Dawson

Geophysical Company (DWSN)

12/20/14
Stock Price $11.00


Currently, the stock market is in the upper end of the valuation spectrum. Finding decent assets to
purchase at great prices is becoming harder and harder. I have no problem with my fund holding cash
during these high valuation times, and with my cash level reaching the 50% range, Im holding a lot of
options on future fear in the market and the ability to purchase assets on the cheap. And by cheap, Im not
looking for a stock thats 10% lower P/E compared to the market or some other metric that makes it
marginally attractive. Investors can create substantially higher returns by plugging their noses and going
to the areas of most fear. However, you can not just buy blindly into these beaten down segments, but a
well researched company, with good assets and little to no debt (or debt that isnt due for a few years)
can create a massive reward for dealing with that sick feeling in your stomach as you push the buy
button. Over time, you come to love that feeling as your brain begins to equate it with future monetary
rewards.

All that being said, one hated segment of the market is the anything to do with oil segment. And within
that segment, you have businesses that have held up decently, like those with refining operations, and
those that have plummeted, like E&P businesses and those that service them. Within this hated portion
of this hated segment you find my latest idea, Dawson Geophysical Company (DWSN).

Dawson provides seismic data acquisition and processing services in the lower 48 states to oil and gas
companies. Dawson isnt going to blow the doors off and post super high ROIC, but they do provide a
required service to the E&P energy firm looking to run an efficient operation. If you can purchase their
assets on the cheap, the investor can receive better than average returns.

Proof of average ROIC and ROE:

They had some high return years as the fracking movement picked up and the market tightened.
However, I think a 10%-12% return on invested capital is about market for these assets. Any growth
would neither create nor destroy value.

Also of interest, in a lot of the years the FCF metric is substantially higher than that from net income. This
is from a depreciation charge that is massively larger than what the company states is their maintenance
capex level. As long as the company goes thru with their current capex budget and spends only at
maintenance capex levels, the free cash flow per share will be substantially larger than the earnings per
share in 2015, as has been the case historically if you subtract out the growth capex.

Just as a check to make sure the capital expenditures the company says was for growth, actually created
growth, well add up all the revenue growth over the past 10 years, and divide that by the amount they
stated was spent on growth:

We can see that for each dollar invested in growth, Dawson earned 72 cents. Generally Id like this a bit
higher, but at a normalized 23% gross margin, taking something away for depreciation and multiplying
by 1 minus the tax rate, gets us between 8% and 10% return on investment. Which isnt surprising
considering the commodity type business and the returns mentioned above. Im not looking at Dawson
as a growth story, so just knowing that they werent (arent) wasting money on growth is good sign that
management is of sufficient quality.

Any investor short this stock would say the industry is horrible, the company is average, oil is currently
over supplied and the price is in the gutter. And guess what? I agree with all of that. But, as Howard
Marks would say, Ya, but at what price? What price would you agree to become the owner of this
business and their assets? I think that 3 years from now, 5 years from now, 10 years from now, people
will still be drilling for oil. Some estimate that theres 45 billion barrels available with current technology
in the Williston Basin alone, and in order to maintain the current production level, 6,000 new wells will
needed to be drilled per year. Thats just to maintain current production levels. The world currently has
approximately 1 million barrels/day in excess supply. However, even if the U.S. keeps production at
current levels, and OPEC never cuts production, that excess supply will be used up as the worlds oil
demands continues to increase at 1 million barrels per year. If the fracking revolution comes to a
grinding halt because of the sub $60 oil, then demand will be increasing as supply is decreasing, thus
causing a shortage and oil spikes again. Or, the current producers keep producing at this rate and the
price of oil rises to meet the marginal cost of producing that oil. In the long run supply and demand
economics wins out and the cost of the commodity must meet or exceed the marginal cost to produce it.
At the expected world demand over the next decade of over 90 million barrels a day, the marginal cost is
north of $90. Perhaps more importantly to Dawson, the American shale oil is on the demand curve south
of the $90 (ultra-deep water is just south, and Id be worried if I was holding Canadian oil-sands assets as
this is the most expensive and first to go).

Enough rambling on macro things that border on the unknowable, lets get back to company specific and
the knowable. If we can agree that Dawson doesnt have some barrier-to-entry to allow it to receive
above the required return, and we can agree that this is a business and industry that will be around in 10
years, the Bruce Greenwald Replacement Value approach is the first method to employ. (If you havent
seen the videos of Greenwalds Columbia Business School lectures, do yourself a favor and google them.
Ive watched all of them numerous times and gain knowledge with each viewing.)




