Billionaire David Einhorn’s Ira Sohn Recommendation: Oil States International, Inc. (OIS)

On May 8^th, a number of value investors such as billionaire David Einhorn of Greenlight Capital (see Einhorn’s stock picks from his most recent 13F filing) presented investment ideas at the Ira Sohn Conference. Einhorn’s comments at public presentations are watched closely; he has had some big hits (such as his short recommendation of Green Mountain Coffee Roasters Inc. (NASDAQ:GMCR) in October 2011) and some big misses (such as, well, his short recommendation of Green Mountain Coffee Roasters Inc. (NASDAQ:GMCR) in October 2012).

This year Einhorn’s pick was Oil States International, Inc. (NYSE:OIS), a $5.4 billion market cap oilfield services company. He claimed that the various businesses Oil States International, Inc. (NYSE:OIS) operates earn higher margins than industry peers and that the market does not give the company enough credit for this financial performance. By doing a sum-of-the-parts valuation, he estimated a fair value for the shares of $118; even after his presentation, the stock is valued at a little under $100. This values it at 13 times its trailing earnings; an analyst darling, even at these levels consensus forecasts imply a five-year PEG ratio of only 0.8. However, in the first quarter of 2013 the company’s earnings fell 24% versus a year earlier (it’s possible that this was due to better weather conditions in the first quarter of 2012).

Einhorn was actually beaten to the punch a bit on his Oil States International, Inc. (NYSE:OIS) pick: activist and value fund JANA Partners, managed by Barry Rosenstein (find JANA’s favorite stocks), recently took a large stake in the company. JANA recently failed in its campaign to break up Agrium (NYSE:AGU). Rosenstein may like the company as is, but its investment thesis goes beyond what Einhorn suggested. One of the company’s business units provides accommodations to oilfield workers, and the JANA team believes that this segment (which is responsible for about 60% of operating income) could be spun out as a real estate investment trust. Real estate investment trusts receive favorable tax treatment as long as they pay a large share of their taxable income to shareholders, so they often pay high yields. Because they pay high yields, they are highly favored by income investors and so “REIT conversions” of a number of businesses have trended upward in the current environment. Again, Greenlight’s value case is based on the company as is, but Einhorn did mention that the stock could be worth over $150 per share in those conditions.

We track quarterly 13F filings from hedge funds and other notable investors, using the included information to help us develop investing strategies; for example, we have found that the most popular small cap stocks among hedge funds outperform the S&P 500 by an average of 18 percentage points per year. We can see that Greenlight did not own any shares of Oil States International, Inc. (NYSE:OIS) at the beginning of this year; the largest shareholder out of the funds we track was Chuck Royce’s Royce & Associates, which had about 3 million shares in its portfolio (check out more stocks Royce owned).

Oil States International, Inc. (NYSE:OIS) can be compared to other oilfield equipment and services companies including Superior Energy Services, Inc. (NYSE:SPN) and Weatherford International (NYSE:WFT). Each of these two is valued at 10 times its forward earnings estimates, with PEG ratios well below 1. This shows that Wall Street analysts consider them, as well as Oil States, to be undervalued. Both companies recorded revenue growth last quarter compared to Q1 2012, though in Weatherford International (NYSE:WFT)’s case net income came in considerably lower. We’d note that Oil States carries a small premium, and certainly in the event of spinning out a valuable REIT it could prove undervalued relative to these peers.

Einhorn’s move suggests that investors in Oil States aren’t necessarily dependent on JANA succeeding in its spinout strategy; the company may be undervalued as is, and it’s certainly more comforting to have the billionaire making that argument than the sell-side consensus. We think that Oil States is a good target for future research; it has a very strong best case scenario (the REIT spinout) and it would be well worth looking into if Greenlight is onto something as far as the current organization of the company.

Disclosure: I own no shares of any stocks mentioned in this article.