Veritas DGC's board gets cold feet on the eve of the company's proposed merger with PGS.

The much-awaited consolidation in the seismic industry was derailed in July by a terse statement from the Veritas board of directors announcing that it was withdrawing its approval and recommendation supporting the merger with Petroleum Geo-Services (PGS).
The reaction by the industry as a whole seems to be a collective, "Now what?"
The merger, after all, would have combined two of the "second-tier" players in the seismic contracting business, creating the world's second largest geophysical contractor after WesternGeco. French company CGG would have been a distant third.
With the merger in shambles, CGG is left to contend with two similarly sized competitors, all of which continue to chase WesternGeco for market share. Worse, the industry's overcapacity problem, which often has forced companies to bid jobs below cost just to keep crews and vessels working, is no closer to being resolved.
The Veritas decision came the evening before PGS's planned second-quarter earnings announcement, which revealed the company's net loss of US $30.6 million, or 30 cents per share. Though the original merger agreement had endured numerous revisions, both companies had, until this point, seemed eager to hammer out a deal. That deal, however, did depend on PGS selling some of its assets and in other ways attempting to reduce its $2.4 million in debt. As the second-quarter earnings were announced, the proposed sale of PGS's Atlantis operations seemed no closer to being realized. The company still was struggling to realize any return on investment for its hugely expensive FPSO Ramform Banff, vastly underutilized in its current location in the UK North Sea.
Veritas management gave no reasons for the board's decision and declined to be interviewed for this article, so one can only surmise that these types of financial woes eventually became more than the company wished to shoulder. "Veritas kept seeing little things that disturbed them, which, when taken as a whole, looked much too risky to proceed," said Jim Wicklund, an analyst for Bank of America Securities.
But the announcement still took PGS management by surprise. "I wasn't in their board meeting, so I would only be guessing if I told you what changed their minds," said Diz Mackewn, president of PGS Geophysical. "But I was there the week before talking to them about the potential merged organization going forward."
At that point, he added, the merger still felt very much "on." "There wasn't a lot of comfort on both sides in some elements," he said. "But certainly we felt at that stage it was going to go ahead."
Without the promise of a merger with a company that traditionally has shown considerable financial discipline, PGS's stock price took a nosedive. A Reuters news report July 31 stated that analysts were "focused on a possible cash squeeze for the heavily indebted company" after the merger talks broke down. John Olaisen, an analyst at Carnegie brokerage in Oslo, told Reuters, "Disregarding extraordinary gains, the figures are worse than market consensus and worse than we had expected. I fear PGS needs significant refinancing and will have to start debt restructuring."
Geoff Kieburtz at Salomon Smith Barney added that his company had maintained a neutral investment rating on PGS with the assumption that the merger would go through. "However, in light of the deal's collapse, we now believe an underperform rating is more appropriate," he said.
Doomsayers predicted the worst for PGS. But despite a stock price that hovered below $1 per share for several weeks, the company continued with business as usual.
"The stock market does what the stock market does," Mackewn said. "All we can do is provide them with accurate information for them to value our stock accordingly. But we're still the same company that we were before the merger was discussed."
In fact, he said, the company has been quite busy since it went into its "silence mode" in October of 2001, and with the merger no longer looming, information on the company can now start to become more readily available. Mackewn said that the geophysical part of the company has been focusing on cash flow and taking advantage of a strengthening contract market, only shooting multi-client projects with a high level of pre-funding and high potential for resale. A cost reduction campaign has been underway for 18 months.
As far as the industry's overcapacity issue is concerned, Mackewn said the general emphasis on the contract market should help. "I think the focus on cash flow and only making multi-client investments in the best of cases will lead to that," he said. "I think there's a feeling of more discipline out there, and I don't think you'll see as many people putting the downturns on their balance sheets as happened in the past. I think there's a consensus among the four major companies that that's not good business for anybody."
Wicklund said that the industry's current business model as a whole will have to change in order to survive. "The oil industry is asking for cheaper seismic and earth-shattering developments, but few of the companies are generating enough cash flow to keep operating, much less plow significant sums back into research and development," he said. "I think the industry has to go into a capital expenditure starvation mode in order to survive."
Competitor representatives agree that something will have to happen, and soon, if the geophysical industry is to see any kind of recovery.
"The industry still suffers from overcapacity in land, data processing and marine in conventional service delivery," said Ken Williamson, vice president of marketing for WesternGeco. "We had anticipated that VGS would have made some reductions in capacity, particularly in marine. We believe that the forces that prompted the failed merger still exist and will eventually lead to a reduction in capacity through attrition, company failure and shareholder/lender impatience with poor results."
He added that the collapse would have no real bearing on his company's strategy. "We're developing and providing new technology that enhances our customers' performance," he said, "and that isn't going to change."
Chief Financial Officer John Yearwood added, "Acquisitions of companies with conventional technology are not part of our strategy. However, we continue to monitor the marketplace for niche technologies that could complement our portfolio."
If any company is at an advantage because of the change in merger plans, it's probably CGG. Left behind when five companies became four and four companies tried to become three, it's now back in the running as a possible merger mate if PGS or Veritas examines that option again. The official comment from Christophe Pettenati-Auziere, senior executive vice president of strategy, corporate planning and control, is that his company's management regrets that the merger can't go forward because it would be good for the industry. "It confirms our analysis regarding the situation at PGS, which was a bit of a problem because of its debt level," he said. "But most likely in the coming months things will not stay where they are. This industry needs consolidation one way or the other."

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