality aside, it is brutally difficult to make successful acquisitions in the oilfield services space, particularly when you don't have a strong core business to bolt smaller companies on to.

 

I continue to think this is only suitable idea for a net net basket or quant strategy.

 

[mjohn707]

Artko capital has a 10% core position in Flotek (gutsy) and shares his thoughts on Flotek in his latest letter: https://www.hvst.com/organization/art-capital-lp/posts/artko-capital-3q-2019-partner-letter-EvrTnLGB .

We believe at these prices we are well compensated for this risk and in return we are getting free optionality on a number of potential positive external and internal scenarios within the next few years such as a return of stronger oil and gas markets; CnF product and the new technically oriented salesforce being as good as management claims it to be and receives customer recognition in form of higher revenues as a result; a profitable revenue layer acquisition and further cost  cutting  efforts  create sustainable profitability  for  the  company;  at the  current  stock price  the strategic committee changes its mind and initiates a share buyback; a successful sale of the company at  a price higher than the zero value  the market assigns to it today  and so on. In a nutshell, Flotek represents  the  type  of  investment  we tend to get  excited  about:  a stock with  extreme  negative sentiment,  industry  and company  specific;  with  low  permanent  capital  impairment  risk,  high uncertainty  and  free  optionality  for  potential  returns  in  the  100s  of  percent  from  these  levels.

 

Can't say I'm quite convinced but a decent read nonetheless.

 

Several things I disagree with in that letter about FTK:

 

* One of the few times I've seen someone lump in restricted cash in with unrestricted cash balance ($97.5 + 0.7 = his $98.2 million #). It's not meaningful difference, but seems like an odd thing to do.

 

* The land and buildings they own are really only liquid if the company (1) liquidates or (2) does some sale-leaseback transactions, which would immediately cause it to start burning even more cash. Also, they may or may not be worth the ~$40 million they are carried at on the balance sheet.

 

* The real risk here isn't a "10 - 20% permanent capital impairment loss." This could be a zero in a couple of years if management blows most of the cash hoard on a bad acquisition and the core business continues to burn cash. Cyclicality aside, it is brutally difficult to make successful acquisitions in the oilfield services space, particularly when you don't have a strong core business to bolt smaller companies on to.

 

I continue to think this is only suitable idea for a net net basket or quant strategy.

 

This was more or less my feeling as well.  And even for a net-net or Schloss type of investment, I thought that this could have been a little cheaper.  Could work out, who knows, but a 10% sizing is very brave to say the least

[Spekulatius]

^ These Artko folks have balls, that’s for sure. So far, it seems to be working out for them.

[Philbert77]

 

i recommend reading the transcript of the last call - or the last 3 calls - before passing judgement.  i think much of the selling was just from people who were playing for a quick buyback, and who were disappointed.  i get it - i am certainly disappointed - but the guy who knows the most about what is going on is not someone who  is career management and just trying to protect their own job.  he is someone whose real job is doing what alot of the people on this board do - investing in small cap stocks - and insider buying from someone like that right before a huge sell off should make people think a little deeper in my opinion.

 

I just read (mostly) the the most recent conference call transcript and I am pretty impressed with David Nierenberg.

 

" Our assessment of the current widespread wreckage in the oilfield services capital market today with so many once mighty companies share prices knocked down to under a buck or single-digit and with such pervasive fear of debt repayment, access the capital and busting covenants and with energy stocks being so out of favor as a percentage of the entire S&P 500 capitalizaiton, convinced us that we are in a buyers' market today for energy businesses.

