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Is Tesco A Technology Stock?

Posted: Jan 13, 2009 13:46 PM by Eric Fox

Tickers in this Article: HAL, RDS.A, NOV, TESO

Tesco Corporation (Nasdaq:TESO) is an oil services company with a narrowly focused product line selling top drives and conventional casing services, but with a proprietary technology that allows rig operators to drill quicker and more efficiently. The stock is off 75% from its high and may present an opportunity for investors with the fortitude to ride out the downturn in energy.

Top Drives
A top drive is a motor placed in the derrick of a drilling rig. Its purpose is to rotate the drill bit, string and drill the well. Tesco has a 25% market share in this approximately $1 billion market. The company also rents units to operators who don’t want to make the capital commitment.

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National Oilwell (NYSE:NOV) is the leading company in this market with a share of just over 50%. This segment provided approximately two-thirds of Tesco’s revenues in the nine months ended September 30, bringing in $253 million. It is also the most profitable for Tesco with operating income of $83 million out of a corporate total of $90 million in the same period.

Casing Services
Tesco provides conventional casing and tubular services, which refers to the process by which pipe is placed into an open hole after drilling. Casing is usually made of steel but can include other materials when necessary. The purpose of casing is to stabilize the well bore to prevent it from caving in and to isolate different formations when needed. Revenue in this segment was $143 million in the nine months ending September 30. This business is not very profitable for Tesco and only provided $7 million in operating income.

Casing Drilling Technology
One reason for the low margins may be the investment Tesco has made in "casing drilling", a technology that allows wells to be drilled and cased simultaneously. The company has spent $25 million so far developing this technology, which is not a small sum for a company that size. Tesco offers this product in collaboration with other companies including Halliburton (NYSE:HAL).

This process eliminates drill string tripping, which refers to the process by which drill pipe is removed from the hole after drilling. This is a cumbersome and expensive operation, as frequently the drill pipe can get stuck down in the hole. Tesco estimates that wells can be drilled in 20-30% less time. (Learn more about the companies that service the oil and gas sector in our Oil Services Industry Handbook.)

One company that used this casing drilling technology is Royal Dutch Shell (NYSE:RDS.A), which used it to drill wells in the Pinedale Anticline in Wyoming.

Financials
Tesco had $8 million in cash and $54 million in debt on September 30. The company’s net debt-to-book capitalization was 11.5%, and it has access to an $81.5 million credit facility. One of its goals in 2009 is to bring net debt down to zero. The company’s debt comes in two parts. The first is $41 million of a revolver due June 5, 2012, and the second is $12.5 million of a term loan due October 31, 2009. It also has $9.9 million of the current portion of long-term debt due over the next year.

Risks
Due to the situation in the credit markets, the company has a risk in the next year of rolling over some of this debt. Also, demand for both casing and top drives are tied fairly closely to the drilling cycle, and it is likely that business has not reached a trough yet in this cycle.

It is always difficult to get new methods adopted in any business, and Tesco may find it difficult to get the industry to implement this new technology.

Tesco’s technology of casing while drilling may get a lift during the current downturn in the energy sector, as exploration and production companies look to drill wells quicker and more efficiently to save on costs. It may also distinguish the company from its peers once a recovery begins, but Tesco must work on getting industry participants to see the benefits of the technology.

To learn more about investing in this sector, be sure to read our Oil And Gas Industry Primer.

By Eric Fox

Eric J. Fox, is the founder of Brittain Capital Management, LLC., which manages the Alesia Fund, LP., a Value oriented long/short investment partnership. You can read more of his views on investments at his blog - Stock Market Prognosticator.

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