Looking ahead, Civeo is studying the possible conversion to REIT status however, there is no guarantee that they will pursue this option or ultimately be approved by the IRS. Either way, the culmination of the spin represents a victory for activist and large OIS shareholder (~11%) Jana Partners who pushed for the move. It’s also a win for David Einhorn who highlighted the company at last year’s Sohn Conference and owns ~5% of its shares. Although the stock has run up a bit since the announcement, many still believe there is more to go, especially if Civeo can obtain REIT status. For additional information on the company, check out its recently amended Form 10 filing, this recent company presentation and our earlier coverage on the topic.
Earlier this week, the company announced it had completed its review and that it would not be converting to a REIT. Instead, they plan to remain a C corporation and redomicile in Canada, where most of the company’s business takes place. The company released a presentation detailing its decision, and listed the key factors:
The board and its advisors evaluated the potential effects of a REIT conversion on earnings, valuation and operational flexibility and determined that redomiciling the company to Canada offers a superior result to a REIT conversion. The primary factors considered include:
- The fact that over 90% of Civeo’s earnings are generated outside the United States, which is not typical for companies that pursue a REIT conversion. Conversion to a REIT for Civeo would not reduce taxes paid by the company in Canada and Australia.
- The significant cash expenditures that would be incurred in connection with a REIT conversion. The company would incur cash expenditures of approximately $720 million in order to fund tax payments of over $300 million, the cash portion of a required earning and profits distribution and transaction costs, which collectively would meaningfully increase leverage metrics.
These key factors result in the REIT conversion being net present value negative, which the board took into account in concluding that redomiciling the company to Canada offers a better alternative. Further, the company’s C-corp structure offers superior operational and financial flexibility coupled with a lower tax rate under the migration transaction without the significant upfront costs.
Civeo expects to execute a “self-directed redomiciling” of the company which is allowable under U.S. tax code. U.S. tax laws permit a company to change its domicile to a foreign jurisdiction without corporate level U.S. taxes provided that such company has “substantial business activity” in the relevant jurisdiction. “Substantial business activity” is defined as foreign operations consisting of over 25% of the company’s total (i) revenues, (ii) assets, (iii) employees and (iv) employee compensation. With approximately 50% or more of its operations in Canada based on these metrics, the company qualifies for a self-directed redomiciling. The recent Treasury Notice is not expected to impact Civeo’s ability to redomicile. However, the success of the migration is subject to potential future changes to tax laws and regulations. Domiciling the company in Canada is expected to achieve a tax rate of approximately 25%-26%, 4%-5% lower than the expected rate under the REIT structure. The company expects to complete the migration over the next six to nine months.
At the same time, the company lowered its projections for next quarter and next year, as the oil E&P’s the company serves reduce their new exploration projects.
The company will provide an update to the business outlook on the conference call. Management will confirm that the third quarter 2014 guidance remains unchanged at $220-$230 million of revenues with an EBITDA margin of 33-34%. However, the company is expecting sequentially lower results in the fourth quarter of 2014. The company anticipates that reduced customer room demand in Canada in the fourth quarter will negatively impact occupancy and rates at its Canadian lodges. Existing customer projects are nearing completion and are shifting towards operations from construction and expansionary activities. In addition, incremental customer projects that were expected to generate room demand have been delayed or their status remains uncertain. In light of this outlook, management is providing a preliminary outlook through the end of 2014. For the fourth quarter of 2014, management is expecting revenues in the $200-$210 million range with an EBITDA margin of 32%-34%. Considering third and fourth quarter guidance, the company is expecting full year 2014 revenues to be $900 million to $920 million with an Adjusted EBITDA margin of 34%-35%.
Given the likelihood of continued weaker accommodations demand and lower rates in Canada, at least in the short term, as a result of the project completions and delayed capital spending referred to above, the company’s 2015 revenues and margins are expected to be materially lower than the 2014 full year estimate. While continuing to closely monitor its customers’ capital spending and overall market dynamics, the company has less visibility going into 2015 than in prior years. Therefore, at this time the company is unable to project the duration of the expected lower results or how cost cutting measures and new revenue projects might mitigate the decline.
Investors reacted in droves to these two announcements, driving the stock down over 50% on Monday and Tuesday, before a small bounce on Wednesday. I believe the market overreacted to this news and I bought some on Monday and Tuesday. I believe that at the current price, Civeo represents an attractive investment option.
Disclosure: The author owns shares of Civeo
Large insider buying (8000 @ $12.21, 24,000 @ $12.86, 8000 @ $12.81) the day after negative announcement and huge price decline usually a good sign.