IG Seismic Services: the next Russian OFS stock to break · PDF file ·...

IG Seismic Services: the next Russian OFS stock to break through

© GEOTECH Holding

RESEARCH DEPARTMENT

OIL & GAS

Alexander Nazarov +7 (495) 980 4381 [email protected]

Alexey Dorokhov +7 (495) 983 18 00 ext. 54504 [email protected]

EQUITY RESEARCH: OIL AND GAS RESEARCH DEPARTMENT

2 Copyright © 2003-2013. Gazprombank (Open Joint-Stock Company)

Alexander Nazarov +7 (495) 980 4381 [email protected]

Alexey Dorokhov +7 (495) 287 6318 [email protected]

IGSS LI OVERWEIGHT Closing price, $ (Jul 26) 27.0 # of shares outstanding, mln 20.8 Target price, $ 50.6 Upside, % 87% Free float 43% Market Cap, $ mln 281 Net debt $ mln 391 Minority interest, $ mln 40 EV, $ mln 712 52-week high 33.0 52-week low 17.5

Source: company, Bloomberg, Gazprombank estimates

IGSS financials summary, $ mln

616 608 680

758 842

87 123 143 166 189

0

200

400

600

800

1,000

2011 2012 2013E 2014E 2015ERevenues EBITDA

Source: company, Gazprombank estimates

IGSS share price performance vs. RIOB Index

60%

80%

100%

120%

140%

160%

180%

Dec 12

Jan 1

3

Feb

13

Mar 13

Apr 13

May

13

Jun

13

Jul 1

3

IGSS RIOB Index

Source: Bloomberg

IGSS shareholders structure

Schlumberger 12%

Free float 43%

Nikolay Levitsky 27%

Volga Resources

13%

Other institutional and private shareholders

5%

Source: company, Bloomberg, Gazprombank estimates

We initiate coverage of IG Seismic Services plc (IGSS), a result of the combination of Russian and CIS seismic assets of GEOTECH Holding, Integra and Schlumberger. We set a DCF-based target price of $50.6 per GDR, implying 87% upside, and an OVERWEIGHT recommendation.

IGSS is Russia’s largest land and transition zone seismic company, operating about 75 seismic crews in Russia-CIS and abroad and holding about a 43% share of the seismic market in 2012. We see IGSS as the only play in Russia’s quickly expanding seismic market with bright prospects. We anticipate the introduction of MET breaks for Russian oil producers, as seismic expenses may nearly double in the local seismic market over the next several years. We also expect an increase in demand for high-density seismic jobs, driving IGSS’ revenues and EBITDA up a respective 37% and 54% over the next three years. We also expect a significant increase in margins due to the end of the price war on the Russian seismic market. Lastly, we highlight the company’s significant multiples-based discount to Russian and international OFS peers.

Largest Russian seismic company with about a 43% market share. IGSS is Russia’s largest and the world’s second-largest seismic company, with 75 active seismic crews. In terms of revenues, IGSS holds a 19-50% market share, depending on type of seismic service. By comparison, Russia’s second-largest seismic company operates just 20 crews.

Joining with Integra ends a price war. IGSS was created as a separate entity combining Russia and CIS seismic assets of GEOTECH, Integra and Schlumberger and was listed on the LSE in December 2012. Before the transaction GEOTECH and Integra were Russia’s two largest competitors for land seismic business. As a result of ongoing price wars between the two, the EBITDA margin of the combined business fell by around 13 pps, from 27% in 2009 to 14% in 2011. The creation of IGSS ended the price war leading to a gradual recovery of prices in the seismic business.

MET breaks to boost seismic spending. It has been proposed that Russian oil majors be granted MET breaks for seismic spending in order to provide a long-term build-up of Russian oil and gas reserves. We estimate that this may add around RUB 150 bln to the Russian seismic market, or about 133% of total market value. As the holder of a majority share of this market, IGSS would be the main beneficiary.

Increase in demand for complex HD seismic to be a second major driver. We also note that Russian oil companies are showing increasing demand for more complex seismic services as Gazprom Neft, which has the first Russian contract for UniQ (a high-density seismic technology, developed by IGSS’ shareholder Schlumberger), will likely be followed by other Russian majors. Exploration and development of greenfields and tight oil resources will also require a significant increase in seismic orders, which we think will be another driver for IGSS’ revenues and margins.

Risks include oil prices, no tax breaks, leverage and liquidity. We see four main risks to IGSS’ investment case. First, a possible decline in oil prices could force oil majors to cut spending significantly. Second, there is a possibility that MET breaks may not be introduced, which would lead us to lower our estimates. Third, IGSS’ net debt/EBITDA is 3.2x*, one of the highest in the Russian oil and gas universe. Fourth, low liquidity may weigh on the company’s share price performance.

