Warren Levy Interview with Wall Street Journal
WSL: Tell us a little about what’s the overall market that you’re targeting and how large it is, and elaborate on the potential growth?
WL: Well the drilling market in South America consists of roughly 600 drilling rigs and around 3,000 work-over rigs so you could consider the whole market to be about a third of the size of the U.S. market. It is a market that’s seen very steady growth over the last decade with general energy demand in South America, and a huge increase in resource discoveries most notably in Venezuela, Argentina, and Brazil. We see the market potential over the next five to ten years should grow an additional 15% to 20%, and we expect that to continue in the decades to come.
WSL: Tell us a little more about the current services that you offer to the oil and gas industry?
WL: We have three primary service lines. The largest is drilling the work-over rigs where we have a fleet of 19 rigs spread around South America. We also have a directional drilling business that we run in association with Scientific Drilling from California, and we have a consulting and engineering business, which does everything from simple well programs right up to contractor operatorship for some small companies in Argentina and Colombia.
WSL: Give us an example of an existing customer and their value position in choosing Estrella?
WL: We try to target a mix of customer base from NOCs to medium sized regional players or junior companies such asCanacol. We’re currently working with Canacol in Colombia on a project in the remote southern area where we’re drilling what are called strata-graphic wells. These are wells that allow the customer to evaluate the formation without having to obtain a full environmental license. It’s kind of like a pre-test of the subsurface. We’ve been working with Canacol for about six months on the project and we’re basically turn-keying the project for them. They give us a location and we go out and take care of everything from building the roads in the location, managing third party suppliers, and drilling the well. It allows Canacol to focus on the core of their business, which is evaluating the subsurface, and turning over the operational responsibility to us. We like that type of approach to allow our customers to focus on their core business, and allow us to bring value in what we’re good at, which is drilling wells.
WSL: What do you feel is so unique about the company that gives you competitive advantages within your market space?
WL: In South America, for a variety of reasons, there have not been a lot of regional companies. Small companies have tended to grow in one market or even with one customer inside of a market, and we’ve had the multinationals that have historically come in from North America and from Europe. What we’ve been able to do is carve out a space in between those two companies where we have a regional footprint, we’re able to offer technology, and expertise, at the level of the multinationals without losing the contact that the local, or mom and pop service companies have with their communities, with their marketing, with their customers. So what we’ve been able to do is create a company where in each country where we operate we are seen as a local but with an international or multinational level of technical excellence. We think that’s a really unique space. It’s something that for lack of financing, for political, and for cultural reasons, very few companies have been able to do in the past, and we’re creating this space with us. As our customers grow, and become regional, especially the Canadian juniors, they’ve looked to us to be able to grow with them and we think it’s a really exciting space going forward here.
WSL: Can you talk about your strategic partnerships and the underlying strategy behind them, and talk a little bit more about the acquisition of Zigma Petroleum Services?
WL: What we were able to do in the directional business we carved out a niche of drilling fairly simple directional wells. The market hasn’t matured as much in South America yet as North America where horizontals will be coming increasingly the norm especially for non-conventional developments, but as time goes on in South America, a combination of environmental concerns and complexity of resources, is driving the increased application of directional drilling. The challenge we faced three or four years ago was the availability of commercially available technology off the shelf was becoming limited and restricted. GE had really done a good job of consolidating a lot of the small suppliers into their service offerings, so we went out and looked at the market looking for access to proprietary technology without developing it ourselves. We were able to create a relationship with Scientific Drilling, have access to their proprietary MWD, logging technology and etc, and it’s a bit of unique relationship both for them and for us because it’s the first time Scientific has allowed a third party to operate their technology on their behalf. We now have a directional drilling business around South America where we effectively have access to proprietary technology but we operate it as Estrella Directional Services. In addition to that we have grown through acquisitions in Colombia, the one you mentioned Zigma Petroleum Services, was the most recent acquisition we completed. When we looked at the Colombian market we wanted to identify a way to grow in the market and obtain critical mass, recognizing there’s some particularities in the market; security, logistics, social responsibility is used in Colombia that require your company to be of a reasonable scale to operate successfully. We identified three potential acquisitions. Zigma was the last one that we completed.
The Zigma story is an interesting one. A company that had a very good reputation and had been operating for some time in the market, and sadly the owner passed away and the company was left in the hands of a widow. We were able to come in, purchase the company, modernize the fleet a fair bit, bring some new technology to the table, and put the rigs back to work. It was a way for us to obtain some scale in Colombia without having to grow one rig at a time.
WSL: What are some major trends you see affecting your core business and how do you believe the company’s position to capitalize on these trends?
WL: The one overriding trend that’s going on right now in South America is the resources being developed being looked at now are increasingly more challenging. It might be deep water off the coast of Brazil, jungle operations in Peru, or the outer Llanos in Colombia where you’ve got physical restrictions and challenges of getting to the resource, or it could be nonconventional in Argentina or the heavy oil belts in both Colombia and Venezuela. These resources require a more sophisticated level of technology than conventional resources have required in the past. What it’s driving is the same type of maturation we saw in North America where more sophisticated rigs, more highly automated rigs, are being required to economically develop these resources. We see this as a general trend region wide. Certainly the development is happening slower than it has happened in North America. We’re lagging typically five to ten years behind, but we do see we’re very close to the tipping point. Because our rig fleet is sophisticated, automated, and we’re able to take advantage of these opportunities more quickly than others, and we’re seen as one of the few companies in the region that’s able to operate these sophisticated rigs, we feel that we’re very positioned to take advantage of a niche that’s going to grow much, much faster than the market in general. That’s the biggest and most important trend we see. There are other secondary trends like increased application and fracking etc. where Estrella’s not currently focused, but we do see the market demand is moving toward very similarly to what happened in Canada and the U.S., to more challenging resource development over the coming years.
