GAMCO Opposes Dril-Quip’s Merger Scheduled for Vote September 5th

Rhea-AI Summary

GAMCO Asset Management Inc., an affiliate of GAMCO Investors, Inc. (OTCQX: GAMI), plans to vote against the proposed merger between Dril-Quip, Inc. (NYSE: DRQ) and Innovex Downhole Solutions. GAMCO, owning 8.32% of Dril-Quip's shares, believes the company is worth more as a standalone entity. Since the merger announcement on March 18, 2024, Dril-Quip's stock has declined 37.5%, significantly underperforming the sector. GAMCO estimates Dril-Quip's 2025 private market value at $39 per share, citing concerns about dilution of Dril-Quip's offshore franchise and weakening of its strong balance sheet. The merger would shift Dril-Quip's revenue mix, increasing exposure to the slowing U.S. onshore market while reducing its offshore focus.

Positive

• GAMCO estimates Dril-Quip's 2025 private market value at $39 per share, significantly higher than current stock price
• Dril-Quip projects EBITDA increase from $71 million to $137 million between 2024 and 2028
• Dril-Quip forecasts cumulative free cash flow of $330 million (almost $10/share) by 2028
• Dril-Quip currently has $189.2 million of cash ($5.50 per share) and no debt

Negative

• Dril-Quip's stock price has declined 37.5% since merger announcement, underperforming sector
• Proposed merger would dilute Dril-Quip's offshore franchise, reducing offshore revenue mix
• Merger increases exposure to slowing U.S. onshore market
• Innovex's net debt and special dividend payment would weaken Newco's balance sheet
• Innovex's existing commitments, including acquisition plans, may further strain Newco's finances

Financial Analyst

GAMCO's opposition to the Dril-Quip-Innovex merger highlights significant concerns for investors. The 37.5% stock price decline since the announcement, compared to the sector's 8.3% drop, suggests market skepticism. Dril-Quip's projected EBITDA growth from $71 million to $137 million (2024-2028) and cumulative free cash flow of $330 million indicate strong standalone potential. The merger's dilution of Dril-Quip's offshore focus (from 60% to 39%) and increased exposure to the slowing U.S. onshore market are concerning. Moreover, Innovex's net debt of $110.6 million post-special dividend contrasts sharply with Dril-Quip's debt-free status, potentially weakening the combined entity's financial position.

Oil Industry Expert

The merger's shift in revenue mix is a critical point for investors. Dril-Quip's current 60% offshore revenue, potentially rising to 75-80% in a normalized market, aligns with increasing offshore activity evidenced by rising project FIDs and tree awards. The proposed merger would reduce this to 39%, while increasing exposure to the U.S. land market at 33%. This strategic pivot comes at a time when U.S. onshore activity is plateauing, potentially limiting growth prospects. The $75 million special dividend to Innovex's private equity owner further strains the deal's financial logic, potentially hampering the combined entity's ability to capitalize on the promising offshore market trends.

GREENWICH, Conn.--(BUSINESS WIRE)-- GAMCO Asset Management Inc. (“GAMCO”), an affiliate of GAMCO Investors, Inc. (OTCQX: GAMI), on behalf of its clients and certain of its affiliates owns approximately 2,866,654 shares of Dril-Quip, Inc. (NYSE: DRQ), representing 8.32% of the 34,452,230 outstanding shares as reported in Dril-Quip’s most recently filed Form 10-Q for the quarter ended June 30, 2024. GAMCO’s Proxy Voting Committee (“PVC”) intends to vote “Against” the proposed merger with Innovex Downhole Solutions (“Innovex”).

Source: Dril-Quip Amendment to Form S-4 Registration Statement filed on 8/5/24, Page 106

On March 18, 2024, Dril-Quip announced its intention to acquire and merge with Innovex. At the time of the announcement, Dril-Quip’s stock price was $23.73. Since Dril-Quip’s announcement that it will acquire Innovex and through August 13, 2024, Dril-Quip's stock price has declined 37.5%, while the VanEck Oil Services ETF (OIH) has declined only 8.3%.