Key financial indicators, $ mln 2011 2012 2013E 2014E 2015E 2016E Revenue 616 608 680 758 842 957 EBITDA adj.* 87 123 143 166 189 221 EBITDA margin 14% 20% 21% 22% 22% 23% Net profit/(loss) -77 13 20 32 52 73 Net margin -12% 2% 3% 4% 6% 8% P/E -3.7 22.5 13.8 8.7 5.4 3.8 EV/EBITDA 8.2 5.8 5.0 4.3 3.8 3.2

Source: company, Gazprombank estimates * Gazprombank estimates

IG Seismic Services: the next Russian OFS stock to break through

29.07.2013

Research Department +7 (495) 287 6318

3 IGSS: the next Russian OFS stock to break through

Contents

Investment Summary ...................................................................................................................................................................................... 4

Key risks ....................................................................................................................................................................................................... 10

Seismic services industry overview .............................................................................................................................................................. 11

Valuation ....................................................................................................................................................................................................... 14

Multiples ........................................................................................................................................................................................................ 15

Financial Outlook ......................................................................................................................................................................................... 16

Appendix ....................................................................................................................................................................................................... 20

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Investment Summary In this report, we initiate coverage of IGSS with an OVERWEIGHT recommendation and target price of $50.6 per GDR, implying 87% upside potential.

IGSS is one of the largest seismic companies in the world and the leading pure-play land and transition-zone seismic company in Russia and the CIS. We see sufficient potential in the seismic services market, as Russian oil and gas companies have established programs to develop greenfields and intensify brownfields, which will likely be supported by government MET breaks for seismic expenses. We do not see any evidence of a potential increase in competition, primarily due to the consolidation of two major players under IGSS. We also note that the entry of new foreign players is unlikely as a result of state regulation and existing access to cutting-edge foreign technologies through Schlumberger, IGSS’ shareholder.

Russia’s largest seismic company. IGSS is Russia’s largest and the world’s second-largest seismic company with 75 active seismic crews, 28 operational bases, and nine advanced data processing and interpretation facilities. According to REnergyCO, in terms of revenues IGSS holds a 43% market share of seismic field operations and 19% of the data processing and interpretation segment. Moreover, according to other estimates based on different approaches (e.g. number of crews or number of shot points) IGSS holds more than a 60% share of the seismic market. According to REnergyCO, the company also holds 2% of the total Russian OFS market. IGSS generated revenues of $608 mln in 2012, down 1% YoY, and EBITDA of $123 mln, up 41% YoY. We estimate that IGSS’ market share in terms of revenues will grow due to higher demand for seismic services from Russian oil and gas companies, as well as its privileged market position in terms of cost effectiveness and regional coverage.

IGSS’ share in Russian seismic market in terms of revenues, $ mln

0

500

1,000

1,500

2,000

2,500

2011 2012 2013E 2014E 2015E 2016E 2017E 2018E

IGSS Others

53% 43% 46%

60%

55%52%49%

57%

Source: company, REnergyCO

IGSS – dominant player on the Russian seismic service market. IGSS was established in 2012 on the basis of a combination of seismic assets of two major companies on the Russian seismic market – GEOTECH Holding and Integra. IGSS’ market share was 43% in 2012, based on REnergyCO estimates. This share looks attractive in the company’s profile and serves as a solid base for growth. Moreover, fierce competition on the market is very unlikely, as the second-largest market participant, TNG-Group, holds a 20% market share, and has 20 crews (55 crews fewer than IGSS) and a smaller presence in oil and gas-producing regions compared with IGSS. Other small companies that emerged from the base of former Soviet scientific enterprises and have four to eight crews are unlikely to survive the price competition and instead will likely focus on existing clients and technologies rather than gaining new ones.

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Market share of Russian seismic companies in 2012

IGSS 43%

TNG-Group 20%

BashneftGF 10%

Other small seismic companies

27%

Source: REnergyCO, Gazprombank estimates

Nor do we expect foreign players to enter the market because of government restrictions that make geological information a state secret. IGSS’ shareholder Schlumberger is the only foreign company present on the Russian seismic market, but it is involved in it with IGSS. We also note that despite declassification of official Russian oil and gas reserves under ABC1+C2 standards on July 9, there was no mention of the ban being lifted on geological research by foreign companies.

Combining seismic business of GEOTECH and Integra ends the price war and creates synergy. Before the combination in 2012 Integra and GEOTECH were Russia’s two largest competitors for seismic business. After the recession in 2009, which caused oil and gas companies to cut seismic spending, both Integra and GEOTECH were involved in a price war in order to maintain market share. EBITDA margin performances clearly showed the consequences.

EBITDA margins of Integra and GEOTECH, % 27% 26%

22%

17%

14%

23%

20% 21% 22% 22% 23% 24% 24%

0%

5%

10%

15%

20%

25%

30%

2009 2010 2011 2012 2013E 2014E 2015E 2016E 2017E 2018E

Geotech Integra IGSS

Source: companies, Gazprombank estimates

We expect the combined IGSS to not only benefit from the end of this price war, but also enjoy significant synergies. Absence of previously persisting overlap in regions of operations allowed IGSS to reduce costs via optimization of logistical and maintenance facilities and personnel.

Second, on the logistics side, due to scale effects the united company will not need to reallocate seismic crews as often as before. The companies’ management teams can recall several cases in which teams from Integra and GEOTECH won each other’s contracts for the following year and replaced each other on the respective sites, causing transportation expenses to double.

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Russian seismic: poor performance, good potential. The performance of the seismic market is directly linked to that of oil and gas producing companies. First, a seismic company’s revenues are primarily a share of an oil company’s development capex, which is one of the first costs to be reduced in difficult times. Second, oil and gas companies that seek to develop greenfields or to intensify brownfields will likely see higher demand for quality seismic and cutting-edge seismic technologies (UniQ). Oil companies showed a sharp decline in such demand in 2008, which was reflected in the performance of seismic companies the following year. The lag stems from fulfillment of already signed contracts and their poor replacement in post-crisis years; the seismic market reached its pre-crisis level only in 2012.

