HAWK: Strategic Alternatives Update

This past Tuesday (11/2) after market hours, Seahawk Drilling announced "[it[ has initiated a process to explore and consider possible strategic alternatives for enhancing shareholder value. These alternatives could include, but are not limited to, transactions involving a sale of assets, a recapitalization, or a sale or merger of Seahawk"  (Full release here).


I wrote about Seahawk on my blog back on September 12.  With a grossly undervalued asset base as well as high cash balance, I believed that shares were moderately to severely undervalued even in the very dire conditions that existed at the time.  A number of catalysts have occurred that have pushed shares over 30% higher from the day I published my analysis.  While it was difficult at the time to place a timeline on the occurrence of these catalysts, shares were so cheap at that point that you could have practically melted the rig steel and found more value than the market was giving credit.  Below are summaries of a few of the recent developments that have helped move shares higher since my writeup:


1. Immediately after my article was published, the BOEMRE and Ken Salazar issued a notice to lessees that all non-working wells in the GoM would need to be permanently capped.  This amounts to approximately 3,500 wells that will need capping over the next few years.  Starting October 15, companies with non-operating wells have 120 days to submit proposals on capping and work should begin following approval.  Because these cappings are just work overs that will take days to a few weeks to complete, lower spec rigs like HAWK's should end up getting utilized and would help provide much needed cash flow.

2. Early Lifting of Deepwater Moratorium:  While this did not directly affect HAWK as a shallow water driller, the move restored confidence that eventually the GoM would return to normal drilling, even if it would be more difficult to get a permit going forward.  While the BOEMRE is still an unorganized mess according to a source, there is at least hope now that things can return to normal faster than expected.  


3. Seahawk entered into a Memorandum of Understanding with Essar Oilfield Services to sell the Seahawk 2025 drilling rig for $14.55MM, subject to Essar being awarded a tender on or prior to February 8, 2011.  If the deal closes, Seahawk will also receive $135K for training and services on the new rig.  While this may be a nice win from a cash flow perspective, more importantly it helped rationalize the market value of their entire rig base to a certain degree.  Since the announcement, shares have climbed significantly as the market mulls whether there will be further rig sales as well as whether the cash may be used to acquire a rig outside the US GoM that may be accretive to cash flow.  For a more fulsome explanation of the the sale and the tax effects, check out Longterm Investing.


4. Announcement of Strategic Initiatives:  Since late spring, HAWK has been at the center of a perfect storm of bad industry trends.  Just about the time of the Macondo blowout, things were just getting going in the GoM after a sluggish previous year.  Rig counts were increasing and HAWK expected to climb out of the operational hole that was most of 2009.  However, the ensuing moratorium, while not affecting shallow water, caused the pace of permits to slow to almost nothing, as mentioned in my previous article.  Coupled with a steady decrease in the price of natural gas, demand for HAWK rigs has remained sluggish and the company has been burning cash at an alarming rate.


While I welcome the exploration of strategic initiatives, I would argue this latest piece of news is somewhat of a non-event.  Clearly, with the sale the 2025 rig, HAWK has been actively exploring ways to work through these tough times and maximize shareholder value and have done a pretty good job at making this clear since the share price lows in August.  


I sincerely hope their new strategic advisor, Simmons & Co., is able to help HAWK think outside of the box and come up with a solution to sell rigs, raise cash or merge the business at a price that is commensurate with the fair value of their rigs and operations.  It is unfortunate that the company has come to this conclusion when they are still in a tight spot operationally and time is of the essence to stop hemorrhaging cash; however, these moves should at least help put a floor on the share price in the near term.  HAWK may not be able to get top dollar for their rigs and their current book of business is extremely thin, but even with the recent increase in share price, an outright sale or a sale of individual assets could provide further upside to shares.  If you are bold enough to base the valuation on the 2025 sale, shares could be worth closer to $20/share...but I'm not sure I'd hold out hope, there's still a steep hill to climb.


3Q earnings next week will help provide a better picture into plans going forward as well as upcoming rig activity and the all important cash burn, which will allow investor to make a fresh determination of the value the market is placing on HAWK's rig fleet.