We believe Dril-Quip is worth more as a standalone company. We believe Dril-Quip's intrinsic value is worth more than its current stock price. However, the company is planning to issue new shares near its all-time lows to fund the Innovex acquisition. According to Dril-Quip's projections in its merger proxy document filed with the SEC on August 5, 2024, Dril-Quip's financials are improving. Between 2024 and 2028, Dril-Quip projects its EBITDA will increase from $71 million to $137 million and generate a cumulative free cash flow of $330 million (or almost $10/share). Dril-Quip currently has $189.2 million of cash (or $5.50 per share) on its balance sheet and no debt. If Dril-Quip achieves its financial targets provided in the proxy, it will have $519.2 million of cash by 2028 (or $15 per share), greater than its current market capitalization. Even though our internal earnings projections are more conservative relative to Dril-Quip's outlook, we estimate Dril-Quip's 2025 private market value (PMV) to be $39 per share.

Among other issues the PVC considered were that Innovex dilutes Dril-Quip's offshore franchise. Dril-Quip's current revenue mix is 60% offshore and 40% international land. In a normalized offshore environment, we estimate offshore revenue is closer to 75-80% of the revenue mix. Offshore activity is increasing, as evidenced by increased project FID, tree awards, and a tight floater market. Newco's revenue mix, however, will be less favorable as 39% of its revenue would be derived from offshore, 33% from U.S. land, and 29% from international land. As part of Newco, Dril-Quip will be increasing its exposure to the U.S. onshore market at a time when growth in U.S. activity is slowing or peaking.

Additionally, the merger weakens Dril-Quip's strong balance sheet. As of June 30, 2024, Dril-Quip had $189.2 million of cash and no debt on its balance sheet. Based on latest available financial information for Innovex, it had net debt of $35.6 million (consisting of $7.6 million of cash and $43.2 million of total debt). Before closing of the merger, Innovex will pay its Amberjack Capital Partners (a private equity firm that currently owns 95% of Innovex) a $75 million special dividend, which we find to be excessive. This special dividend will increase Innovex's net debt position to $110.6 million prior to the merger. Following the proposed merger, Innovex would have other existing commitments that will further weaken Newco's balance sheet, such as its intention to acquire the remaining 80% of Downhole Well Solutions (DWS) that it doesn’t already own.

For all of these reasons, our PVC intends to vote “Against” the proposed merger.

GAMCO Investors, Inc., through its subsidiaries, manages assets of private advisory accounts (GAMCO), mutual funds and closed-end funds (Gabelli Funds, LLC) and is known for its Private Market Value with a Catalyst™ style of investment.

View source version on businesswire.com: https://www.businesswire.com/news/home/20240814966689/en/

Robert Leininger

Chair, Proxy Voting Committee

(914) 921-7754

For further information please visit www.gabelli.com

Source: GAMCO Asset Management Inc.

FAQ

Why is GAMCO (GAMI) opposing the Dril-Quip merger scheduled for September 5th?

GAMCO opposes the merger because they believe Dril-Quip is worth more as a standalone company. They cite concerns about dilution of Dril-Quip's offshore franchise, weakening of its strong balance sheet, and increased exposure to the slowing U.S. onshore market.

How has Dril-Quip's stock performed since the merger announcement with Innovex?

Since the merger announcement on March 18, 2024, Dril-Quip's stock price has declined 37.5%, significantly underperforming the VanEck Oil Services ETF (OIH), which declined only 8.3% in the same period.

What is GAMCO's (GAMI) estimate for Dril-Quip's 2025 private market value?

GAMCO estimates Dril-Quip's 2025 private market value to be $39 per share, which is significantly higher than its current stock price.

How would the merger with Innovex affect Dril-Quip's revenue mix?

The merger would change Dril-Quip's revenue mix, reducing offshore exposure from 60-80% to 39%, while increasing U.S. land exposure to 33% and international land to 29%.