Performance of seismic and oil markets

771868

1,1331,216

772

1,0751,166

1,416

0

200

400

600

800

1,000

1,200

1,400

1,600

2005 2006 2007 2008 2009 2010 2011 20120%

20%

40%

60%

80%

100%

120%

140%

160%

180%

200%

Seismic market revenues, $ mln, LHS MICEXO&G Index, RHS

Source: REnergyCO, Bloomberg As brownfield production growth opportunities in Russia are generally exhausted, we expect oil companies to actively develop greenfields in order to maintain current oil production. We see increased spending by oil and gas companies on exploration of greenfields and optimization of brownfields as one of the major drivers to decent future performance of the seismic market. We estimate that starting from 2015, the share of greenfields in total oil production will grow at a 13% CAGR from 4% to 51% until 2035. Therefore, seismic companies will likely enjoy increased development capex and higher demand for more-profitable high-quality seismic surveys from oil and gas producing companies. In these terms, IGSS’ exclusive access to UniQ technology contributes to the company’s promising prospects.

Russian oil production forecast, mln bbl

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

2000 2005 2010 2015E 2020E 2025E 2030E 2035E

Currently producing f ields Fields yet to be developed Fields yet to be di scoveredUnconventional oil NGL

mln bbls

Source: IEA, Gazprombank estimates

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IGSS is represented in all major oil-producing regions of Russia, including Western Siberia, Eastern Siberia, Timan-Pechora, and the south of Russia. This benefits the company due to cost effectiveness and makes its services more attractive for oil and gas producing companies.

Revenue breakdown by region in 2012

Western Siberia 47%

Eastern Siberia 21%

Timan-Pechora 18%

Volga-Urals 9%

Kazakhstan 4%Other 6%

Source: Company

However, a more important advantage for IGSS is its presence in major Russian greenfield regions. The company has 35 field seismic crews (46% of the total amount) in one of the most promising regions – North-West and West Siberia. The company is also well-represented in East Siberia, where it maintains 17 field seismic crews (23%).

Major Russian greenfields

Region Oilfield name Reserves, mtoe (ABC1+C2)

Year when production starts

IGSS capacity

East Siberia

Talakan 200 2009 17 field seismic crews, 5 operational bases

Verkhnechonskoye 120 2009 Yurubcheno-Tohomsk 499 2016 Kuyumbinskoye 277 2017

North-West Siberia and West Siberia

Vankor 525 2009

35 field seismic crews, 7 operational bases

Russkoye 408 2015 Novoportovskoye 238 2016 Pyakyahinskoye (gas) 61 2016 Suzunskoye 44 2016 East-Messoyahskoye 374 2016 Tagulskoye 196 2019 Russko-Rechenskoye 22 2019 West-Messoyahskoye 177 2020 Lodochnoye 57 2018 N.Rogozhnikovskoye 90 2017 Imilorkoye 194 2015

Timan-Pechora Naulsk 51 2014 12 field seismic crews,

8 operational bases Trebs and Titov 140 2013 Source: Gazprombank estimates

We do not treat offshore as a significant near-term driver. It should be mentioned that many significant greenfield projects, such as Korchagin, Prirazlomnoye, Filanvskovo and North Chayvo, are offshore. IGSS has no offshore seismic facilities, and has no plans to invest in offshore equipment (acquisition of vessels) for offshore services in the near future. However, IGSS has a potential to participate in offshore development in cooperation with Schlumberger, which has a fleet of modern vessels suitable for offshore development. We do not treat this potential as a significant source in the company’s revenues so far.

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MET breaks – the main possible near-term driver. Following authorization by Prime Minister Dmitry Medvedev, the Russian government is currently preparing amendments to the Tax Code that will make seismic exploration expenses deductible for MET purposes. At the same time, after introduction of the gas MET formula, we understand that the Russian government is in no position to significantly decrease the total amount of oil MET collected. Hence, we anticipate an increase in the base MET rate with possible deductions for seismic expenses. The reason for this is straightforward – Russia is missing out on new significant discoveries in oil and gas; the country’s reserves replacement is based mainly on an increase in the recoverability ratio of brownfields, as well as the development of greenfields discovered prior to 2000.

Russian oil reserves life vs. oil reserve life of key regions of the world, years

2214

22

38 39

78

122

0

20

40

60

80

100

120

140

RussianFederation

Asia Pacific Europe &Eurasia

Africa North America Middle East S. & Cent.America

World average: 53 years

Source: BP, Gazprombank estimates

To quantify the potential effect, even without being largely optimistic, we compare the total amount of MET payments with the seismic market. We estimate that total Russian MET payments (including oil and gas MET) would be around $78 bln in 2014, while the total seismic market is estimated at slightly more than $1.5 bln, or roughly 2% of MET payments. So even if we conservatively assume that the total MET deduction would not be limited to just 3% of total MET payments, the possible additions to the seismic market total almost $2 bln. This could more than double the potential size of the seismic market, which could be a huge driver and one that we did not anticipate back in 2012 during IGSS’ listing.

At the same time, we should realistically assume that the whole deduction may not have immediate effect as early as 2014. Moreover, we note this is still not law yet, and just a possibility, albeit a very realistic one.