 

 

Therefore, we should recognize the very considerable opportunity costs of using cash mainly for financial engineering, the opportunity cost of possible misallocation of capital today is about as high as I've ever seen it. Because our cash is so strategic revaluable now, we are intense about protecting it four ways; continuing to reduce cost, managing our balance sheet to generate cash through monetization of working capital controlling CapEx and discretionary investments and collecting escrows; steering the mix of our product sales toward our most profitable products; and using our new upgraded sales team to drive revenue growth again. Our policy has to be this, do not let our cash become a melting block of ice. Rather, use time to make prudent profitable allocations of scarce capital in a buyers' market.... To conclude, we would like to take full advantage of the balance sheet strength, which our cash is so precious and valuable today relative to paying out cash and dividends or repurchases. There is no certainty that we will make an acquisition, nor should we act under pressure to make one. But there would be a very different certainty if we had dividend and out the cash or use the large portion of it to do repurchases, because that cash then would be gone and could no longer be used to buy and build growth, scale, profitability, and build further on our solid C&S platform in a buyers' market. So we're going to keep the pressure on cost reduction, protect our cash, grow CnF and scour this buyers' market for sensible prudent business combinations, which could add value." https://seekingalpha.com/article/4284394-flotek-industries-inc-ftk-ceo-john-chisholm-q2-2019-results-earnings-call-transcript?part=single

 

I would also add that Matthew Sweeney of Laughing Water Capital is also a proponent of Flotek: https://static1.squarespace.com/static/5d93ed0b59166652b0d66427/t/5d9f479eca9e7941403f75d4/1570719647500/2019+LP+Meeting+Transcript.pdf

 

Essentially FTK is a bet on a jockey with a business sitting on a stack of cash.

[Foreign Tuffett]

Philbert77, I disagree.

 

Nierenberg on the Q2 call on the strength of the core business:

 

So if I may borrow from Ronald Reagan, there definitely is a pony in this room, and this pony's name is CnF. If CnF were not the pony, then the strategic capital committee could lean towards paying out a large special dividend, or even towards selling the company. But a profitable core product, which adds value, which can be focused and grown and which has growth opportunities in EOP, we definitely want to build on that. And our C&S growth opportunity is being substantiated in real time by half of dozen large customer prospects. We do have several other organic growth opportunities in other parts of the company.

 

Well, the market is pricing the stock like their core business is complete garbage, so if he really believes all that then buying back shares with their surplus cash is a no-brainer. However, here's the very next thing he says:

 

Next, because we are in a buyers' market for oilfield services, have $100 million and are protecting it vigilantly, the strategic capital committee is evaluating inorganic growth opportunities, which to grow revenue and profit. Our evaluation of these with Citi has already considered approximately 40 possibilities.

 

He (1) is just bad at allocating capital and/or (2) is irrationally confident that he will pull the trigger on a really good acquisition and/or (3) he doesn't actually believe everything he said about the core business and/or (4) is now an entrenched insider.

 

 

[Philbert77]

He (1) is just bad at allocating capital and/or (2) is irrationally confident that he will pull the trigger on a really good acquisition and/or (3) he doesn't actually believe everything he said about the core business and/or (4) is now an entrenched insider.

 

I'm not so sure about those statements. I don't believe his faith in the core business and the plan to make acquisitions in a cash starved environment to be mutually exclusive. Share buybacks are not the end all and be all of investing. Additionally, Nierenberg has substantial skin in the game - he is going to play this in a way that benefits his holdings as well.

 

I like what Matthew Sweeney thinks:

 

"with Flotek, sticking with valuation for another minute, we have an escape hatch too. There are multiple ways to win. Right now it seems like the plan is to clean up the business and then try to grow the business, but if it seems like that is too hard, or isn’t working, there is an escape hatch in that this business could be sold too...  if the incentives weren’t inline, if instead of Nierenberg we had a real born and bred wildcatter making the decisions then I would weight the probability of a sale at zero, but Nierenberg is rational – he has no ego tied up in this – he thinks like an equity owner because that is the business he is in – so if the current plan to clean up the business and make some acquisitions doesn’t work, he’ll look out for his best interest, which is the same as our best interest, and push to sell the company and we’ll do fine. " https://static1.squarespace.com/static/5d93ed0b59166652b0d66427/t/5d9f479eca9e7941403f75d4/1570719647500/2019+LP+Meeting+Transcript.pdf

 

Give it a 2 or 3 years and we'll see who is right.  As the saying goes - "time and truth march hand in hand".

