Reviewing Battered IPO’s: Superior Offshore (DEEP)

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There is one fairly new small cap oil and energy company that keeps coming up in discussions over and over locally in Houston: Superior Offshore International Inc. (NASDAQ:DEEP).  The company is a fairly recent IPO and has never recovered the bulk of its post-IPO losses.  Merrill Lynch and J.P. Morgan brought this offshore deepwater services operator public at $15 in the middle of the $14 to $16 range, but the company was able to boost the offering by 1.5 million shares to 10.1+ million shares because of high demand. 

Superior offers subsea construction and commercial diving services to the offshore oil and gas industry, serving operators in the outer continental shelf and deep waters of the U.S. Gulf of Mexico was well as offshore Mexico, Latin America, Africa and the Middle East.  The company operates a fleet of 10 or 11 service vessels and provides remotely operated vehicles and saturation diving systems for deep water and harsh environment operations.  As of the last available figure, it employs 665 offshore personnel in North America, Africa, South Africa and the Middle East. 

If you have been watching oil lately with oil prices back over $80.00 per barrel, you would wonder what is going on.  This stock is in the right sector and there is a chance that it has been oversold and overlooked.  Of course, there is also the chance that there are problems in the business model change.  Because this is in the red hot energy services sector and has been kept down this long we have had it on a watch list.  It does not meet the criteria to become a formal pick for our Special Situation Investing Newsletter for a myriad of reasons, but it is one of the companies in the sector we have on a small cap watch list.

Two less discussed issues may be keeping a lid on this.  It is possiblethat with no major hurricane damages this year for the company to havea sudden surge of repair demand, but indirectly this has kept a lid onday rates even for companies that aren’t so repairs-oriented because itkeeps prices lower and instant demand down.  It also looks like afterthe completion of a management 10b5-1 planned share sale that the CEOand key manangement owns 52% of the company. 

The traditional 180-day lock-up period would also leave 6 to 7 weeksfor this 180-day lock-up period for the company and for employees tosell shares.  But officers recently entered a 10b5-1 stock sale planthat provides for the sale of up to a total of 359,332 shares beginningon October 25, 2007 at prevailing market prices, subject in some casesto minimum price thresholds.  Assuming all of the shares covered by thePlans are sold as provided in the Plans, Mr. Mermis would continue toown 616,000 shares, Mr. Burks would continue to own 205,334 shares, Mr.Koch would continue to own 410,667 shares, and Mr. Guarisco wouldcontinue to own 205,334 shares. Following the sale of all sharescovered by the Plans, all executive officers and directors of theCompany as a group would beneficially own approximately 52% of theoutstanding shares of the Company.

The stock’s short interest in September was listed as 783,700 shares,which was actually down 13% from the 906,800 in August.  This stockfell deep with the markets in the end of July to August period, but hasyet to come bac kmuch from the lows.  Shares fell from $18.00+ down toalmost $10 and sit around $11.50 today.

It entered into an amendment on its senior credit facility in Augustand there may just not be that much excitement around its earnings andguidance after it posted a net loss last quarter, which had beendelayed by a few days.  The loss included a debt retirement charge,charges for relocating to Houston, and IPO charges along with its firstround of Sarbanes-Oxley and stock-based charges.  With the loss postedat the last earnings, the company noted that revenues were impacted bythe continued dry-docking and significant upgrades to the SuperiorEndeavour as previously disclosed. Its ‘Superior Endeavor, a DP IIvessel returned to its working fleet after a $25 million upgrade at thestart of September (announced).  Four-point surface diving vesselutilization and dayrates were significantly lower in the second quarterof 2007 as compared to the second quarter of 2006 because of decreaseddemand in the Gulf of Mexico.  The guidance for 2007 put revenues in a$265 to $285 million range, which was under a limited estimate at thetime.

President & CEO James Mermis noted that results were disappointingbut transforming from a shallow water Gulf of Mexico contractor into aninternational and deepwater subsea construction and services companyhas created strong opportunities for revenue and margin growth.  Healso noted the largest backlog in company history.  If you read intothe forecasts it sounds like there will be more coming expenses forsetting up permanent presences in Trinidad, the UAE, and Qatar.

There is somewhat of an environmental and political issue here,although that could be said of any onshore or offshore energy andenergy services company.  Because of its size, the company is also alsoprobably perceived as being dependent on individual contracts where onedelay could have a material impact. 

The company operates on the outer continental shelf and deep waters ofthe U.S. Gulf of Mexico.  It seems that if offshore drilling is allowedto be placed farther out and down deper than before then the companywill be a winner.  We acknowledge that this is a very political andongoing development, and that is one of the issues holding sharesdown.  Merrill Lynch started it with a Buy rating and J.J.Morganstarted it with a Neutral rating.  The smaller companies listedoriginally as co-managers were Howard Weil, Johnson Rice, and Simmons& Co.  If this company raises more cash via stock sales in thefuture it may want to expand its underwriting group to essentially buymore coverage.  Jim Cramer has been bullish on the company ahead of theIPO and after its IPO, but that alone is never enough.

The stock’s high is $19.58 and based upon a $15.00 IPO pricing, sharesare down 41% from the post-IPO highs and down 23.3% from the IPOpricing.  The demand was there at the IPO because it priced more sharesthan originally set and the stock barely traded under $17.00 after theIPO until it began the big slide in mid-July.  The company’s market capis a mere $298 million today, so it flies well under most radar screensin a field where there dozens upon dozens of other much larger and morewell known public competitors.

It would seem that the company is in the right sector at the righttime.  Unfortunately the stock has been a poor performer since comingpublic and there seems to be a lack of major data and current trackrecords to judge the company on.  We have looked into the issues we sawand elaborated on possible other issues behind a non-recovery after thesell-off.  We are also interested in what the company will do about thelack of larger Wall Street coverage in the stock (road shows may be inorder).  It seems like the company needs to draw in more outsideresearch IF it wants to get its story out there. 

A call into the company has not yet been returned and we have not beenable to get any direct quotes or added explanations from the companyabout these and other potential issues.  We’ll be issuing a follow-upif there is anything to add.  Otherwise, we’ll have to play the waitand see game with everyone else.

Jon C. Ogg
October 4, 2007

Jon Ogg can be reached at; he produces the SPECIAL SITUATION INVESTING NEWSLETTER and he does not own securities in the companies he covers.