Total MET collected vs. seismic market size with possible additions in 2014, $ bln

65.9

79.3 77.5 78.4

1.2 1.4 1.5 1.50

1

2

3

4

5

6

7

8

9

10

0

10

20

30

40

50

60

70

80

90

2011 2012 2013E 2014E

Total MET, $ bln (LHS) Seismic market, $ bln (RHS) Possible upside, $ bln (RHS)

1.9

Source: Finance Ministry, IGSS, Gazprombank estimates

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Seismic market structure – we expect an increase in high-density jobs and data processing. In terms of types of seismic surveys, we anticipate growth in the share of 3D seismic services due to increased demand for exploration of greenfields from oil and gas companies. We estimate the average YoY growth in this segment at 5% up until 2016. We also expect growth in HD (high density) seismic exploration in response to complex geology of existing and new oil and gas fields. We see seismic field operations to remain the major source of IGSS’ revenues, especially combined with the exclusive three-year right to use UniQ technology. As we also expect seismic surveys to become more complex, we also see growth potential in the data processing and interpretation (DP&I) segment (9% average growth YoY until 2016). However, in 2011 and 2012, IGSS did not have as significant a share in the DP&I segment as it did in the OFS segment, which contributed the most to revenues. We expect the share of the DP&I segment in the company’s revenues to remain unchanged, though we estimate that IGSS’ share in the overall DP&I segment will slightly increase.

DP&I segment, $ mln Oilfield seismic segment, $ mln

0

20

40

60

80

100

120

140

160

180

2011 2012 2013E 2014E 2015E 2016E

IGSS Others

23% 19% 19%20%19%19%

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2011 2012 2013E 2014E 2015E 2016E

IGSS Others

55% 44% 46%

53%50%48%

Source: REnergyCo, Gazprombank estimates

IGSS has a diversified structure of orders for seismic services. The major share in revenues in 2012 came from Gazprom Neft (13.8%). However, we expect Rosneft’s share to increase in the coming years, primarily due to the purchase of TNK-BP and therefore the combination of order books.

Revenue breakdown by customer in 2012

Gazprom Neft 13.8%

Gazprom 13.1%

TNK-BP 9.5%

Rosnedra 9.3%

Rosneft 9.3%Bashneft 6.5%

Lukoil 4.8%

NOVATEK 3.9%

SurgutNG 3.5%

Others 26.3%

Source: Company

The government also contributes to the company’s revenues through state orders. In 2012, the share of orders from the Federal Subsoil Use Agency (Rosnedra) in the company’s revenues was $57 mln (9.3%). We do not expect the revenues from government orders to decline, however, its share will be less due to increasing revenues from other companies.

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Drivers of growth

We see increased demand for seismic services from oil and gas companies as the major driver of the company's growth. The prime sources are the introduction of MET-deductible seismic expenses and strong demand for high-quality seismic surveys. Oil companies will also need to optimize production from depleted brownfields, and especially explore near-field opportunities. The demand for cutting-edge Schlumberger technologies will also contribute to IGSS' growth.

An increase in the complexity of seismic surveys will also have a positive impact on the company's future performance. In response to complex geology of mature and new oil and gas fields demand for 3D-HD seismic surveys and especially for the UniQ technology is likely to grow over time, so the company's revenues will increase.

Following the combination of seismic business of GEOTECH and former Integra, there are no significant competitors left in the industry. Therefore, we can expect price recovery for seismic services in Russia and higher EBITDA and net margins for IGSS through economies of scale and cost savings from synergies, which will be reflected in EBITDA and net margins.

Increased demand outside Russia. Already in July, IGSS signed a large two-year contract for seismic services with CAIRN INDIA Ltd. We estimate that this particular, and other possible contracts, may contribute up to 10% of total revenue in 2014.

Key risks Oil prices. Oil prices are still quite volatile and depend on a number of

unpredictable political and economic factors. If oil prices decline over time, oil companies are likely to reduce their capex, which will directly affect seismic companies' revenues. However, the market consensus does not indicate a decline in oil prices. We use 2013 Brent oil price forecast of $106 per bbl.

Increase of competition on the market. As we expect significant growth in the exploration and development of greenfields, there will be high demand for technologies, it still may not be enough for oil companies. The major obstacle preventing international seismic majors from entering the game is the law defining Russian mineral resources as a state secret. At this stage, we consider the probability of market liberalization as very low, but other big players in the market, such as TNG-Group or Bashneftgeofizika, may also find ways to enter into partnerships with international seismic majors and thus receive the ability to employ new technologies. We note that IGSS has exclusive access to Schlumberger technologies.

Decrease in government orders. The share of government orders (Rosnedra) in IGSS' revenues is 9.3% ($58 mln). We expect this share to decrease over time due to a rising share of oil and gas company orders, driven by MET changes. Despite the slightly lower profitability of government orders, we consider this a stable source of revenues, though it will play an insignificant role in future revenues and be replaced by indirect support through taxation. We also note the government has created Rusgeology, a state-run entity which may be responsible for future state seismic orders. We've heard concerns it may affect the seismic market, but note that IGSS has agreed to create JV with Rusgeology. As a result, we note Rusgeology activity may rather benefit IGSS, than being a risk.

