Investment thesis

Shares of Hornbeck Offshore Services (NYSE:HOS) are an attractive security, even if the industry is in trouble. Unlike its competitors, HOS is well positioned to survive the market downturn.

What is going on?

The outlook for the worldwide Offshore Support Vessel market is bleak and turning darker every day. Shares of Hornbeck Offshore Services plummeted by 22% on February 16 after the company posted its earnings. On that single day, the trading volume reached over 8 million shares, which is one-fourth of the total shares outstanding.

The OSV market is extremely oversupplied. Currently, close to 200 vessels face demand for less than 100.

Over a year ago, HOS already showed signs of strength compared to its competitors: a cleaner balance sheet, a much newer and high-spec fleet, excellent management, and relatively late debt maturities. Now, the market has come to recognize this situation, and even after the recent cut in market prices, HOS still has the largest capitalization among its competitors.

During the earnings call, Hornbeck Offshore's CEO, Todd Hornbeck, made a very interesting comment:

"Third, and as I said earlier, we believe value creation in the offshore vessel space cannot begin, again, without meaningful acquisitions of high-spec assets and businesses over the overleveraged industry players. Given our ultra high-spec fleet profile, successful operating track record, ample cash position, and public company platform, we think we are the natural acquirer in such a transaction, especially in the domestic Jones Act market.

Earlier in this cycle, the industry mantra was lower for longer. The message we have recently been hearing from our customers, almost uniformly, is that they now see oil prices as lower forever. They no longer view this as a U-shape recovery, but an L-shaped recovery, or so we're told.

Deepwater projects can work in that kind of world, but not at economics that drive key pieces of the supply chain out of business. Lower forever must also mean greater efficiencies and reliability in this supply chain. Smart acquisitions can achieve those objectives in the OSV space, given the high operating risk and capital-intensive nature of this business. And for this industry, such acquisitions are necessary."

This has puzzled a few fellow investors. (How can a company in such dire situation turn to acquire "assets and businesses"?) But actually, Mr. Hornbeck has already stated multiple times that he could use the revolving credit facility to finance acquisitions.

Let's take a look at some key balance sheet items:

Cash on hand is certainly not enough to repay the debt. The company's cash position has decreased by $43 million in the last year, or 16%. But the debt starts to mature in late 2019. There is plenty of time for a recovery and for management to find options and creative solutions.

Let's compare Hornbeck Offshore's situation with Tidewater, the largest player in the industry. Tidewater has not defaulted only because the debtholders are granting limited waivers for covenant compliance. Its current liabilities are $2.3 billion, and current assets are $1.16 billion. The company is struggling for survival and is at the mercy of its lenders, but still paid $3 million to management for "Talent Retention".

Looking ahead

We can get a glimpse of the future if we look at the North Sea OSV market, where Solstad Offshore recently acquired 3 competitors. Among those are Farstad Shipping.

Farstad Shipping could not meet its obligations, so the debtholders converted to equity. This meant a wipeout for shareholders, because the shares outstanding jumped from 39 million to 4.9 billion.

Immediately after that, all shares of Farstad were converted into class B shares of Solstad Offshore (the acquirer). The combined Solstad plus Farstad is much larger, and the former debtholders of Farstad can cash out by simply selling their new Solstad shares in the open market. Solstad did not need to lay out cash, and the company acquired very clean assets.

GOM situation

The Gulf of Mexico offshore industry will always need some OSVs, and someone must be there to manage those assets. When debtholders take over failed competitors, they will probably take the logical steps towards maximizing value and cashing out as much as they can.

Many companies that operate in the Gulf have extremely negative cash flows. Some are unable to meet 2017 commitments - like Island Offshore and Gulfmark. As the saying goes, "If something cannot go forever, then eventually it must stop". There are too many companies operating in the OSV market - too many vessels, too many headquarters, and too many G&A expenses.

Consolidation in the industry is going to happen, and there will be a lot of pain for shareholders.

One Bright Side

In the US zone of the Gulf, offshore operations are forced to hire Jones Act-qualified vessels. Those vessels must be owned, crewed and operated by Americans. And if they are owned by a foreign entity, even for one day, the vessels stop qualifying forever.

In order to maximize value in the event of a consolidation, all the assets need to be put under a competent American management with long experience in this industry. This points to very few companies, like HOS and SEACOR Holdings (NYSE:CKH).

Takeaway

My thesis is this: By now, a significant portion of debtholders in the industry are hedge funds that have acquired the debt (i.e., the companies!) at a very low cost basis. They will merge them with the survivors, just like it happened in the North Sea, and sell their new shares in the market.

(That's why they want to do it with a company that is already public - there is no point in merging with Edison Chouest and then be stuck with an illiquid stake in a private company.)

Some facts about HOS:

Yes, there are other companies besides Hornbeck that could be acquirers. Also, HOS could go to zero and be wiped out. But the story is getting better every day. I believe that at current prices, even after a some dilution of current shareholders, the stock could bring a very reasonable return in a few years.

For investors, this has been an exciting roller coaster ride, and the development of this crisis stirs both our interest and our nerves.

Disclosure: I am/we are long HOS.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Hornbeck Offshore: A Consolidator In The Offshore Supply Vessel Industry - Seeking Alpha