High Arctic Energy Services 2: A Catalyst

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Overview

For those of you who weren't here or don't remember, High Arctic Energy Services was the first writeup in the Thursday Think Tank series. The high-level takeaway from that writeup was that High Arctic had the potential for great returns simply based on its replacement value. In other words, High Arctic was (and still is) significantly undervalued- even if you were to ascribe zero or negative economic value to the businesses themselves. The good news is that management and the board finally realized this too. After buying enough shares to cross the 50% threshold they have decided to make major changes. These changes are the topic of today's writeup, but if you want some background on the company I attached the original writeup here:

High Arctic Energy Services: Another Shot at the Energy Trade

With their last quarterly release, High Arctic announced that they have the "Intention to Return Capital and Reorganize." This plan comes in three parts: a return of capital to shareholders, a maintaining of the Canadian snubbing business as a public company, and a spinning off the PNG business into a private company. Let’s break each of these parts down individually. 

Capital Return

This part really can't get much more simple. Management plans to return the $32.80M from the sale of the Canadian welling business to shareholders. This is about 60% of High Arctic's market cap based on current price levels around $1.30. Oh, and did I mention that it's tax-free? Not a bad start.

Canadian Public Company

In the last year, High Arctic has sold both of its Canadian businesses: well servicing and snubbing. As mentioned before, the well servicing business was sold in a straight cash transaction that netted the company $38.20M. In selling their snubbing business, High Arctic chose to take a different approach. Rather than taking the cash and running to the bank, High Arctic took a 42% stake in the buying entity, Team Snubbing. This is again pretty simple to value, as management lists this figure in the company's earnings reports. As of March 31, 2023, management values the Team Snubbing holding at $7.92M. In addition, the Canadian company will own High Arctic's 49% stake in Seh' Chene, a production site that is operated by High Arctic. Together, management values these holdings at $8.11M. On top of this, the company will keep and use $130M in non-capital tax loss carryforwards. In plain English, this means that the first $130M the company makes in profits won't be taxed.

PNG Private Company

Now to the part which I believe has the most potential: the PNG business being spun off as a private company. The first thing of note isn't quantifiable, though it is important. This is the part of the company that management is choosing to stick with and operate. Of course, it is always open to interpretation, but this also seems to be the business that they’ve seemed the most excited about on recent investor calls. Though he did not put any specific numbers to this, CEO Michael Maguire did say that as we start to see the already planned PNG projects come online over the next several years the cash flow could mirror, if not better, the company's numbers from 2010-2018. As a quick aside: the time frame here is of note, as management was very clear that new projects in PNG will take at least a year to start coming online. Now to the numbers. I could only find High Arctic's financials going back to 2013, so I'll assume 2010-2012 were similar. Over the span of those six years, High Arctic averaged $42.4M in operating cash flow. If the PNG business were to average this for just two years then the business would generate more cash than the entirety of High Arctic's current market cap! Now of course this new entity would be a private company rather than a public one, meaning you need to figure out how you will monetize your ownership without the more easily accessible liquidity of public markets. While management again was not explicit in giving any details, they did reference that they expect to return cash to shareholders in a similar manner to the last upcycle if this comes to fruition. Management is also very proud of their returns to shareholders in general. When you visit the High Arctic investor relations page, one of the first things you'll see is a chart titled "Shareholder Distributions 2012 - 2022." It's also worth mentioning that they love to tout High Arctic's monthly dividend. To wrap it up: as the various PNG projects develop throughout the rest of the decade and beyond, owning a key player in the industry's development, that generates and distributes large amounts of cash, for less than half a year's worth of cash flow (after taking out the cash distribution and the value of the Canadian company), and far below replacement cost seems to be an attractive risk-reward opportunity. 

Other Items of Note

• Management and the board control about 55% of the shares, meaning any vote is simply a formality

• Management seems to be extremely focused on doing all of these initiatives in the most tax-efficient manner possible (if you couldn't tell already)

• For what it's worth, CEO Michael Maguire said he will be buying more shares once his blackout period ends

Summary

Often the best investments are the ones that are simple and hit-you-over-the-head obvious. High Arctic seems to be one of these cases. The company has long been undervalued, and it is more than welcomed to see management doing something about it. This catalyst should result in a low risk-high return scenario- my favorite set up.