Leverage. IGSS has a significant amount of debt on its balance sheet. Net debt/EBITDA stands at 3.2x, compared to the average industry level of 1.4x (56% lower). This indicates that the company may suffer from a lack of liquidity in the future. However, in our model we expect this ratio to decline to 1.7x as soon as 2016. We note that IGSS has zero currency risk, as 100% of its debt is ruble-denominated.

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IGSS net debt/EBITDA profile 3.2

3.0

2.42.0

1.7

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

2012 2013E 2014E 2015E 2016E Source: Company, Gazprombank estimates

Seismic services industry overview How to locate an oil basin. Seismic data acquisition uses the principles of seismology to estimate the properties of the Earth’s subsurface from reflected seismic waves (low frequency acoustic waves). In order to locate oil or gas basins the seismic survey method requires a controlled source of seismic waves, such as explosive charges, a specialized airgun or a vibrator unit. Such seismic waves pass through the Earth’s subsurface, and at each layer within the Earth a portion of the wave’s energy reflects back and then is recorded by receivers, while the rest refracts through.

On land, the typical receiver used is a small, portable instrument called a geophone, which converts ground motion into electrical signals. In water, hydrophones are used, converting pressure changes into electrical signals. Receiver signals are then processed using computers, following which they can be interpreted by technical specialists using techniques of various level of sophistication

The main consumer of seismic survey services is the oil and gas industry, which uses seismic survey services to map and interpret potential and confirmed oil and gas reservoirs.

Seismic survey services are used extensively in greenfield exploration, as well as in the appraisal of discovered but undeveloped fields and optimization of production at already producing fields.

Basic land seismic setup

Source: Deutsche Bank

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Overview of seismic sources. The main techniques used to generate seismic waves for onshore data acquisition include:

the explosive-and-drilling technique, which uses explosive charges placed in shallow wells

the vibration impact, or vibroseis, technique, which uses industrial vibrator units which produce impact on the ground surface

the impulse technique, which employs the physical impact or electromagnetic pulse sources

Vibroseis is generally less expensive than explosive-and-drilling, however, it can be unsuitable for certain types of terrain (e.g. swampy areas such as Western Siberia). In such regions the explosive-and-drilling technique is typically the preferred method for seismic surveys. The explosive-and-drilling technique may also produce higher-quality data in certain circumstances. In offshore and transition zones the main sources used include pneumatic sources (“airguns”) and pulse electromagnetic sources.

Explosive-and-Drilling Vibroseis

Impulse Airgun

Source: IGSS

Overview of seismic technologies. The seismic acquisition technologies used to analyze the seismic waves are:

2D. Two-dimensional images of the underlying geological formations are created based on signals received from single lines of sources and geophones on the surface. This technique is primarily used for surveys of unexplored areas in order to identify potential hydrocarbon bearing structures. Cost-effective, these surveys are the least expensive to perform and can be used to cover large areas efficiently.

3D. This technique builds on the 2D method by laying sources and geophones over predetermined two-dimensional areas on the surface, creating a three-dimensional seismic image of the underlying formations. It is primarily used to develop a more detailed understanding of geological structures identified as being potentially hydrocarbon bearing – or to improve understanding of already producing reservoirs.

4D. 4D involves placing 3D seismic surveys over the same producing fields, at intervals, over a predetermined time scale. This allows for monitoring of changes in the reservoir.

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3D3C and 4C. The more complex surveys, 3D3C and 4C are typically used to gain a better understanding of recently discovered reservoirs. These technologies produce a more accurate image of subsurface structures. In certain conditions, they can also separately identify oil, gas and water within such structures. This significantly increases the accuracy of resource assessments and reservoir modeling.

Seismic Side Scan Surveys (SSSS). A technique which utilizes scattered waves to identify low-amplitude tectonic faults.

Microseismic. Used to register seismic data during hydraulic fracturing, the Microseismic technique allows the user to monitor the operation in real time.

Processing and interpretation are not straightforward. Once acquired, seismic data needs to be manipulated into a dataset. This can be used to infer the subsurface structure and produce visual outputs. Processing is an exercise in reverse engineering. It attempts to deliver a model of the earth’s crust that fits the recorded data after an explosion. The recorded data is in the form of reflected waves after having been modified by the earth’s rock and the geophones.

Mathematically, backing out a model of the rock formation given the recorded data is as much art as science, and is complicated by several factors.

The geophones and recording system introduce distortions, i.e. what gets recorded is not exactly what arrived at the geophones.

The signal to noise (S/N) ratio decreases with depth - the deeper the reflections have travelled to and from, the more attenuated the energy is and the lower the S/N ratio. Lower S/N ratios imply less-reliable processed results.

Filters are applied to the recorded data to try to remove distortions introduced by equipment and the setup, but such filters invariably also remove some useful information, and thus decrease the S/N ratio.

The solution is often very sensitive to small changes in the filters applied and other model assumptions.

Quality in seismic means density of shot points. The quality of seismic service does not depend solely on data processing, although it is critical – in order to process data, you have to collect it first. This leads to a very straightforward dependence – the more shot points you make, the higher the quality of seismic data you are likely to obtain.

