DALLAS--(BUSINESS WIRE)--The text of the letter follows.
May 30, 2018
Nokomis Capital LLC
2305 Cedar Springs, Suite 420
Dallas, TX 75201
Layne Christensen Company Board of Directors
Layne Christensen Company
1800 Hughes Landing Boulevard, Ste 800
The Woodlands, TX 77380
To Layne Christensen Company Board of Directors:
The Granite Construction Incorporated1 (NYSE: GVA, hereafter “Granite”) offer from February 14, 2018 substantially undervalues the Layne Christensen Company (NASDAQ: LAYN, hereafter “Layne”). This becomes clear in reading the background of the merger, which describes an egregiously mishandled process. Nokomis Capital LLC controls 758,444 shares of Layne.
Cetus Capital LLC offered a clear and concise analysis in the 13D filed March 20, 2018. The response from Layne’s board and management has been vague, attempting to redirect away, rather than address, the points Cetus Capital raised. Nokomis Capital LLC bought Layne shares on our own expectations of future cash flow, which are similar to Layne’s internal forecast provided to Greentech (Layne’s banker for the transaction, hereafter “Greentech”) and described in the May 15, 2015 14A filing. Layne’s internally generated forward expectation of future EBITDA for calendar years 2019, 2020, and 2021 are $82mm, $107mm, and $129mm, respectively. The 2021 estimate is a 330% increase over CY2017.
The press release from the Layne dated February 14, 2018 described the Granite transaction as “$17.00 a share,” a “premium of 33%” and an “increasing presence in the growing water midstream business.” By the May 15, 2018 letter announcing the shareholder vote, the Layne Board Chairman shifted to defending Greentech and the sales process, and citing multiples of historical financial performance. Those historical numbers are far less relevant in light of the changing profile of the business.
In reading through the history, we were surprised to see Greentech’s list of similar businesses. The process that the Layne Board executed did not even include asking each of these obvious candidates for indications of interest in bidding. Only one oilfield service firm was solicited for interest, and that was before the Delaware Basin water asset was an opportunity Layne could discuss. We think the process was haphazard, particularly because no potential bidder was given the chance to evaluate the Delaware Basin water asset. We spoke with multiple oilfield service companies who are interested in the Delaware Basin water asset.
Looking back through the narrative, the first December 2017 offer of $16.25 was rejected by the board as being too low. We agree. The Layne board is now making the argument that this transaction price represents a good value for shareholders. We think that it is a great deal for management with over $32mm of golden parachute payouts, and an incredible payday for Greentech, which is earning more than $8mm for a flawed process that added no discernable value. Those payouts may have clouded judgement around determining if this is a fair value for shareholders.
Moreover, the October 30, 2017 offer price of $15.25 was rejected by the Layne board as insufficient. However, at that point, Layne had not finalized their agreement with the General Land Office for exclusive water rights on 80,000 acres in the Delaware Basin, which became the Delaware Basin water asset. In fact, Layne did not even sign the Delaware Basin water asset agreement until after rejecting the $15.25 offer. Shortly after signing, Layne management described it as a “goldmine.”
Through investor meetings and presentations prior to the Granite transaction announcement, Layne’s management team clearly indicated a future expectation of $60mm of future EBITDA from the combined midstream water assets. This included $10mm from the Hermosa pipeline including the extension, and around $50mm for the Delaware Basin water asset. Together, this accounts for half of the expected 2021 EBITDA in the forecast Layne gave Greentech. When we asked directly, Layne’s management suggested that the proportion was closer to a third. We think the Layne management team is being dishonest about the ratio of that estimate to try to get the Granite transaction done. Before the Granite transaction announcement, Layne CFO Michael Anderson outlined two separate formulaic expressions that each resulted in $50mm of EBITDA, and a payback under two years on the required capital investment.
The Delaware Basin water asset is a goldmine, and a significant contributor to the huge EBITDA growth in Layne’s internal forecast, as well as ours. Layne’s board solicited no bids beyond Granite, and captured no value for shareholders, for this goldmine. The lack of incremental value for this Delaware Basin water asset and the inept sales process are the central reasons that we intend to vote against the transaction.
We asked Layne CEO Michael Caliel about the lack of bidders. We noted that the Layne board did not discuss a transaction with any other potential bidder after signing the Delaware Basin water asset agreement. As we have shown, the Delaware Basin water asset represents about half of the 2021 estimate Layne presented to Greentech. Mr. Caliel responded by saying that anybody could have brought them a bid, and no one has. We are concerned by the passiveness of this response. It demonstrates an extraordinary lack of initiative and a poor use of a competitive bidding process to capture shareholder value. This lack of basic fiduciary effort compelled us to write, and point out our disappointment with the price, the process, and the effort.
Principal, Nokomis Capital LLC
1 Nokomis has a short position in Granite in order to minimize exposure to Granite’s share price in the event that this transaction is approved by shareholders.