The first thing I always look at for a company is the debt level. When investing in a beaten down
industry, this is absolutely critical. You want a company that can weather the downturn and be around
for the eventual recovery. During the downturn, all the weaker players will go bankrupt, will be acquired
at a low price, or will liquidate. This will cut the industrys supply to meet, or fall below, the level of
demand. Investing in only businesses with rock solid balance sheets will provide comfort to an investor
investing in an uncomfortable industry. As you can see, Dawson has almost $50 million in cash and
equivalents, while debt is only $11.7 million. After subtracting out cash for operations, Dawson has
excess cash of approximately $26 million, or over $3.10/share (almost 30% of current stock price). The
only adjustment I made for replacement value verse book value is the addition of goodwill for the
intangibles (sales staff, training, structure of business, all the things youd have to pay and set-up if you
started this business from scratch). Generally this goodwill line item will be between 1 and 3 times SG&A
depending on the structure of the business. I used 2.5x their SG&A of $16 million. Im not splitting hairs
here. With a book value of $25 share, a replacement value of $30 shares, and the current market value of
$11, the investment decision isnt dependent on a few bucks. If it were, youd want to drill down on each
item and fully vet it.

I included a liquidation value as a worst-case scenario. The major write-downs were receivables and
PP&E, with PP&E being the most subjective. This comes in at $9 a share, not much below current prices.
However, based on their ability to sell the equipment if they decided to liquidate, this worst-case scenario
price can rise or fall a bit. Given the equipment is fairly new and modern (at least modern as seismic
equipment gets), I feel my write-down of over 60% is very conservative. This is not a bad worst-case
scenario.

With the replacement value hurdle cleared and showing a substantially higher valuation than the current
market price, Ill move on to the earnings power value (EPV). Taking last years numbers and
remembering that it was a down year, we get a conservative FCF/share of just over $2. Current stock
price of $11 means a price to free-cash-flow (FCF) of 5.5. We also have to remember that Dawson has
over $3 a share is excess cash. Thus, $11 minus the $3 divided by our $2 in FCF provides us with a 4
price/FCF or a 25% cash return. Below is a chart showing the historical multiples for different valuation
metrics and the value of the stock today if we used those multiples (remember, these values are based on
2014 numbers which were down):

So thats what its worth based on 2014 numbers. However, Im more interested in whats a normalized
earnings power of Dawsons assets. I want to take a conservative approach to my normalized numbers,
and if the price Mr. Market is offering to sell me his shares of Dawson is still attractive, Ill then have a
valuation based on the balance sheet and the income statement to support the investment.

Over the past 8 years, revenue has ranged from a high of $334 million in 2011 to a low of $257 million in
2007 (2014 was $261 million). If we take the median revenue wed get $295 million. To double check
this number to make sure it makes sense, we can divide by $21 million (the average revenue/crew
employed Dawson has had over the past decade) to get an idea of how many crews theyd have to
employ. $295/$21 gives us 14 crews. Which, coincidently, is what they project next years crew count to
be.


For the gross margin Ill use 22%. They had over 25% margins between 2005 and 2008, so I feel 22% is a
conservative normalized gross margin. Depreciation of $40 million, the amount they charged in 2014.
Dawsons SG&A expense of the past 5 years has been between 3% and 4.5% of sales. On the upper end of
4.5%, would give us just over $13 million. However, based on Dawsons 2014 amount of $16 million, Ill
be conservative amount of $15 million (the $16 million from 2014, minus some one-time charges).



Utilizing the assumptions above, a 37% tax rate, and a $20 million maintenance capex (CEO has stated $8-
$10 million, but we want to be conservative) provides us with cash earnings of $3.30 a share. The sharp-
eyed reader may notice that the $3.30 is not sustainable over the long term given that the deprecation
charge of $40 million will shrink as Dawson only puts $20 million back into the business via capital
expenditures. If we fully tax the difference of $20 million, we get a cash EPS of $2.37. Considering the
move from $3.30 to $2.37 would happen over time, Ill take the mid point of $2.80 for our EPV.