WSL: We’ve been operating in a very difficult economy. What are some positive highlights you could extract from your recent quarter?
WL: 2012 was a challenging year for us. What we ran into was a very high concentration of rigs with one customer in Colombia, and when that contract came to an end somewhat unexpectedly, we were in a position where we needed to reposition the fleet and we needed to reallocate resources on to other contracts. We spent the year working on that, swapping some assets between Peru and Colombia, moving some assets into Argentina, redistributing our fleet in Colombia, so it was really a year where we had a lot of equipment influx. We see 2013 being a really crucial year for us. The first quarter so far this year has seen our utilization go back up to 100% in Argentina. We’ve got a number of the rigs back to work in Colombia, and around the region we see good demand for our services. What we really see is the most recent quarter was a repositioning quarter for us, and it puts us on a very stable ground with more than half of our rigs on long-term contracts, so we believe we will be able to have a stable operating for our print going forward.
WSL: What key goals and strategies are you focusing on to ensure future success and improved long-term shareholder value?
WL: I think the issue for us is maintaining operational consistency. We like the idea of long-term contracts. We like the idea of relationships that are more partnership based, directly negotiated things with customers rather than only competing on competitive bids. Diversification of the customer base I think as well is very important. As I’m sure you’re aware, the market tends to favor a certain size or type of company and can be quite biased regionally. Colombia was very hot three or four years ago. It’s fallen a little bit out of favor and the access of capital to our customers is a very crucial part of the puzzle in terms of how much activity we’re going to be able to have available to us. When we focus on our customer base we like to maintain some diversity between national companies, medium and small players. We want to make sure we don’t have too many eggs in one basket and replicate the problems we had at the beginning of 2012, and by focusing on long-term contracts with a diverse customer base, we think we’re going to be able to ride out any ups and downs that may occur in one country, one region, or one sector of the market, and deliver consistent results over the long-term.
WSL: Are there any misnomer’s or misconceptions investors might have about the company that you’d like to put to rest, and do you fully think the investment community fully understand the potential the company has to offer?
WL: I think there’re two common misconceptions with our company. One is because there are so few small cap service companies operating overseas there is a tendency by investors to look at the rig market as being something that’s very volatile. The reality is the North American rig market is extremely susceptible to commodity price movements, and historically has seen massive shifts in activity with relatively small movements in the commodity price. That’s not the case in South America. There is enough activity, which is politically motivated, where countries are looking to obtain energy independence. There’s enough activity of large resource development where people are looking at an average commodity price over the long-term that what we end up with is a much more stable operating profile, a much more stable market. 2008 to 2009 we saw about 10% to %15 reductions in the market in South America versus 50% to 60% reductions in the activity in North America. When people look at us they tend to see a company that is small and is exposed to a highly volatile market. We are small, relatively speaking but we are not exposed to anywhere near the level of volatility risk that our competitors in North America are.
The other is that because of the scale of the company and some of the growth pains that we went through in 2012, there has been some concern in the investment community about the company being able to meet its debt obligations and being able to meet its growth commitments. We’ve repaid over $20 million of debt over the last 12 to 13 months, we’ve taken on a very strong regional financial partner in Southern Cross Group, who’s been able to give us an infusion of equity, and give us some stability going forward. I think the company is very, very well positioned to take advantage of general market growth inside South America.
WSL: Based on your visions and accomplishments, how would you categorize the next two to three years as a period for your company?
WL: I think it’s really a crucial period for us. We’ve now grown the company to being close to $100 million a year in revenue. We’re getting to the point where the cash flows we’re generating not only can service our debt, but can give us a little breathing room for growth, and we see that the marketing opportunities that have come up particularly in Argentina, we believe that Colombia will continue to grow in the coming years as well as the environmental permitting issues become available. Because we’ve carved out this niche as a company with the regional reputation of high quality service and high quality equipment, we believe we’re very uniquely positioned to take advantage of this growth. We’re starting to see again opportunities to negotiate directly with customers for long-term contracts and with the stable financial footing and stable performance bases, we’re hopeful the market will accompany us to be able to take advantage of those opportunities and take the next step of growth from the 19 rigs that are out today towards the 50 to 60 rigs where we think we’re going to have substantial influence in how the market in South America behaves.
WSL: In conclusion, what’s the best reason you’d give to potential investors about getting involved with Estrella International?
WL: I think Estrella’s unique and today the market is heavily undervaluing the potential both in the company and in South America. Our enterprise value puts us at a valuation of something like 40% to 50% of our hard asset value. Our fleet is very young. Our position in the market and reputation with customers is very strong, and really what I think the market has done is targeted the whole South America small cap market as being a space with little interest, and maybe we’ve fallen off the radar screens of a number of people, but there’s huge growth potential for the company going forward. I think what the market, the investor community, needs to understand is South America is expected to see very strong economic growth, high single digit and slow double digits in a number of countries for an extended period of time, and that the energy demand is outpacing the general economic growth. We’re going from a market, which has historically been seen as a supply house for North American crude requirements to a market that has substantial internal domestic demand, and there’s a huge resource potential across the region for that demand to be met. What’s needed is the expertise for the investment and the equipment to be able to develop those resources, so I think we’re very well positioned to take advantage of this growth. Like I said I believe we’re substantially undervalued to where we should be today.