Largest Proppant Supplier with Vertically Integrated Business Model and Sizable Growth Potential
Fairmount Santrol (FMSA Holdings Inc.) is one of the world’s oldest and largest producers of sand-based proppants for hydraulic fracturing and oilfield exploration and production (E&P). Fairmount produces the broadest range of proppants in the market with a focus on resin-coated products and high-quality sand that exceeds American Petroleum Institute specifications (API-spec). In addition, for over 100 years, Fairmount and its predecessor companies have provided high-quality sand based products, applications knowledge and technical innovation to industrial and recreational (I&R) customers in the glass, foundry, sports, recreation and building products markets.
On October 3, 2014, Fairmount went public in a liquidity event for selling shareholders. The IPO was downsized and values the company at $2.6 billion, at 8x Adjusted EBITDA which is well below the company’s 23% annual Adjusted EBITDA growth, making shares a compelling buy at current levels given rising demand for specialty proppants, the company’s comprehensive product portfolio and logistics network, and its potentially game-changing SSP proppant which is now in field trials.
Fairmount operates its business with a strong commitment to three pillars of sustainable development: people, planet and prosperity. The company is strongly committed to health, safety and the environment (HSE). Its lost-time statistics are less than half of the industry average and 10 of its facilities operate with zero waste going to landfills. The company’s annual HSE targets include the number of trees planted to offset Tier I and Tier II carbon emissions. These initiatives have contributed to higher employee engagement and commitment, better community relationships and profitable long-term growth.
IPO – Selling Shareholders Only
Before the offering, Fairmount was 51% owned by ASP FML Holdings LLC (an affiliate of private equity firm American Securities LLC) that acquired a controlling stake in August 2010. Through this IPO, ASP FML and certain other selling shareholders planned to sell 44.5 million common shares at $21-$24 per share. Underwriters have been granted a 15% over-allotment option on 6,675,000 additional shares within 30-days.
On October 3, 2014, Fairmount priced its offering at $16 per share, well below its initial price range of $21 – $24 per share, and downsized the offering from 44.5 million to 25 million shares with an overallotment option on 3.75 million shares, down from 6.675 million shares earlier. Shares closed their first day of trading at $16.00 even, right at the revised offering price., with a market capitalization of $2.6 billion.
The company itself did not sell shares and will not receive any of the net proceeds.
No Dividends: Post IPO, Fairmount does not plan on paying dividends. The company’s debt covenants also include restrictions on cash dividend payouts.
$2.6 Billion Valuation at $16.00 per share with Valuation Multiple below 23% Annual Adjusted EBITDA Growth
At $16.00 per share, Fairmount has a market capitalization of $2.6 billion on $1.17 billion in sales (for the 12-months ended June 30, 2014), $326 million in Adjusted EBITDA and $113.9 million in net income, valuing shares at 23x earnings and 8x Adjusted EBITDA which falls short of 23% annual Adjusted EBITDA growth. (Adjusted EBITDA adjusts for sizable non-cash depreciation, compensation and other expenses.)
Investors Face Significant Dilution of $17.73 on Negative Net Tangible Book Value
With shares at $16 (as of 10/3/2014), new investors face immediate dilution of $17.73 per share based on net tangible book value deficit of $(1.73) or $273 million.
Fairmount’s Self Suspending Proppant (SSP) Offers Game Changing Advancement, Potential for Sharp Stock Gains in Early 2015
Fairmount’s proprietary SSP product represents a new category of proppant transport with coating technology that lowers specific gravity, uniformly distributes proppant through fractures, maximizes propped area, retains conductivity and reduces the need for chemicals. SSP increases initial production rates and enhanced ultimate recovery (EUR) of a well. It has applications across the entire proppant spectrum with an addressable market of 50 million tons because this coating technology can be applied to raw sand, ceramic proppant and resin-coated proppant. The company is currently conducting SSP field trials with Chesapeake Energy and expects full commercial launch by early 2015. Successful field trials and good marketing could make this a game changer for the company and the competitive landscape so patient investors could see shares spike significantly higher in early 2015.
Industry Trends Favor 10.5% Annual Growth in Demand for Resin-Coated Sand
Fairmount has benefited from broader industry trends such as an E&P push in North America over the past decade with horizontal drilling and hydraulic fracturing. As volumes ramp, E&P companies want to increase well yields and welcome innovations that enhance productivity.
