Superior Shareholders Must Drill Down for Deal Value (Update 1)

Superior Energy Services'(SPN) $2.6 billion cash and stock offer to purchase Complete Production Services(CPX) for a 60% premium killed the acquirer's stock on Monday as investors fretted over possible dilution and a hefty premium paid.

Superior Energy shares closed down more than 13% at $3.78 with volume reaching 22.75 million, well beyond the issue's trailing three-month daily average of 1.04 million.

But investors aren't making the correct call, says Trey Stolz, a managing director of research at Iberia Capital Partners. Stolz argues that a panicked market may be overlooking the fact that though the deal will double Superior's outstanding shares, it will also more than double Superior's earnings streams.

"If you just add the net income of the two companies and just divide it from the new shares, its 17% accretive for Superior shareholders if you look at 2012 projections," said Stolz in a phone interview with TheStreet.

On Monday the onshore and offshore oilfield service company agreed to buy Complete for roughly $2.6 billion, valuing the shale drilling rig and services provider at $32.90 a share and 60% premium to Complete's share prices prior to the announcement.

Superior is offering a .945 portion of its own stock and $7.00 in cash for each Complete share, taking a 52% stake in the company. Superior will be issuing new shares for the stock piece of the deal, according to a press release. The math works out that Superior will be adding roughly 75 million shares to make the purchase, doubling its outstanding shares to roughly 154 million.

When the markets opened Monday morning, the selloff of Superior's shares was a resounding negative opinion on the deal considering its potentially dilutive effects and price.

Investors fleeing the deal may be overlooking some important facts, including the profit and revenue that Complete brings to the table. In the most recent quarter, Complete had rev! enue of $551.9 million and net income of $54.5 million, both larger than Superior's revenue of $510.8 million and earnings of $48.1 million.

Potentially overdone concerns of dilution aside, 60% is a hefty premium, "I think anytime you see a transaction at a 61% type of premium there is going to be an initial reaction in the market like this," said Stolz. In the press release announcing the deal, Superior noted the $32.90 a share price tag is a 30% premium over the average price of Complete Production Services' shares in the last two months. What wasn't said is that Complete shares have fallen over 40% from their July highs.

"On an absolute basis we don't think it's a high price. We think it's a great asset and changes the makeup of Superior going forward," said Stolz. He estimates that the takeover was done at a price of 9 times 2012 earnings and 4.9 times cash flow.

The deal is also on par with prices paid in the sector. Buyers of oil-services companies have paid an average premium on 51.1% for companies over $500 million in market cap in the last twelve months and they've paid at a level of 20.4 times income excluding extraordinary items, according to data compiled by Bloomberg.

Premiums paid and dilution aside, the key of deal according to Stolz, is that Superior is entering high-margin shale drilling equipment and services businesses that are going to benefit from the booming exploration of onshore reserves from across the country.

"They are entering some service lines that we like, pressure pumping, coiled tubing [well intervention] fluid service for shale gas and oil drilling... The pressure pumping has been building with the shale play, that market segment has really been exploding," said Stolz.

Other oilfield services companies like RPC(RPC), Basic Energy Services(BAS) and Key Energy Services (KEG) may also benefit from the same sales and merger trends, says Stolz.

That optimistic outlook for drilling equipment and services may not be shared by the investors right now. "The market is discounting EPS well below current consensus for the entire group," said Michael Marino an analyst at investment bank Stephens in an email to TheStreet.

There is concern that the demand for parts and services to supply the shale drilling rush may fall in coming quarters. He added in a follow-up phone interview that investors are valuing Superior based on what the price of oil means for rig usage and consequently oilfield servicing profit margins. "If oil goes up, this is going to look like a great transaction. They made their bet, it's on North America, I think that strategically makes a lot of sense to them but there is some near term risk to it," said Marino.

After reaching a post-recession highs this year above $110 a barrel, WTI crude oil has fallen to $85.59 a barrel as of Monday. At $80 a barrel, Marino says demand to drill and the number of rigs in use may fall, pressuring servicers to lower prices.

Complete earned its first annual profit since 2007 in its most recent year ended Dec. 31, recording net income of $84.2 million on a nearly 50% increase in revenue to $1.56 billion. In the most recent quarter ended June 30, the company reported revenue of $551.9 million, up more than 40% from the same period last year and a near tripling of net income.

Complete Production Services, founded in 1994 and with $1.5 billion in revenue and 5000 employees, sells pressure pumps, piping and well services for the hydraulic fracking that's used in shale gas drilling. It has a regional focus in North American shale, including operations in the largest shale reserves like the Haynesville Shale in North Louisiana, the Marcellus Shale in Pennsylvania, the Bakken Shale in North Dakota, the Fayetteville Shale in Arkansas, the Woodford Shale in Oklahoma and the Barnett Shale region of North T! exas.

In a statement announcing the deal, Superior Energy Services Chief Executive David Dunlap said, "Together we will have enhanced positions in large sectors for key products and services that are high in usage intensity and deemed critical by our customers during their drilling, completion and production processes."

Dunlap replaced former CEO Terrence Hall in April 2010. This is his largest acquisition to date, previously he'd been an executive vice president and chief operating officer of BJ Services Company, a piece of Baker Hughes(BHI). His other acquisition was to buy sand control completion tool businesses from Baker Hughes in August 2010.

In an analyst call Monday morning announcing the deal, Dunlap said, "Our business is very strong and our growth potential is very strong. And I think what we've created is a diversified company regardless of what the market has to bring."

Superior Energy Services reported its highest revenues and net income since the BP's Macondo oil well blowout in 2010, the worst environmental catastrophe in U.S. history. Its annual revenue in 2010 of $1.68 billion are still below all-time highs of $1.89 billion in 2008. With drilling resuming in the Gulf of Mexico and strong international offshore drilling activity, Superior's revenue more than doubled to $81.8 million in the most recent quarter.

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