T-3 Energy Services (TTES) Update

Well TTES continues to fall and test my resolve. Thankfully, GHM has rebounded a bit, so I'm not completely getting killed in this market (though I've lost substantial paper profits in the last few weeks).

It's hard to figure out who is selling TTES. Since the company is primarily controlled by First Reserve, and they are of course not selling, who is selling the stock and why? In truth, the float is so small, that you can't really read anything into the stock price movements. For now, I still think the best course of action is to focus on the fundamentals. Since, there is no public information that seems to challenge my bullish thesis that a liquidity event, such as a sale or acquisition, will occur by the end of 2005, I can only reach the conclusion that the selling is being done by retail investors who are either scared of losing more paper profits or who bought at higher prices.

That being said, TTES filed an 8-K today detailing the completion of the sale of it's distribution business. As I suspected the sale was completed for $8.8 million in cash. TTES used all the cash to reduce debt, so their debt level now is down to $4.8 million from close to $14 million at the end of June.

A company divesting a business, paying down debt, and focusing on a higher-growth more profitable business? What's not like.

I guess what can be surprising to people is that the company's sales, after the divestiture of the distribution business, appear to be declining. However, that sort of analysis holds no water, when you value a business. What matters is an apples-to-apples comparison of sales and more importantly the level of earnings and cash-flow, not sales. If a certain division is draining resources and adds nothing to overall profitability, it's a smart decision to divest that business and focus on higher profit-generating divisions.

Anyway, looking at the pro-form financials, post divestiture, it appears that TTES will do  $90 million - $100 million in revenues with the remaining business in the coming year. Interestingly, the current business (Pressure Control Products) did $0.07 in Q1 2005, and $0.22 in Q2 2005. So as you can see, the business is expanding rapidly, primarily due to increasing gross profit margins (the most important margin to watch). Maybe TTES does $0.25 in Q3?

So what's the business worth? Who knows, but I don't think the current price is at all inflated. Worst case, the stock is worth $12 or so, as I've noted in the past (8-12X Cash-Flow). The upside can still be significant assuming an acquisition or sale of the company. Even if those things don't occur it seems that the earnings growth here can easily justify a $15 stock. Then again, if sentiment has truly turned negative for the energy sector, the stock will be dead money. I'll have to wait for next quarters earnings (early November) to make a decision as to what to do here.

However, as mentioned in the first write-up on this stock, this is not a multi-year hold. It is only a hold on speculation that some major liquidity event will occur by the end of 2005. To sell before year-end 2005, would therefore negate the whole purpose of the gamble and would ruin the fun here.