PETROLEUM GEO-SERVICES Don t poke the sleeping bear SELL TP: NOK13.0

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1 EQUITY RESEARCH Research report prepared by DNB Markets, a division of DNB Bank ASA Energy Q2 results review PETROLEUM GEO-SERVICES Don t poke the sleeping bear PGS reported a strong Q2; however, the combination of low backlog and weak outlook comments for the winter should escalate the balance sheet concerns further. In the event of another need for new equity for the third time since late 2015, we see risk that investors might require a discounted equity issue. Despite the balance sheet concerns, earnings toward to the peak of the last cycle are required to defend current market cap. Hence, we have downgraded our recommendation from HOLD to SELL; our target price remains NOK13. Strong Q2, weak outlook. PGS reported a strong Q2 with EBITDA of USD112m, 37% above our estimate and 41% above consensus. The beat was mainly driven by strong late sales. The company reported a 27% sequential drop in backlog, and see a "low and competitive contract bidding activity for Q4". We have made only marginal estimate revisions on the report, with e EBITDA up 2 4%. Balance sheet issues to intensify. On our numbers, we see PGS running out of liquidity in late 2018, at the same time as a possible covenant breach. Our flat revenues for 2018e result in our EBITDA being 26% below consensus. In our view, significantly higher oil prices would be needed to meet current consensus and avoid a balance sheet restructuring. With the company moving closer to a potential need to raise equity for the third time since late 2015, we believe investors might require a deeply discounted equity issue this time as recent equity offerings have resulted in 56% and 24% losses for investors. Should the company pursue this path, depending on the equity need and required upside to fair value, we see a possible fair issue price of NOK10 12, representing 30-40% downside from current share price. Downgraded to SELL; target price stays NOK13. On historical multiples, earnings toward the peak in the last cycle would be required to defend current market cap. In our view, a weak winter and start to 2018 will trigger consensus revisions for 2018, resulting in the balance sheet issues becoming a consensus view. For a name with 14 BUY ratings among 23 analysts, we believe this will trigger downgrades in coming months. Year-end Dec e 2018e 2019e Revenue (USDm) 1,502 1, EBITDA adj (USDm) EBIT adj (USDm) PTP (USDm) EPS rep (USD) EPS adj (USD) DPS (USD) Revenue growth (%) EBITDA growth adj (%) EPS growth adj (%) nm nm nm nm nm EBITDA margin adj (%) EV/Sales adj (x) EV/EBITDA adj (x) EV/EBIT adj (x) nm nm nm nm nm P/E adj (x) nm nm nm nm nm P/Book (x) ROE (%) 12.0 nm nm nm nm nm nm ROCE (%) nm nm nm nm nm Dividend yield (%) SELL TP: NOK13.0 PGS versus OSEBX (12m) Jul Sep Nov Jan Mar May Jul Petroleum Geo- OSEBX (Rebased) Source: Factset SUMMARY Recommendation (prev.) SELL (HOLD) Share price (NOK) 17.0 Target price (previous) (NOK) 13.0 (13.0) Upside/downside potential (%) -24 Tickers PGS NO, PGS.OL CAPITAL STRUCTURE No. of shares (m) No. of shares fully dil. (m) Market cap. (NOKm) 5,757 NIBD adj end-2017e (USDm) 1,089 Enterprise value adj (USDm) 1,814 Net debt/ebitda adj (x) 2.80 NAV per share (NOK) 16.1 SHARE PRICE PERFORMANCE Abs. 1/3/12m (%) 23/-7/3 Rel. 1/3/12m (%) 11/-21/-24 High/Low 12m (NOK) 31/14 Source: Company, DNB Markets (estimates) ESTIMATE CHANGES (USD) Year-end Dec 2017e 2018e 2019e EPS (old) EPS (new) Change (%) nm nm nm Consensus Sales (old) Sales (new) Change (%) Consensus ,081 Source: DNB Markets, Source: Bloomberg ANALYSTS Jon Masdal jon.masdal@dnb.no Martin Huseby Karlsen martin.huseby.karlsen@dnb.no Please see the last two pages for important information. This research report was not produced in the US. Analysts employed by non-us affiliates are not registered/ qualified research analysts with FINRA in the United States.