Disclosure: Author is long HAWK

Dialog Semi 3Q: Record Revenue, Thesis Still Strong

Last week I wrote an article on Dialog Semiconductor prior to their reporting of 3Q results.  Based on strong earnings of several of DLG's largest customers, shares had run up into earnings in anticipation of a strong report.  Analyst estimates had also accelerated to well above management guidance.  Prior to earnings, I believed shares were fairly priced and would only see upside if numbers were truly explosive.  With analysts getting ahead of themselves immediately leading up to the report, the risk was certainly to the downside.

Dialog reported a record revenue quarter, but predictably it did not meet analyst expectations and shares sold off almost 8% the day of the report.  I used the opportunity to pick up some additional shares since I had been trimming my holdings around €13.50-13.70 leading up to the report.

Despite not hitting analyst numbers, this was a great quarter for the company from a revenue, margin and product development perspective.  Revenue came in at $79.5MM, above the top end of management guidance for the quarter and a record for the company.  Revenue could have been even higher, but due to other supplier constraints at some of their customers, some Dialog inventory went unused this quarter.   Margins were also solid, with gross margin coming in at 46.3%, which was 1.0% higher than last year.  According to my conversations with management, gross margin could have been even better, but because of higher manufacturing costs in Asia due to lower available capacity, they were not able to wring out some additional volume discounts.  Despite comments on the call about overstretched capacity utilization, Dialog was on time with all shipments to customers for the quarter.

Dialog maintained a very healthy balance sheet with no debt and a cash balance of $145.6MM.  Inventory was a little bit higher than expected, but not alarming given the typical elevation going into Q4 holiday season and due to capacity issues.  This need for secure supply is evidenced by the higher finished goods segment of inventory.  Below are the summary results for Q3 and a projection for Q4 based on historical results for margins and my expected top line growth:

Based on latest discussions with the Company, I learned that the pricing analysis provided by iSuppli (main supplier of consumer gadget part pricing to the finance community) that tends to drive analyst projections for Dialog tends to be higher than actual pricing.  As these prices are a closely guarded secret, I was told some of the prices provided by iSuppli can be materially higher the customer cost, because iSuppli does not take into account volume discounts and contract arrangements.  As such, I have pulled back on my 4Q assumptions as well as Apple’s contribution to top line.  Below are the new summary numbers for 4Q.

Due to analyst’ tendency to get ahead of reality, Dialog gave guidance for 4Q gross margin, expecting it to remain roughly similar to 3Q based on their conservative stance in the face of capacity constraints.  On the revenue side, the company was equally conservative, almost to a fault in my opinion.  Revenue guidance was maintained at $290-295MM for the year, representing a growth rate of 34% YoY for the full year.  While this is strong growth overall, the Company has already earned almost $210MM in revenue through 3Q.  At the high end of guidance, 4Q revenue growth would be only 10.7% YoY compared with around 50% growth for the prior years.  For this reason, I am projecting revenue at ~$105MM, or a 36% growth rate YoY.

On the new product (or free option) front, Dialog is making good progress with its low power audio codec, with one customer shipping a consumer device utilizing the chip as well as another product that is in development with the chip.  There will be some revenue from the chip in 4Q10, with a more material impact on revenue starting in 1Q11. 

On PMOLED, the first products being developed by TDK utilizing the smartXtend chip were debuted at a trade show in Japan this quarter.  Dialog is also working with another yet-unnamed partner to develop similar technology that is expected to be revealed in 4Q10.  The Company is managing expectations on the product, stating that product tests and supply chain development will be ongoing for the remainder of 2010.  Early-adopters (2^nd tier consumer products companies) will likely bring products to market in late 1Q11 and assuming successful adoption, larger tier 1 players could adopt on a large scale in late 2011. 

Finally, the Company announced a key partnership with Intel and a design win regarding its recently launched DA6011 companion chip, which is primarily intended for industrial and automotive usage.

Overall, a great quarter operationally with financial results held back slightly by some capacity constraints at the customer level.  Because analyst expectations had been ratcheted up in the weeks prior to earnings, shares fell almost 8% the day of the report, although they have mostly recovered to what I would again call a relatively fair value based on existing operations.  Looking forward, Dialog has bright prospects as it takes advantage of top-tier customer relationships while it works to diversify revenue streams and develop new, innovate products.  At any level below the current prices, I would look to continue to accumulate shares as long as positive developments continue.

Disclosure: Author is long DLG