UniQ technology, which we consider one of the main drivers for IGSS, is provided by Schlumberger, an IGSS shareholder. The main difference involves the density of shot points. If a conventional modern 3D seismic job assumes about 100 shot points per km2, UniQ assumes about 400, which is much more profitable for a seismic company. For an oil company, UniQ technology:

gives access to high quality data acquisition: high density, high resolution

identifies separately oil, gas and water structures under certain conditions; enhances validity and reliability of lithology, reservoir characterization

is suitable for extremely complex geological conditions

provides high point-receiver channel capacity

supports wide range of point-receiver spacing options

can be used with various sources

is adaptable: can be used from desert to Arctic conditions

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Comparison of Conventional Technology with UniQ Conventional Shot Gather UniQ shot gather

Conventional Stack UniQ Stack

Conventional Impedance (Lithology) UniQ Impedance (Lithology)

Source: IGSS

Valuation IGSS went public in December 2012. The stock trades on the LSE Main Market, with one GDR consisting of two common shares. In order to estimate the fair price of IGSS common stock, we apply the DCF method.

We apply WACC methodology to estimate the target price for one GDR. In our calculation we take the one-year average YTM of the Russia 30 eurobond as the risk-free rate, which equals 3.5%. For the equity-risk premium, we use the 10-year average difference between the RTS Index implied yield and the Russia 30 Eurobond yield, which equals 8%.

The company’s beta is based on sector-specific beta and an adjustment coefficient, which includes such factors as transparency of ownership, liquidity, leverage, trading risks and others.

We also note that the company has no public debt, so the cost of debt was estimated using cost of peer debt adjusted for IGSS’ leverage.

29.07.2013



WACC calculation Risk-free rate Russia 30 Eurobond 1Y average YTM for dollar rate 3.5%

Basic equity risk premium 10Y average of difference between RTS Index implied yield (E/P) and Russia 30 Eurobond yield 8.0%

Adjusted beta Sector beta * adjustment coefficient 2.03 Cost of equity Risk-free rate + adjusted beta * Risk premium 19.7%

Cost of debt before tax shield Calculated using cost of debt of peers adjusted by company's leverage 5.6%

Tax shield 20% WACC cost of debt Cost of debt * (1 - Tax shield) 4.5% % of equity Estimated target value 72.2% % of debt Estimated target value 27.8% WACC 15.5%

Source: Bloomberg, Gazprombank estimates

IGSS valuation model summary, $ ‘000 2012 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E Revenue 608,482 679,673 757,700 842,180 956,856 1,086,032 1,242,543 1,412,516 1,589,321 1,783,385 1,996,072 EBITDA 123,016 142,798 166,180 189,203 220,907 258,360 304,380 354,444 407,361 466,758 532,816 EBITDA margin 20% 21% 22% 22% 23% 24% 24% 25% 26% 26% 27% EBIT 41,347 69,180 87,361 109,378 135,663 167,106 208,623 253,264 299,998 352,442 410,717 Cash taxes on EBIT - 2,006 - 6,491 - 6,902 - 10,998 - 16,212 - 22,272 - 30,231 - 39,725 - 50,045 - 61,771 - 74,854 NOPAT 39,341 62,689 80,458 98,380 119,451 144,834 178,393 213,539 249,953 290,672 335,863 DD&A and other non-cash charges 81,669 73,618 78,820 79,824 85,243 91,255 95,756 101,180 107,363 114,316 122,100 WC adjustments - 37,111 - 32,430 - 14,624 - 35,752 - 42,340 - 38,216 - 53,350 - 57,629 - 59,625 - 65,585 - 71,768 CAPEX - 56,688 - 94,736 - 64,870 - 89,502 -108,422 - 99,264 - 106,894 - 114,547 - 121,420 - 128,705 - 136,428 FCF 27,211 9,141 79,784 52,950 53,933 98,608 113,906 142,542 176,271 210,697 249,767 DCF 4,007 69,075 39,689 35,000 55,402 55,406 60,029 64,269 66,509 68,259 Discount factor 1.155 1.155 1.334 1.541 1.780 2.056 2.375 2.743 3.168 3.659

Source: Gazprombank estimates

IGSS valuation model summary, $ ‘000

WACC % 15.5% Sum DCF $ ‘000 517,644 Perpetual growth % 1.0% Terminal value $ ‘000 1,739,270 PV of terminal value $ ‘000 475,326 Enterprise value $ ‘000 992,970 Net debt (end 2013) $ ‘000 425,501 Minority share $ ‘000 40,854 Equity value $ ‘000 526,615 Number of shares # ‘000 20,833.4 Target price per GDR $ 50.6

Source: Gazprombank estimates

We set a target price of $50.6 per GDR. Therefore, based on the 24 of July 2013 price of $27, we see 87% upside potential for IGSS common stock, supporting our OVERWEIGHT recommendation.

Multiples IGSS common stock trades with a discount to almost the entire peer group, both on projected EV/EBITDA and P/E multiples. The only exceptions is EV/EBITDA for its seismic peers, but this metric is non-representative for the last one, as it has only one company multiple.

Thus, we conclude that IGSS is undervalued based on multiples as well, and is traded with 20-53% discounts to peers, indirectly supporting our DCF-based target price.