North American fields have a higher number of wells per rig, shorter intervals between frac stages and longer lateral lengths. This has driven-up the volume of proppants to 6,000 to 10,000 tons per well at the high end – the equivalent of 60-100 railcars or 240-400 truckloads.
In addition, producers prefer different specialized proppants for each well stage to match well-specific geological characteristics and optimize conductivity. This translates into greater demand for specialty resin-coated proppants which perform better than raw sand and cost less than ceramic proppants.
As a result, demand for resin-coated sand is expected to grow 10.5% annually through 2018, 9.3% for raw frac sand and 9% for ceramic proppants. Moreover, demand has far outstripped the supply of high-quality API-spec raw sand due to the difficulty of finding high-quality frac sand deposits large enough to justify capital investments, deposits in close proximity to oil and gas reservoirs or Class I rail access.
Overall, Fairmount’s portfolio breadth, scale, outstanding logistics infrastructure and R&D innovation are key considerations in vendor selection as producers look to consolidate their purchasing to lower costs.
Strategy Driven by Investments in Anticipation of Rapid Demand Growth
Fairmount plans to drive long-term growth and shareholder value by increasing reserves and processing capacity, expanding logistics capabilities, increasing market penetration of its resin-coated proppants, developing and commercializing high-performance proprietary proppants and operating with a strong commitment to customers, employees and communities.
As of September 2014, customer demand for proppants far exceeded production capacity so the company plans to invest in new reserves and expand production capacity. It expects to add 1.0 million tons in annual proppant processing capacity in Q1 2015 when operations commence at a recently acquired facility in Brewer, Missouri. Fairmount also plans to increase sand production by 1.5 million tons at an existing facility by Q2 2016. In addition, the company has the option to control additional reserves on three Northern White and one Texas Gold property and expects to develop frac sand facilities at these greenfield sites by mid-2016. The company currently has 2.4 million tons of annual coating capacity and plans to add 0.8 million tons of new capacity by the end of 2015.
Since 2011, Fairmount has acquired or developed 24 distribution terminals with 13.1 million tons of additional annual transloading capacity, and continues to invest in rail, storage and terminals infrastructure to meet growing demand. Fairmount also plans to leverage unit train efficiencies to reduce freight costs and improve cycle times for its railcar fleet which it plans to grow by about 35% through the second half of 2015 to meet growing customer demand.
Fairmount’s high-performance resin-coated proppants enhance reservoir conductivity compared to raw sand, and are a cost-effective alternative to lightweight ceramic proppants. The company’s specially designed proppants reduce flow-back and offer superior performance across most operational metrics. Sales of resin-coated products also generate higher per-ton profit compared to raw frac sand and the company plans to highlight these factors to increase market share for its resin-coated products.
Fairmount has a strong pipeline of promising high-performance proprietary proppants and is currently (September 2014) conducting field the trials for its Propel SSP product which it plans to commercially launch by early 2015.
Early Market Entry, Investments in Growth Have Positioned Fairmount as Industry Leader with Preferred Status
Fairmount began investing in large-scale proppant production capacity in the early 1980s and its early customers include Halliburton and a predecessor company to Baker Hughes. Over the past 30 years, the company’s proppant solutions business has grown significantly with vertically-integrated operations that combine mining, sand processing, in-house resin manufacturing and resin-coated proppant manufacturing, backed by industry-leading research and development (R&D) and an extensive nationwide logistics network to deliver high volume products in record delivery times to customers in every major E&P basin in North America.
The company’s primary focus areas include sand reserves, processing assets, product delivery capability, proactive customer relations and proppant R&D. As of year-end 2013, Fairmount had 498.2 million tons of proven mineral reserves, 11 active sand processing facilities (with 12.3 million tons of annual capacity), a resin manufacturing facility and 11 coating facilities with 2.4 million tons of annual capacity.
Since 2009, the company has expanded its annual raw frac sand capacity by 6.0 million tons and its coating capacity by 1.5 million tons through organic growth and strategic acquisitions. In addition to the U.S., Fairmount has coating facilities in key growth markets such as China, Denmark and Mexico.
