Ion Geophysical Corp (IO): This Company Solves the Most Critical Problem That Its Customers Face

I am a fan of lateral thinking when it comes to finding investment ideas. John Neff, one of the most successful fund managers in history, invested in steel drill pipes manufacturers when he was searching for indirect beneficiaries of the oil and gas boom during his time. Ion Geophysical Corp (NYSE:IO), a provider of seismic data related products and services, represents another way to play the U.S. shale boom. Its advanced seismic data technology gives it an edge in helping exploration and production companies in navigating unconventional reservoirs and difficult environments. Moreover, it faces less business and financial risks than its peers, with an asset-light model. Ion Geophysical Corp (NYSE:IO) is undervalued, with a forward P/E and PEG of 10.5 and 0.83 respectively.

Problem solvers are valued by customers

I remember how many students, presenting their business proposals for an entrepreneurship module in my university days, were unable to answer a simple question from the professor: “What problems does this company solve for its customers?” It is a simple question that separates successful companies which retain and grow their customer base from failures which saw their customer walk out of the door.

It will be easy to illustrate the value of Ion Geophysical Corp (NYSE:IO)’s services and its importance to customers, through a few examples of the kind of problems that its customers face. For example, the Arctic, where a quarter of global undiscovered reserves is thought to be, is tempting for many exploration and production companies, but they have difficulty in acquiring sufficient data to mitigate exploration risk. Ion Geophysical Corp (NYSE:IO) has proprietary under-ice technology that allows it to provide critical seismic data for customers in certain areas in the Arctic, which was previously not possible. Back to the example of shale gas, with low natural gas prices, shale operators have to be more efficient with their exploration efforts to protect their margins. That is where Ion Geophysical Corp (NYSE:IO)’s 3D ResSCAN program comes into play, helping customers reduce development costs with better measurement techniques.

Asset light model avoids the twin evils of leverage

I am skeptical when I read research reports where analysts are positive on certain high-ROE companies because of high operating leverage and financial leverage. Leverage is a double-edged sword that cuts both ways. During good times, higher leveraged companies outperform their peers in terms of profit margins and ROEs. However, when the tide turns, excessive debt levels and a high proportion of fixed costs to variable costs could result in operating losses and bankruptcy.

Ion Geophysical Corp (NYSE:IO) maintains an asset-light model by focusing on its strengths in technology and owning only the seismic equipment, data processing infrastructure and software. It neither owns any seismic data acquisition assets such marine vessels nor operates any land crews of its own. Instead, third party contractors are hired to do most of the seismic data acquisition work for Ion Geophysical Corp (NYSE:IO). As a result, ION Geophysical keeps its fixed costs and capital expenditures low with this strategy. Also, it has a strong balance sheet with a low gearing of about 20%, as it does not incur huge amounts of debt since it does not have to finance vessel ownership. In the event that oil & gas prices drop and business activity decreases, the negative impact on margins and ROA will be less severe, given ION Geophysical’s smaller asset base.