[Foreign Tuffett]

Q2 rev: $34.692 million

 

Q3 rev: $21.879 million

 

Not good

[Foreign Tuffett]

Notes from the call that just ended. I do not warranty the accuracy of these!

 

 

Q3 call: "We expect sales to continue to be depressed in Q4." We won't see the full benefits of all the new initiatives we are working until next year.

 

CFO: "We expect Q4 to be similarly challenging [relative to Q3]." They've engaged a consulting firm to help reduce expenses and become more efficient.

 

Capital allocation: Sounds like they are still focused on acquisitions, but they have slowed down their search due to industry backdrop.

 

Chairman: Q3 revenues were "disappointing and frustrating." "we are doing all we can to preserve" our liquidity. Our investors urged us to stay away from inorganic opportunities. We pressed the pause button on acquisitions. We are searching for CEO's successor.

 

CEO: "It has taken time to get new sales team up to speed." We don't talk in great specificity about our sales mix.

 

CFO: trying to push breakeven rev # below $40M per Q (they are well below that # right now!). ~189 total employees @ end of Q3.

 

CFO: we are not really looking at acquisitions outside of the energy space. Sounds like no acquisition until a new CEO is in place.

 

Analyst question: "Why not buyback stock here?" -- Chairman: "It has been extensively considered and we will continue to think about it...CEO candidates really like the "balance sheet as it is today", so it is a "bit premature" to buyback stock until a new CEO is in place.

 

"Budget exhaustion" in onshore E&Ps.

 

Analyst question: "Have u thought about putting the company up for sale?" Chairman: "we have made alot of progress on cost reduction." "I think we owe it to everybody to complete our own cost reduction work"...."it is premature to decide to throw in the towel and put the company up for sale"..."I'd like to see all the things that we can do to make ourselves better" 

 

Analyst: You have taken a much riskier strategy by choosing to build your own salesforce instead of putting company up for sale after sale of Florida Chemical completed.

[writser]

Ugly numbers. They really seem hell-bent on growing / turning around the business. Maybe it will work out but I don't like it.

[Foreign Tuffett]

I think I am beginning to understand why management is "hell-bent" (as writser put it) on trying to turn the ship here.....

 

Page #30 of the Q3 10-Q: They have ~ $72 million of contractual obligations for "supply commitments for raw materials."

 

What are these mystery supply commitments? Look at page #30 of Q2 10-Q:

 

"In addition, the Company executed a long-term supply agreement for terpene product, which serves as a feedstock to some of the Company’s key value-added products. The term of the agreement runs through September 2023, with an option to extend for an additional year. This agreement secures the Company’s access to a sufficient supply of terpene and includes a minimum annual purchase requirement at variable prices during the term of the agreement."

 

FTK can't let its horribly money losing business run off (or shrink its way to break even), as it is on the hook to continue to purchase certain quantities of terpene.

 

 

Hat tip to this smart dude on Twitter who figured all this out:

 

https://twitter.com/Teutoburg1/status/1194376841471156239

 

 

Foot stomp to FTK management for poor disclosure related to this issue.

[writser]

Solid research. Not sure I agree 100% with the premise that this is limiting management. As far as I can see we're talking $18m / year for 4 years. Not sure how big of a part Terpene is of their COGS but with "product operating expenses" of ~100m+ annually I'm not quite convinced that the contract will be killing if revenue drops a bit. And with ~$110m in cash there should be room for buybacks regardless. Not to mention that they still can put up the company for sale.

 

But in broad lines I agree. Teutoburg calls the division sale a 'sale-leaseback' and it looks like he has a point. Also one gets the impression that management is trying to sweep this issue under the rug - not mentioned in any recent call / press release afaik.

 

Still happy I'm on the sidelines.