Quintana Energy Services (QES) – Merger Arbitrage – 14% Upside

Current Price: $1.11

Offer Price: $1.27

Upside: 14%

Expected Closing: H2'20

Investor presentation

 

This is a highly risky merger of two nano-cap service provides for Oil & Gas industry.

On the 3rd of May it was announced that KLX Energy Services is acquiring Quintana Energy for 0.4844 KLXE per each QES share. Shareholder approvals of both companies are required. 76% of QES shareholders are supporting the transaction. Given the current tough industry situation KLXE approval is also likely.

The market seems to have significant doubts regarding this merger. Due to the ciris in O&G industry, the offer came as an underbid and QES was initially trading at a negative -29% spread (see chart below). However, it took a whole month for the spread to converge closer to zero and then turn positive in the beginning of June. Thus it seems that the market was so skeptical about the success of this transaction that both companies' stocks were just trading independently of each other. With May's recovery in the oil price and improved sentiment within O&G industry the merger now looks somewhat more likely and spread turned positive.

KLXE shareholders

QES and KLXE provide drilling pumping, pressure control, wireline and similar services for O&G industry. Both companies have been hit very hard by the covid-19 and turmoil in the O&G industry - due to deteriorated demand and increased supply of oil and gas, the drilling activity has plummeted. Customers of QES/KLXE are experiencing significant downstream capacity and storage constraints and have considerably reduced their capital investment programs. This resulted in a sharp fall of demand for both companies' services and this trend is expected to continue into Q2 and well beyond. So far Q1 revenues fell by 35% and 43% YoY for QES and KLXE respectively, while net losses more than doubled.

KLXE is also loaded with large pile of debt ($243m, while its market cap is $65m), which currently trades (senior notes maturing at 2025) at 41 cents to a dollar. So bankruptcy risk is high in the eyes of bondholders and equity trades as an option on potential recovery in KLXE operations.

 

Merger Rationale

The strategic rationale is sound here - both companies need this merger in order to increase the chance of survival (press release):

It is our view that consolidation in the oilfield services industry is essential to remain cost-competitive in an environment where oil prices and demand may be depressed for an extended period.

Companies' businesses are complementary and they also expect to cut $40m expenses after the combination (annual SG&A for QES is around $55m and $100m for KLXE).

Liquidity wise as of Q1'20 QES had $23m in cash +$21m of available credit facility and KLXE $125m of cash + $42m of available credit facility. Situation has likely deteriorated after the quarter end.

Moreover, KLXE even states that after completing the transaction with QES it intends to pursue additional acquisitions in the future. Since 2018 KLXE has done 3 tiny acquisitions and even before the current crisis it was already looking for further targets (proxy):

In particular, at various times from the end of 2018 until the beginning of 2020, KLXE engaged in preliminary discussions with another publicly traded oilfield services company regarding a possible combination of the two companies.

Management holds 9.5%. Other shareholders:

KLXE shareholders

2 COMMENTS

  1. Ilja

    I posted this over the weekend, but it seems the spread shrunk to 7% on Monday’s open with QES moving +36% and KLXE +29%. Meanwhile, I don’t see any updates to explain this movement today.

  2. Ilja

    Interesting trading with these two – spread now stands at negative 2.3%. Risks remain relatively unchanged and I see no other reasons for such moves except KLXE and QES getting pumped up by “Robinhood” investors lately (both firms seems to fit into their “near bankruptcy” profile as well).
    http://robintrack.net/symbol/QES

    So overall, based on this “luck”, the idea played out with 9% return in ~1 week.

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