2 2016 Contract Multi-client Other 2017e Contract Multi-client Other 2018e DNB Markets Petroleum Geo-Services Investment case overview Share price performance, DNB Markets target price, bear- and bull-case scenarios NOK17.0 NOK20.0 (17%) 15.0 NOK13.0 (-24%) 10.0 NOK7.0 (-59%) 5.0 Jul 2016 Nov 2016 Mar 2017 Jul 2017 Nov 2017 Mar 2018 Jul 2018 Historical Share Price Performance Price Target (Jul 18) Current Share Price Source: FactSet, DNB Markets Target price methodology We value the stock on an EV/EBIT to reflect the variations between multiclient and contract. In addition, we use an NAV. Current market cap and end-2018e net debt imply EBIT of USD198m is required on historical multiples versus a 9-year average of USD126m after impairments. We derive our NAV of NOK16.1 from newbuild parity for its vessels and by applying a 1.0x multiple to the multiclient library. Given the balance sheet risk, we apply a 20% discount to our NAV when setting our target price, in line with where the stock has bottomed out historically. Source: DNB Markets Downside risks to our investment case Shooting multi-client projects with poor economics could be a cash drain. Further cutbacks in E&P spending, resulting in a prolonged depressed seismic market. DNB Markets investment case and how we differ from consensus We expect continued weak fundamentals over the next 12 months, and we see more downside potential to the share price. We expect more negative consensus updates and downward estimate revisions near term. We expect greater focus on the company s weak cash flow and pressure on the balance sheet. Upside risks to our investment case Rising oil prices and exploration spending quickly translating into increased interest in seismic data and higher revenues. Limited investment in exploration over the past few years shifts oil companies focus back to seismic spending. Source: DNB Markets Source: DNB Markets Source: DNB Markets Revenue bridge e (USDm) Source: DNB Markets (forecasts), company (historical data) 2

3 Q2 results PGS reported Q2 EBITDA of USD112.5m, above our estimate of USD82.2m and consensus of USD80m. The beat was mainly driven by late sales, coming in 49% above our estimate and 46% above consensus, while contract revenues also came in above expectations. Free cash flow was a deficit of USD15m, with the miss mainly due to increased account receivables. Figure 1: Reported versus expectations Q2/17e Deviation (%) Deviation, Abs Q2/ e USDm Reported DNB Cons* DNB Cons* DNB Cons* Actual DNB Revenue % 15% EBITDA % 41% One offs EBITDA Adj % 41% Cash EBITDA Adj EBIT Impairments & other one offs -8.7 EBIT Adj Net finance Pretax earnings Net result EPS Contract revenues % 10% MC pre-funding % -2% MC late sales % 46% DP & other revenues % 0% MC cash investment % -5% Pre-funding level 115% 117% 111% -2% 113% 103% Source: DNB Markets (forecasts), company (historical data/consensus) Earnings risk increasing again The backlog at end Q2 was down 27% sequentially, to USD248m (from USD340m at end- Q1). Backlog is now 28% of 12-month forward revenue consensus, which is a low historical level. Historically speaking, backlog coverage has needed to be c40% for revenue expectations to move upwards, implying that the backlog would need to increase by 40%, to USD350m, or revenue expectations to fall by 30% (NOK6/sh) to be at this level. With the low backlog coverage, we believe that the earnings risk has increased further and that PGS is dependent on a stronger near-term recovery very shortly to prevent further downward revisions to consensus. Figure 2: Backlog (USDm) versus 12-month forward revenue consensus (% of backlog) % % % % % % 0 0% Backlog (l.h) Source: Company (historical figures), Bloomberg (estimates) Backlog in % of 1-y fwd rev (r.h) 3

4 Estimate revisions Figure 3: Estimate revisions post Q2 report New estimates Old estimates Changes 2017e 2018e 2019e 2017e 2018e 2019e 2017e 2018e 2019e Revenue EBITDA EBIT Net finance Pretax earnings Net result EPS Contract revenues MC pre-funding MC late sales DP & other revenues MC cash investment Pre-funding level 107% 100% 95% 103% 100% 95% 4% 0% 0% Capex Source: DNB Markets (forecasts), company (historical data) DNB versus consensus For 2018, our flat revenue forecast translates into our EBITDA being 26% below consensus. In our view, consensus growth expectations in 2018 and 2019 remain too optimistic given the oil companies continued efforts to cut offshore spending. Figure 4: DNB versus consensus DNB estimates Bloomberg consensus DNB versus consus (abs.) DNB versus consus (%) USDm 2017e 2018e 2019e 2017e 2018e 2019e 2017e 2018e 2019e 2017e 2018e 2019e Revenue , % -16% -21% Revenue growth YoY 6% -2% 9% 6% 16% 15% EBITDA % -26% -34% EBIT Net finance Pretax earnings Net result EPS Source: DNB Markets (estimates), Bloomberg (consensus) 4