Taking the $2.80 in per share normalized earnings power; I then multiply it by an acceptable multiple to
come to an EPV. Historical P/E multiples are of no use as negative years have distorted the result. Thus
we are left with a few options; take 1/(k-g), use an industry avg. multiple, or utilize the historical P/FCF
multiple. Ill be using the P/FCF for my valuation. Given the small size of this business in comparison to
others in the oil services sector, I feel this is the best method to proceed with. So, 10 times 2.80 equates
to an EPV of $28.00. Ill add in $2-$3 of excess cash per share and I get a stock value of between $30 and
$31. The EPV is pretty darn close to the replacement value of $30.10 (which is exactly what we should
find in a business lacking barriers to entry).

Given all the turmoil in the oil industry, I think itd be prudent to run a worst-case scenario for our
normalized EPV. In every investment I make, I always ask myself Monish Pabrais question of, Is this a
low risk / high uncertainty situation. Sam Zell also does something to this regard in that he spends the
majority of his time looking at the downside. If he can live with that, and theres some upside, even if
unquantifiable, hell move forward with the investment. The most revenue DWSN has had in the previous
few years was about $330 million. If we say that the U.S. oil production gets so bad over the next 3-5
years that Dawsons revenue normalizes at 50% of this, we get revenue at $165 million. Dawsons CEO
has stated maintenance capex is currently around $8-$10 million. I think it would be realistic to believe if
revenue fell by 50% that PP&E could be cut by 50% and maintenance capex would fall even further than
the $8 million dollar mark. However, to be conservative, Ill stay with $10 million for capex. So $165
times conservative gross margin of 22% equates to just over $33 million. Subtracting out the $10 million
in capex and $10 million in SG&A gives me just over $16 million. After-taxes of 37%, I get an EPS amount
of just over $1.25/share. Even if I assume that the $38 million in current excess cash gets eaten up in
restructuring costs, at a 10 multiple the value of DWSN in the worst-case scenario is $12.50, above
todays market value.

With the recent headlines of oils price collapse in great abundance, the short-term dangers are obvious.
Lower oil prices, means less capex by the E&P firms, means less spending on seismic services, means pain
for DWSN. The key here is the short-term pain. Current, depending on what report you view, oil supply
is running in excess of demand to the tune of 600k b/d to 1.4 million b/d. This means we either have to
wait for demand to catch up, or someone has to cut back, which has traditionally been OPEC. Im not

going to go deep into a forecast of when and where oil price levels will end up, because I, nor anyone else,
can predict this, but based on basic supply and demand curve, the marginal cost to supply the needed 90+
million barrels a day of oil is in the $80 to $110 per barrel depending on the costs taken into account.
This gives me an indication that the price of a barrel of oil will be within this range at some point in the
future. I have no idea when this future event will happen, but Dawson has a rock solid balance sheet, and
as shown above in the worst-case scenario, can weather bad times quite well for an extended period of
time.

The reluctance of typical portfolio managers and analyst to withstand short-term volatility is of great
advantage to those of us with longer-term time periods. As Buffett was buying domestic stocks for his
personal account during the depths of the great recession, he noted that his entire portfolio would soon
be domestic stocks and that the stocks would turn positive before the headlines or economy did. This
was his way of saying embrace the short-term pain and take advantage of the massive sale in stocks
resulting from the flood of investors running for the door. It also reminds me of a fellow student during
my MBA days replying to a teachers questions if hed buy BP at current prices (a short period after the
gulf oil spill). He said he would once more clarity about the situation came to light. His statement sums
up the majority of investors. They want certainty and have historically paid a high premium for that
warm, fuzzy feeling certainty brings.

Summing things up:
- 1-5 year price point of $25-$35
- Worst-case scenario $1.25 EPS
- Plenty of excess cash
- Current pain should subside as oil production normalizes or world-wide GDP grows
- Biggest risk = short-term volatility
- $30/$11 = Approx. 170% cumulative return over 1-5 years




Note: Dawson has announced a merger with TGC Industries (TGE). This write-up is already much longer
than I planned, so Ill save the write-up of the merged company for another time. It doesnt change the
premise of the investment, and potentially makes it more attracted as management thinks they can
modestly cut expenses. I chose my play into this investment idea through Dawson rather than TGE as I like
their management better and believe theyre in a stronger market, just in case the merger fails to go
through.


Disclosure: I am long Dawson and may sell at any point without notice. This is not a recommendation to
purchase this stock, as this investment may not fit your financial situation. Consult your own financial
advisor. Do your own research.