Don't Take Grant Prideco for Granted
Grant Prideco (GRP: NYSE)
By Bear, Stearns & Co. ($49.49, March 29, 2007)
We have raised our rating on Grant Prideco from Peer Perform to Outperform, and we have set a year-end 2007 price target of $65.
The momentum of consolidation and buyouts in the oilfield steel-tubular-products area continues at an astonishing pace. Yesterday's announcement of the acquisition of Lone Star Technologies by U.S. Steel is the fifth buyout of an U.S. oilfield tubular company in the past 12 months.
Buyout valuations also are on the rise. The $67.50-per-share purchase price of Lone Star equates to a multiple of 18 times estimated 2007 earnings and an enterprise value/earnings before interest, taxes, depreciation and amortization multiple of 8.5 times on estimated 2007 EBITDA.
Hydril, a company being acquired by Tenaris, is a closer peer to Grant Prideco than is Lone Star. Hydril at the buyout price of $97 per share is valued at a multiple of 19.8 times estimated 2007 earnings and an EV/EBITDA multiple of 11.6 times on estimated 2007 EBITDA. Grant Prideco at yesterday's closing price of $49.49 is valued at a price-to-earnings multiple of 12.5 times and an EV/EBITDA multiple of 9.1 times (based on our 2007 estimates of earnings and EBITDA).
Grant Prideco's three core businesses -- drilling products, drilling bits, and tubular technology -- are performing strongly as evidenced by the company's operating margins of 30% and EBITDA margins of 32% in 2006. The company is the world leader and the largest manufacturer of drill pipe, with 18 million feet per year of production capacity. It is the premier global franchise in high-performance drill pipe and has maintained both its technology and market share leadership in the current business cycle. Low-cost capacity expansions have helped to boost returns on invested capital to a projected 31% in 2007, up from 26.5 % in 2006.
We believe that near-term weakness and uncertainties relating to the North American gas-drilling market will have little impact on Grant Prideco's earnings, and even less influence on the value of Grant Prideco to a potential strategic buyer of the company. Lone Star Technologies has felt a much greater impact from the U.S. gas-drilling slowdown than has Grant Prideco.
However, Lone Star's attractiveness to U.S. Steel was in no way diminished by the near-term weakness in U.S. gas drilling. In the case of Grant Prideco, we believe that investors can confidently look beyond the impact of a temporary slowing in drill-pipe orders, which might come later in 2007 if the direction of the U.S. gas-drilling market continues to be uncertain.
Grant Prideco is a much larger company than either Hydril or Lone Star (which are both around $2 billion in equity market capitalization). Grant Prideco currently has an equity market capitalization of $6.4 billion and would have an equity market value of $8.3 billion at our price target of $65, which we believe is a minimum buyout price for the company. Despite its much larger size, we expect that there are multiple potential buyers of Grant Prideco that could finance an acquisition in the $8 billion-to-$10 billion range.
As the number of "un-acquired" companies in the oilfield steel-tubular and steel-products niche shrinks, the scarcity value of the companies that remain increases. This is evident in the price paid for Lone Star, which was the last remaining independent manufacturer of oilfield casing and tubing until its purchase by U.S. Steel.
Lone Star's buyout price is at a 36% price-to-earnings multiple premium to the average buyout prices of Maverick Tube, NS Group, and Oregon Steel, the three oilfield steel-tubular-goods companies that were purchased by larger international steel companies last year. We believe that Grant Prideco's scarcity value is growing by the day as the steel industry and the oilfield-service industry consolidate.
Grant Prideco is strongly positioned globally and, more than any other company we follow, has the best prospects of receiving the kind of buyout proposal that simply can't be refused.
-- Robin Shoemaker
-- Jason Strominger
-- Mark Brown