5 Liquidity need again On our estimates, PGS is set to run out of liquidity by late-2018, which is ahead of current consensus expectations of liquidity being sufficient until On the basis of liquidity challenges by late-2018, too much debt, and covenant issues again at the same time, we believe focus on the company s balance sheet will intensify. Figure 5: Liquidity forecasts musd Q1/15 Q3/15 Q1/16 Q3/16 Q1/17 Q3/17e Q1/18e Q3/18e Gearing metrics uncomfortably high With the collapse in earnings and rising debt, PGS gearing is uncomfortably high in our view, particularly given the off-balance sheet commitments of three vessels. To compare a multiclient company to other asset-heavy oil service companies, we prefer to adjust EBITDA by subtracting capitalised multi-client costs. As seen below, PGS had NIBD to cash EBITDA above 8.0x in For 2017 and 2018, we forecast this to be around 8 11x, which we find too high. (In a bear scenario, it could be argued that EV to cash EBITDA of 8x is fair, implying zero equity value under the current capital structure.) Looking at traditional NIBD to EBITDA, we expect this to be around 3.0x. This compares to the company s target of maintaining this figure within a range of 1 2x. Figure 6: Net debt (left hand side, USDm) and NIBD to EBITDA (right hand side, x) 1, , e 2018e 0.0 Net interest-bearing debt (l.h) NIBD / (EBITDA - MC cash cost) NIBD / EBITDA 5

6 Valuation reflecting significant improvement With a negative earnings outlook, traditional valuation metrics have been put aside for PGS in recent years. On a traditional one- and two-year forward EV/EBIT, the company is now in negative EBIT territory. Hence, despite consensus expecting a recovery (with revenue up 15% YOY in 2018), a valuation on traditional metrics makes little sense to us. We expect 2017 to be a tough year and see few signs that oil companies will increase spending in time to save 2018 earnings and cash flow. We forecast end-2018 NIBD of USD1.1bn for PGS and at its current share price, this figure would yield an end-2018e EV of USD1,876bn. Assuming a normalised EV/EBIT multiple of 9.5x in line with the historical average (prior to the more recent spike), we calculate EBIT of USD198m would be needed to defend the current share price. As seen in the chart below, the required earnings are well above its 9-year average of USD126m, and towards the peak of the last cycle as such earnings has only been achieved in two of the last nine years. We believe that in a weak market, investors will not be willing to price PGS stock on earnings multiples requiring one of the best years the company has seen in the previous cycle. Figure 7: EBIT needed to defend current share price on 2018e EV (USDm) e 2018e Actual Consensus DNB Current valuation In setting our target price, we use a combination of NAV and normalised earnings and factor in the expected cash burn in the coming years. We have a NAV of NOK16/share, which is based on vessel asset prices and the multi-client library at book value. PGS is trading at a P/NAV of 1.12x on our updated NAV, in line with its historical average of 1.16x. In one of the worst markets in the industry s history, and with balance sheet risk, we believe that the share price should be trading at a discount to historical averages and below its fair value. With the company moving closer to a potential need to raise equity for the third time since late 2015, we believe that investors might require a deeply discounted equity issue this time as recent equity offerings have resulted in 56% and 24% losses for investors. Should the company decide to take this step, depending on the equity need and required upside to fair value, we could see a potential fair issue price of NOK10 12, representing 30-40% downside from current share price. 6

7 Figure 8: Historical price to NAV (x) Jul-10 Mar-11 Nov-11 Jul-12 Mar-13 Nov-13 Jul-14 Mar-15 Nov-15 Jul-16 Mar-17 PGS NO (1.12x) Average (1.16x), Bloomberg 7