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IGSS relative valuation Price, $ Market capitalization, $ mln EV, $mln EV/EBITDA P/E 2013E 2014E 2015E 2013E 2014E 2015E IGSS 27 281 712 5.0 4.3 3.8 13.8 8.7 5.4 Discount/premium to Russian OFS -20% -18% -13% 8% -17% -38% International majors -32% -28% -25% -15% -28% -45% Offshore -27% -22% -21% 5% -10% -36% Seismic 11% 14% 20% -13% -32% -56% Small cap international -47% -44% -59% -53% -58% -68% Russian oil servicing companies Eurasia Drilling Co. 43 6,362 6,757 7.4 6.3 5.2 14.7 12.7 11.3 C.A.T.Oil (in Euros) 18 901 926 7.0 6.0 5.2 19.3 15.3 12.4 HMSG 3 294 825 4.2 3.3 2.6 4.4 3.5 2.6 Average 6.2 5.2 4.3 12.8 10.5 8.8 International majors Schlumberger 83 109,626 115,796 9.2 7.8 6.5 17.4 14.4 12.3 Halliburton 45 41,727 45,163 7.1 5.7 4.8 14.0 11.0 9.4 Weatherford 14 10,598 19,275 6.4 5.2 4.5 17.4 11.0 8.4 Baker Hughes Inc. 48 21,160 25,145 6.5 5.2 4.4 16.1 11.6 9.8 Average 7.3 6.0 5.0 16.2 12.0 10.0 Offshore Nabors Industries 15 4,446 8,000 5.1 4.4 3.7 18.4 12.2 9.1 Patterson-UTI Energy 21 3,142 3,695 4.1 3.7 3.4 15.6 13.5 12.5 Helmerich&Payne 66 7,017 7,079 5.0 4.7 4.1 12.1 11.9 11.3 Diamond Offshore 72 9,941 9,979 8.9 6.2 5.3 15.3 10.0 8.5 ENSCO 60 13,974 18,250 7.4 6.2 5.2 9.2 7.8 6.8 Noble Corp. 40 10,047 15,910 8.7 6.3 5.1 14.3 8.6 7.0 Northern Offshore 1 235 235 3.0 1.9 1.9 6.3 3.9 4.5 SeaDrill Ltd 42 19,821 31,452 11.9 9.8 8.5 14.9 11.4 9.2 Transocean Inc 49 17,729 25,249 7.3 5.9 5.4 11.4 8.3 7.7 Average 6.8 5.5 4.7 13.1 9.7 8.5 Seismic Veritas 25 4,457 6,651 4.5 3.8 3.1 14.7 10.6 8.9 ION Geophysical 6 947 1,015 n/a n/a n/a 13.8 10.2 n/a Dawson Geophysical 40 319 307 n/a n/a n/a 19.2 17.7 16.0 Average 4.5 3.8 3.1 15.9 12.8 12.4 Small cap international Precision Drilling 10 2,648 3,774 5.9 4.9 n/a 13.7 11.0 9.0 Trican Well Service 14 2,080 2,744 9.2 5.4 n/a 44.7 12.4 13.6 Core Laboratories 150 6,823 7,056 19.7 17.4 15.3 28.4 24.6 21.5 Basic Energy Services 14 583 1,388 5.5 4.4 4.3 n/a 28.4 18.5 Exterran Holdings 32 2,089 3,854 6.7 5.7 n/a 50.8 37.0 29.2 Oil States Intl. 95 5,244 6,191 7.1 6.4 n/a 14.0 12.3 10.3 Oceaneering 77 8,302 8,264 11.2 9.4 7.7 23.3 19.5 16.7 Average 9.3 7.7 9.1 29.2 20.8 17.0

Source: Bloomberg, Gazprombank estimates

Financial Outlook

Revenues.We expect the seismic market to grow at a 5% CAGR until 2016. However, we also expect IGSS to outperform the market, which may result in 12% revenues CAGR until 2016. The company’s revenues are derived from an increasing number of shot points and their average prices. In our view, the first major driver of growth in shot points is increasing demand for seismic surveys from oil and gas companies. This comes from an estimated decrease in production from current oilfields, and the need to develop greenfields and optimize brownfields. We also see increased MET in exchange for tax deduction of seismic surveys costs from taxable income as a driver of revenue growth and incentivizing oil companies to spend more on seismic surveys.

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Revenue forecasts, $ mln

608680

758842

957

0

200

400

600

800

1000

1200

2012 2013E 2014E 2015E 2016E Source: company, Gazprombank estimates

The end of the price war between GEOTECH and Integra gives the company a good position to determine prices in the market. We estimate the YoY growth in average price for a shot point at 4%. We also expect UniQ technology to be in high demand, which will cause the price of the service to increase on average by 7% YoY until 2016, we estimate.

Price forecasts, $ ‘000 per shot point

0.38 0.39 0.41 0.420.44

0.21 0.23 0.24 0.26

0.0

0.1

0.2

0.3

0.4

0.5

2012 2013E 2014E 2015E 2016E

Seismic Uniq Source: company, Gazprombank estimates

EBITDA. Combining drivers for IGSS’ growth with a privileged market position, we see good potential for an increase in the company’s profitability. We also note that synergies from the merger and cost efficiency will likely cause operational costs to grow slower than revenues. Therefore, we see the EBITDA margin rising to 24% in 2016, which results in an EBITDA CAGR of 16% by 2016.

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EBITDA forecasts, $ mln

123143

166

189

221

0

50

100

150

200

250


Capex. Capex is primarily spent on channels for recording of reflected waves. We estimate that the company will maintain an average of five shot points per channel and nine shot points per UniQ channel. We expect a significant increase in capex in 2013 due to implementation of UniQ technology. We then estimate capex to normalize at a level of $65 mln and grow at an average YoY rate of 30% until 2016.