For product delivery, Fairmount has Class I railroad capability to each of North America’s major oil and gas producing basins, and truck and barge access to certain other basins through an integrated logistics platform that includes 46 proppant distribution terminals. Since 2011, the company has acquired or developed 24 distribution terminals that significantly enhance its annual transloading capacity. The company’s I&R markets are served through seven additional terminals. As of August 2014, Fairmount had 8,500 rail cars and expects to grow this fleet to over 13,200 by end 2016. Farimount also plans to add unit-train delivery to three production facilities and three basin terminals to reduce freight cost and improve cycle times for its railcar fleet.
The company has about 80 proppant customers and 850 customers across all end markets. Fairmount believes in genuinely partnering with customers for the long-term with market-based pricing and minimum volume commitments that give customers greater flexibility in budgeting and supply, and make Fairmount a preferred supply partner.
Over the years, Fairmount has addressed significant E&P technical challenges by working directly in the field and laboratory with its customers to develop proppants with greater crush resistance, greater fracture penetration, reduced backflow and maximized proppant fracture area to enhance oil and natural gas recovery while reducing operating expenses, equipment damage and downtime.
With high E&P volume growth in the U.S. and increasing uptake internationally, the proppant business is experiencing significant double-digit growth as the market for raw and resin-coated proppants recovers from a lull in 2012.
In 2013, Fairmount sold 7.5 million tons of proppant for $988 million in revenue, $293 million in Adjusted EBITDA and $105 million in net income with significant free cash flow.
Competitive Strengths Fortify Leadership Position, Growth Prospects
Fairmount is a leading proppant producer with the broadest product suite; the industry’s largest captive terminal footprint and broadest logistics capabilities; a history of successful innovation and new product development; trusted long-term customer relationships; economies of scale and high-productivity operations that deliver strong free cash flow; and a highly-experienced management team that is fully aligned with stockholders.
product suite addresses over 90% of the proppant market.
In 2013, the company was the largest supplier of resin-coated sand and the second-largest supplier of raw frac sand.
Its raw frac sand comes in all mesh sizes of high-performing API-spec Northern White and branded Texas Gold brown frac sand which has delivered cost advantages in Eagle Ford, Permian and other select basins. Fairmount’s portfolio of resin-coated products provides a range of conductivity, flow-back and strength attributes. With raw and resin-coated products, the company has comprehensive proppant solutions for all well characteristics, with scale and logistics infrastructure that give the company unique flexibility to fulfill large orders in shorter time frames than its competitors.
Moreover, with higher proppant consumption per well and increasing demand for tailored well-completion solutions, Fairmount’s portfolio breadth, scale and logistics deliver formidable competitive advantages.
Fairmount has the largest proppant logistics network in the industry which allows it to sell high volumes directly to producers in all major basins through 46 distribution terminals. In 2013, approximately 80% of the company’s proppant volume was sold in-basin at its distribution terminals, up from 65% in 2012. The company ships products on Class I railroads using a fleet of over 8,500 railcars (including 800 railcars provided by its customers). By Q3 2014, the company will have expanded unit-train capabilities to three of its processing facilities and three of its in-basin terminals for lower freight cost and improved cycle times. Currently, over 70% of its terminals’ capacity is dedicated exclusively to distributing Fairmount products. This logistics infrastructure has been developed over the years and cannot be easily and quickly replicated by competitors.
Fairmount credits close field and laboratory working relationships between its R&D staff and producers for practical, industry-leading innovations and high customer satisfaction, and leading edge proppant solutions that enhance the effectiveness of well completion for conventional to complex multi-stage horizontal wells. R&D involvement and its vertically-integrated business model give the company unique insights into current and future customer needs. The company’s resin-coated portfolio includes specialized proppants tailored for downhole performance at varying depths and geologies.
Fairmount structures customer contracts with practical and manageable terms that give customers financial and delivery flexibility and foster trusted long-term relationships.
The company has designed its vertically-integrated operations for low maintenance expenses, low production costs and high operational cash flow. Fairmount owns a substantial majority of its reserves and its processing plants are in close proximity to rail access for the lowest cost per ton-mile and reduced need for road transportation. As a result, Fairmount reliability ships high volume products by the most cost-effective mode of transportation and uses these cost savings to invest in sand reserves, processing, coating, research and terminal facilities.
