McDermott International (NYSE: MDR): The Best Kept Secret in the Energy Industry

May 12, 2010 ( Investorideas.com energy newswire ) Investorideas.com releases energy commentary from Karl Miller on McDermott International (NYSE: MDR):
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It is common knowledge that the top of my conviction must own or buy list are Occidental Petroleum (OXY) an outstanding mid-cap integrated oil, gas and chemical producer; Chesapeake Energy (CHK) the premier acquirer, developer and producer of low cost shale gas with a world class set of integrated oil partners, and McDermott International (MDR) a company that primarily services U.S. Utility power generation fleet, performs U.S. government contract work, and services the oil and gas industry through fabrication and other non-drilling related operations, in addition to the balance of the disclosed energy portfolio.



For public interest I disclosed my model energy portfolio "Charitable Energy Stocks" on January 27, 2010. To see my model energy portfolio go to weblink: http://www.naturalgasstocks.com/Karl_Miller/news/1281.asp



However, I feel that one of my model companies, MDR, while being one of the highest rated buy stocks by Wall Street Energy Analysts, is completely misunderstood by the majority of the market and investors. So let’s dispel some fallacies and focus on the facts and more importantly, the real value of MDR, and why it is a “must own” energy stock.



The MDR Board of Directors, with shareholder approval, plan to spin-off the company into two (2) separate publicly traded companies in a spin-off of Babcock and Wilcox in a tax free transaction, which is targeted to be completed by the end of June 2010, a little over a month from now. The two companies will be owned 100% by the current MDR shareholders and operate under the following names and structure:

1) McDermott International which, per the Company will take on the name of J. Ray McDermott S.A. will continue to focus and lead the industry in Offshore Oil & Gas Construction segment provides engineering, construction, installation and project management services to offshore oil and gas field developments worldwide. They operate in most major offshore producing regions throughout the world, including the U.S. Gulf of Mexico, Mexico, the Middle East, India, the Caspian Sea and Asia Pacific. J. Ray McDermott, S.A. will employ approximately 16,000 people worldwide.



2) The Babcock & Wilcox Company ("B&W") per the Company is a leading technology innovator in power generation and a specialty manufacturer of nuclear components with a rich legacy spanning over 140 years. B&W designs, engineers, manufactures, and constructs power generation systems, primarily for large utility and industrial customers, as well as related aftermarket parts, services and environmental control systems. For its largest customer, the U.S. Government, B&W supplies nuclear components for defense programs and manages and operates nuclear facilities and environmental management sites. B&W, including its joint venture companies, employs over 15,000 people worldwide.



Now, while a tax free spin-off is always interesting, what is more interesting is the value inherent in the current consolidated MDR entity and the value creation and exposure to various sectors of the US and Global energy market the spin-off provides investors. Offshore Oil & Gas Construction segment provides engineering, construction, installation and project management services to offshore oil and gas field developments worldwide



Firstly, I can speak with authority on J. Ray McDermott, S.A. They are “Not” engaged any drilling or exploration activities. What they do is what we commonly refer to as “selling pick axes to the miners”, and collect a hefty fee for providing such services as Offshore Oil & Gas Construction segment provides engineering, construction, installation and project management services to offshore oil and gas field developments worldwide. Secondly, they double by being called in to repair any and all offshore oil and gas infrastructure problems, will go anywhere in the world, will take virtually any job for the right price, and trust me, they charge a fortune to mobilize and just to get their equipment on site, let alone start the daily billing for equipment, labor and insurance and other overhead, plus a health profit margin. Thirdly and most importantly, near and dear to everyone at the current time, they clean up, cap, and repair deep sea pipelines, flanges, and wellheads.

So if we use a home contractor example, one can look at J. Ray McDermott as the Builder/Contractor, interior trade worker who installs the plumbing, electrical, and HVAC, among other furnishings, and is also the Contractor that is called in to clean up fire and water damage. They have been doing this since the 1960’s, and are arguably the best in the business and as I said, will take virtually any job, anywhere in the world, as long as the Client is willing to pay the mobilization charges J.Ray charges, which the client always does, given the limited nature of competition in the sector.



Now, let’s look at B&W and what value they deliver to shareholders. They design, engineer, manufacture, and construct power generation systems, primarily for large utility and industrial customers, as well as related aftermarket parts, services and environmental control systems and their largest customer is the “U.S. Government”. Given the stability and lucrative nature of servicing the current U.S. Nuclear power generation fleet of power plants, and government facilities, B&W can be looked at as an annuity for shareholders, much like some of the top Master Limited Partnerships in the Oil and Gas Sector, like Kinder Morgan. They are going to deliver a steady, healthy stream of cash flow to investors each year, and the cash flow is expected to grow, especially as the U.S. Government becomes more involved in the development of future nuclear technology to replace the aging U.S. Nuclear generation fleet of power plants and the aging nuclear powered fleet of submarines, aircraft carriers and cruisers for the U.S. Navy. B&W also services and cleans up coal plants by installing “scrubbers” among other technology to capture and reduce the carbon emissions, among other services, such as cleaning the boiler piping and tubing, inherent in both nuclear and coal fired power plants.



So where does this leave shareholder who own MDR before and after the spin-off of B&W into a separately traded company. MDR is currently priced near $25/share in the market. Just on a stand-alone basis, MDR should be valued somewhere in the $30-$35/share price range on a combined cash flow multiple (EBITDA multiple) and a discounted cash flow model valuation, given the companies virtual monopoly in its respective business lines.

Now, if we take the sum of the parts analysis, and put an 8-10X EBITDA multiple on projected operating income per company plus organic growth, you are looking at a $9 billion enterprise value ,which using the approximate outstanding shares of 230,000,000 shares, yields a value of $40/share.
Conclusion: Compared with the current stock price of $25/share, I view MDR as undervalued by 60% on a consolidated and a spin-off basis. MDR post spin-off should provide the equivalent of $40/share within 12-24 months to investors and based upon the current share price, up to a 60% return on invested capital.

Follow Karl Millers market and energy commentary at
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Mr. Miller is a globally recognized energy executive and institutional investor with a balance of both financial and energy sector expertise. Mr. Miller began his career on Wall Street during the 1980s and has an extensive background in banking, commodities trading and risk management.

Mr. Miller has built, restructured and managed energy businesses for major public energy companies on several continents, including PG&E Corporation, Electricite de France, El Paso Energy, Enron Corporation and JPMorgan Chase.

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