Capex forecasts, $ mln

57

95

65

90

108

0

20

40

60

80

100

120

2012 2013E 2014E 2015E 2016E Source: Gazprombank estimates, company

Dividends. The company has no plans to pay dividends until it reaches a net debt/EBITDA of 1.5x. Thus, we expect to see the first dividends paid in 2016-17.

Net debt/EBITDA forecasts, $ mln

3.23.0

2.42.0

1.7

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

2012 2013E 2014E 2015E 2016E Source: Gazprombank estimates, company

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Free cash flow. We forecast a 53% decrease in FCF in 2013 due to the high level of capex. However, we estimate FCF in 2014 to be at a record level for the company, mainly due to our forecast of UniQ service growth and lower capex compared to 2013. Starting from 2015, we expect free cash flow to be normalized, which will support the company’s ability to pay dividends.

FCF forecasts, $ mln

27

9

80

53 54

0

10

20

30

40

50

60

70

80

90


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Appendix IGSS financial summary 2012 2013E 2014E 2015E 2016E 2017E 2018E Operational data 2D, # '000 248 258 268 277 284 293 305 3D, # '000 1,291 1,333 1,406 1,477 1,580 1,732 1,886 Uniq, # '000 - 142 189 251 334 368 405 Average price per 1 SP, $ '000 0.38 0.39 0.41 0.42 0.44 0.46 0.49 Uniq price, $ '000 - 0.21 0.23 0.24 0.26 0.28 0.30 Income statement, $ mln Revenues 608 680 758 842 957 1,086 1,243 Field seismic operations 579 617 679 742 825 933 1,063 Uniq - 30 43 61 88 103 123 Processing and interpretation 21 22 24 27 30 34 38 Other revenues 9 10 11 12 14 16 18 Cost of sales -490 -548 -604 -663 -747 -840 -949 Labor and wages -182 -204 -225 -249 -281 -317 -361 Materials and supplies -98 -110 -122 -135 -152 -172 -196 Oilfield services -84 -93 -104 -116 -131 -149 -171 DD&A -63 -69 -74 -74 -79 -84 -88 Transportation -24 -30 -34 -39 -46 -52 -60 Operating lease -16 -17 -19 -21 -23 -26 -30 Other third parties services -18 -20 -22 -24 -28 -32 -36 Other -5 -4 -5 -5 -6 -7 -8 SG&A -74 -69 -73 -78 -84 -90 -97 Net other income/expenses -3 7 7 8 9 10 12 EBITDA adj. 123 143 166 189 221 258 304 EBIT 41 69 87 109 136 167 209 Net financial expense -45 -44 -47 -45 -44 -44 -40 Income tax 9 -5 -8 -13 -18 -25 -34 Net income 13 20 32 52 73 99 135 Minority share 1 1 2 3 4 5 7 Balance sheet, $ mln Assets 998 1,063 1,091 1,151 1,241 1,337 1,462 Non-current assets 651 673 660 672 696 706 719 PP&E 472 494 481 491 515 525 537 Investments in associates 29 30 30 31 31 32 32 Current assets 348 390 431 479 544 631 742 Inventories 70 79 87 96 109 123 140 Receivables 231 258 287 319 363 412 471 Cash 19 14 26 24 25 50 81 Equity 373 393 426 477 551 650 785 Retained earnings -10 9 40 88 158 252 379 Liabilities 626 670 666 673 690 687 677 Non-current liablilities 271 289 277 271 266 248 222 Loans 226 244 232 226 221 203 177 Current liablities 355 381 389 402 424 439 454 Loans 173 185 177 173 170 158 141 Accounts payable 128 143 158 174 195 220 248 Cash flow statement, mln CFO 123 143 166 189 221 258 304 WC adjustments -37 -32 -15 -36 -42 -38 -53 Cash tax paid -2 -6 -7 -11 -16 -22 -30 Net CFO 84 104 145 142 162 198 221 CFI -28 -56 -38 -53 -64 -58 -62 CAPEX total -57 -95 -65 -90 -108 -99 -107 Net CFF -52 -53 -94 -92 -97 -115 -128

Source: Gazprombank estimates, company


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Copyright © 2003-2013. Gazprombank (Open Joint Stock Company). All rights reserved

This report has been prepared by the analysts of Gazprombank (Open Joint Stock Company) (hereinafter – Gazprombank) and is based on information obtained from public sources believed to be reliable, but is not guaranteed as necessarily being accurate. With the exception of information directly pertaining to Gazprombank, the latter shall not be liable for the accuracy or completeness of any information shown herein. All opinions and judgments herein represent solely analysts’ personal opinion regarding the events and situations described and analyzed in this report. They should not be regarded as Gazprombank’s position and are subject to change without notice, also in connection with new corporate or market events that may transpire. Gazprombank shall be under no obligation to update, amend this report or otherwise notify anyone of any such changes. The financial instruments mentioned herein may be unsuitable for certain categories of investors. This report should not be the only basis used when adopting an investment decision. Investors should make investment decisions at their own discretion, inviting independent consultants, if necessary, for their specific interests and objectives. The authors shall not be liable for any actions resulting from the use of this report. Any information contained herein or in the appendices hereto shall not to be construed as a solicitation or an offer to buy or sell any securities or advertisement, unless otherwise expressly stated herein or in the appendices hereto.

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