Risks Tied to E&P Industry Slowdown, Regulatory Restrictions on Fracking, Mining, Water Use
The company has high dependence on sand-based fracking activity in North America which brings in 87% of Fairmount’s revenue but is susceptible to demand, supply and price volatility on global and geopolitical factors. Any sustained drop in oil and gas prices will depress E&P activity and lower Fairmount revenues. Additionally, rising environmental and legislative opposition to fracking could impact revenues even when oil and gas prices are high.
Transportation and handling accounts for 70% to 80% of the price of delivered sand and delivery can be adversely impacted by labor disputes, derailments, a spike in railcar leasing rates and adverse weather conditions. If added expenses cannot be passed on, Fairmount’s cash flow and profit margins will erode. In addition, Fairmount could face specific risks if it fails to profitably commercialize its self-suspending proppant (Propel SSP) and loses the initial investment made to acquire this technology.
Fairmount receives 30% of its revenues from Halliburton and 36% from FTSI, so any drop in sales to these two key customers would adversely impact revenues.
Further, of the company’s total 2013 volumes, as much as 45% was produced at its Wedron Silica facility so any slowdown at Wedron will impact sales. However, Wedron’s share should drop to 35% of sand processing capacity and 24% of annual coating capacity as production picks up on recent acquisitions.
In addition, multiple counties in Wisconsin and Minnesota have moratariums on raw frac sand mining due to environmental and water use issues.
Management Has 20+ years of Pioneering Industry Involvement and Focus
Most of Fairmount’s leadership team has been in place for over 20 years and was instrumental in developing the frac sand segment through innovation, new process technologies, greenfield capacity expansion, strategic acquisitions and a logistics-enabled, vertically-integrated model. Management has delivered 14% compounded annual revenue growth since 1994 and 25% CAGR since 2009. Management has significant equity ownership that aligns it with shareholders and encourages high returns on invested capital and profitable long-term growth.
The company is headed by President and Chief Executive Officer Jenniffer D. Deckard who has been with the company in finance and managerial positions since 1994. Chief Financial Officer Christopher L. Nagel has been with Fairmount Santrol since June 2011 and has prior CFO experience. Joseph D. Fodo serves as Executive Vice President and Chief Operating Officer and has held operational roles within the company since October 1999.
Management is regularly advised by the company’s founders who also hold Board positions and have valuable industry and customer contacts.
Financial Results Show Robust Revenue Growth, Continued Investment Through Down Cycles
Over the past five years, Fairmount has steadily grown volumes and diversified its product portfolio to include high-performance resin-coated variants. As a result, revenue and Adjusted EBITDA have mostly been on an upward trajectory barring a dip in 2012 with an industry-wide slowdown. For the last 12 months (LTM) ended June 30, 2014, Fairmount had $1.17 billion in revenue and $326 million in Adjusted EBITDA. And, to management’s credit, they continued to look ahead and steadily increased investment capex (capital expenditure) through the years to $132 million for the 12 months ended June 30, 2014.
Sequentially, volumes have grown 13% in Q2 2014 over the previous quarter, with Adjusted EBITDA up 18%. Year over year, volumes have risen 34% while Adjusted EBITDA gained 23% (well above the company’s Adjusted EBITDA valuation multiple of 11x).
Fairmount is committed to an operating model that maintains a strong and stable balance sheet where cash flow exceeds capital expenditures and debt service, and gives the company flexibility to pursue organic and acquisition growth opportunities. The company’s vertically integrated model is key to maintaining cost controls and delivering higher margins than competitors.
As of 6/30/2014, Fairmount had $2.9 million in cash and $1.27 billion in long-term debt (3.9x LTM Adjusted EBITDA).
Fairmount Santrol has management that is committed to the proppant segment, with foresight to keep investing through good and bad cycles on developing sustainable industry leadership through a logistics and R&D supported vertically integrated model. As the largest supplier of raw sand proppant and the second-largest supplier of resin-coated proppant, and with its R&D, rail and logistics infrastructure and deep value-based customer relations, Fairmount has uniquely positioned itself as a best-in-class, dependable industry innovator – a position that is virtually impossible to replicate as demand for highly specialized proppants continues to rise. In addition, the introduction of its SSP product in early 2015 could literally result in a sharp boost in revenue and profits and deliver handsome returns within the next six to nine months. For its IPO, Fairmount reduced its offering price substantially to $16 per share, a level that offers compelling upside as demand for specialty proppants grows.