Exterran Corp (EXTN)

Share Price: $10.20
Mkt Cap: $361 million
EV: $746 milllion
Historical Recap:
Exterran Corp. was split from Exterran Holdings (renamed to Archrock following spinoff) in 2015, creating two separate corporate structures. Archrock retained the leading US based midstream compression business with its aggregate 3.5 million horsepower. The spinoff, Exterran Corp, controls the international contract operations, international aftermarket services, and the global fabrication (product sales) businesses.

Business Model:
Exterran is an integrated global systems and process company that offers solutions in oil, gas, water, and power midstream markets. It is the leading provider of full-service natural gas contract compression, and a supplier of aftermarket parts & service. Exterran Corp. is a leader in natural gas processing and treatment as well as in compression products & services. It aims to provide commercial customers with a single source for compression, production, and processing needs, and offers a highly customized and wide variety of products, equipment, and facilities.

The company has three segments:
1.     Contract Operations (25% of revenues, 62% of gross margin): The segment is responsible for compression, processing, and treatment services for natural gas and crude oil. It is driven by the initial terms of renewable contracts that last between 3-12 years, and by the monetization of reserves. Cash flows are supported by these long-term commercial contracts with large customers from leasing out equipment and facilities to allow customers to outsource their compression, production, and processing needs in order to achieve higher production rates. For customers that prefer to acquire and develop their own infrastructure assets, Exterran sells the underlying assets to customers at the end of a contract lease term. During the duration of the contracts, customers pay monthly service fees on leased compressor units on one site or an entire facility. Contract operations are tied to global oil and natural gas production and consumption trends, which are less cyclical than exploration activities.
2.     Product Sales (65% of revenues, 30% of gross margin): The segment is responsible for the engineering, manufacturing, installation, and selling of natural gas compression packages to independent oil & natural gas producers. Products include wellhead, gathering, residue, high pressure natural gas compression equipment, cryogenic plants, mechanical refrigeration and dew point control plants, condensate stabilities, water treatment equipment, integrated power generation and skid mounted production packages for onshore and offshore production facilities.
3.     Aftermarket Services (9% of revenues, 8% of gross margin): The segment provides maintenance, repair, overhaul, upgrade, startup, commissioning services to customers who own their own oil & natural gas compression related equipment. It is driven by loan term agreements that range from 1-4 year renewable contracts.

Competitive Advantage:
Exterran is the leading provider of full service natural gas contract compression and a supplier of new, used, OEM and aftermarket parts and services. It supplies large OEM customers such as Caterpillar, Ariel, GE Waukesha. Its product sales are highly scalable, with limited capital requirements, and an installed base that drives AMS growth opportunities. Exterran prides itself on the stickiness of its customer relationships, due to significant switching costs since buyers seek custom designed and differentiated variety. This leads to higher margins, and greater customer loyalty. Though companies like Caterpillar are highly vertically integrated, Exterran’s ability to outsource and have highly technical expertise allows it to retain them as customers. In addition, it utilizes tapered integration, using its own in-house CAT trained technicians working with independent Caterpillar to improve the quality of work through a form of competition.

Exterran is an integrated systems and process company within the midstream. It’s integrated, with in-stock equipment, in-house engineering & design, it has its own procurement, manufacturing, construction, maintenance, installation, and product financing divisions to ensure that it’s a one-stop-shop for all of its customers. Its long-term stability is evidenced by its historically high renewal rate of around 85%, and its backlog with $1.4 billion of pipeline opportunities (as of 4Q 2018).

Organic Growth:
In the Q4 2018 and Q2 2019 earnings calls, Girish Saligram (COO) mentioned multiple positive developments for Exterran:
1.     ECO has signed over $800 million since the spinoff, which includes $350 million in 2018 alone. The contracts are expected to generate $130 million in annualized revenue as projects come online. Newly booked contracts for business will be characterized increasingly by more predictable contracts in the nature of integrated plant instead of pure compression packages as has been in the past.
2.     For O&M contracts with large customers, Exterran has been sacrificing short-term margins in order to build its customer base for transactional parts relationships.
3.     As Argentina develops into a stable exporter, there will be demand for gas processing plants and compression stations. Exterran has invested in the shale play at Vaca Muerta.
4.     With the expiration of its non-competes, Exterran is now capable of offering their customer service agreements with their product orders.
5.     Despite some contracts dropping off due to plants being taken out of service, Exterran has signed key contracts in Asia Pacific and Latin America. These contracts range from overhaul services to long-term parts agreements and operations, and maintenance services. The company is expecting around $300 to $500 million in contract renewals over the next 12 to 18 months.
6.     In the AMS side, there will be more of a focus on higher margin, more profitable aspects of maintenance, like upgrade services. Additionally, Exterran will exit lower margin services like routine maintenance and provision of craft labor.
7.     Exterran consolidated its two compression facilities in Houston in order to take advantage of significant volume opportunities.

Exterran isn’t the textbook model of a great business. Its revenues are declining over time, it’s earnings are cyclical. Free cash flow is very lumpy when considering both growth and maintenance capital expenditures. When considering just maintenance, then it’s highly free cash flow generative and shows some consistency. While operating cash flows are much more stable than earnings (and consistently positive), the most predictable way to value Exterran is based on tangible book value. As a cross-analysis, and a secondary way to value Exterran is through sum of the parts.

Valuation Method #1: Tangible Book Value

Valuation Method #2: SOTP

Insider Ownership
Sam Zell’s Equity Group Investments has a long-term stake in Exterran Corp, according to an EGI report released in June 2019. Zell has a representative on Exterran’s board, Mark Sotir. Sotir is the Executive Chairman of Exterran and a managing director & co-president at EGI. In November and December of 2018, EGI subsidiary Chai Trust purchased 933,820 thousand shares averaging $21 per share. From Exterran’s latest proxy, Chai Trust has 12.8% ownership in the company.

1.     In February 2019, the board approved the company to purchase up to $100 million in shares through February 2022. Thus far, as of Q2 2019, Exterran has repurchased 1,021,578 shares at $13.83. Repurchases were done below book value which is a great sign (for reference: BV per share is $15.57). In terms of a capital allocation decision, buybacks are a better way to return value to shareholders than paying out a dividend. In the annual, it’s written that Exterran does not anticipate paying out a dividend.
2.     Additional share purchases by Chai trust, and by management.

1.     Exterran is dependent on the financial conditions of MPLX, Archrock, & Petrobas Brasilero, as the three companies are Exterran’s largest customers.
2.     If Archrock cannot pay its contingent tax liabilities, then Exterran is held liable to pay.

3.     Slowdown in natural gas demand

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