8 Forecast changes P&L New Old Change (USDm) 2017e 2018e 2019e 2017e 2018e 2019e 2017e 2018e 2019e Revenues Cost of sales Gross profit Operating expenses EBITDA EBITDA adj EBITDA margin (%) Depreciation EBITA Amortisation Impairment of intangibles EBIT EBIT adj Net financial items PBT Taxes Discontinued operations Net profit Adjustments to net profit Net profit adj Per share data (USD) EPS EPS adj DPS Other key metrics (%) Revenue growth EBIT adj growth nm nm nm nm nm nm EPS adj growth nm nm nm nm nm nm Avg. number of shares (m) Capex OpFCF NIBD adj 1,089 1,151 1,271 1,097 1,177 1, Source: DNB Markets Forecast changes By segment and assumptions New Old Change (USDm) 2017e 2018e 2019e 2017e 2018e 2019e 2017e 2018e 2019e Revenues Contract revenue Multi-Client pre-funding Multi-Client Late-sales Other Assumptions MC cash investment Prefunding level in % Source: DNB Markets 8

9 Quarterly numbers (USDm) Q Q Q Q Q Q Q2 2017e Q3 2017e Q4 2017e Revenues Cost of sales Gross profit Operating expenses EBITDA Depreciation EBITA Impairment of intangibles EBIT Associated companies Net interest FX gains Other financial items Net financial items PBT Taxes Discontinued operations Net profit Adjustments to net profit Net profit adj Dividend paid Avg. number of shares (m) Per share data (USD) EPS DPS Growth and margins (%) Revenues, QOQ growth Revenues, YOY growth EPS adj, YOY growth nm nm nm nm nm nm nm nm nm Gross margin EBITDA adj margin Depreciation/revenues EBIT adj margin nm nm nm nm nm nm nm Net profit margin nm nm nm nm nm nm nm nm nm 9

10 Adjustments to quarterly numbers (USDm) Q Q Q Q Q Q Q2 2017e Q3 2017e Q4 2017e EBITDA EBITDA adj EBITA Impairment of intangibles EBITA adj EBIT Impairment of intangibles EBIT adj Net profit Impairment of intangibles Net profit adj Quarterly numbers by segment and assumptions (USDm) Q Q Q Q Q Q Q2 2017e Q3 2017e Q4 2017e Revenues Contract revenue Multi-Client pre-funding Multi-Client Late-sales Other Assumptions MC cash investment Prefunding level in %

11 Annual P&L (USDm) e 2018e 2019e Revenues 1,135 1,253 1,518 1,502 1, Cost of sales Gross profit Operating expenses EBITDA Depreciation EBITA Amortisation Impairment of intangibles EBIT Net financial items PBT Taxes Effective tax rate (%) Discontinued operations Net profit Adjustments to net profit Net profit adj Dividend paid Avg. number of shares Per share data (USD) EPS EPS adj DPS Growth and margins (%) Revenue growth EPS adj growth nm nm nm nm nm Gross margin EBITDA margin EBITDA adj margin Depreciation/revenues EBIT margin nm nm nm nm nm EBIT adj margin nm nm nm nm nm PBT margin nm nm nm nm nm nm Net profit margin nm nm nm nm nm nm nm nm nm nm 11

12 Adjustments to annual P&L (USDm) e 2018e 2019e EBITDA EBITDA adj EBITA Impairment of intangibles EBITA adj EBIT Impairment of intangibles EBIT adj Net profit Impairment of intangibles Net profit adj Per share data (USD) EPS Recommended adjustment EPS adj Cash flow (USDm) e 2018e 2019e Net profit Depreciation and amortisation Change in net working capital Cash flow from operations (CFO) Capital expenditure Acquisitions/Investments Divestments Cash flow from investing (CFI) Free cash flow (FCF) Net change in debt Dividends paid Other Cash flow from financing (CFF) Total cash flow (CFO+CFI+CFF) FCFF calculation Free cash flow Less: acquisitions Less: divestments Growth (%) CFO CFI FCF CFF FCFF nm nm nm nm nm nm nm nm nm nm 12

13 Balance sheet (USDm) e 2018e 2019e Assets 3,035 3,137 3,276 3,544 3,563 2,914 2,817 2,849 2,668 2,501 Trade receivables Other receivables Current financial assets Cash and cash equivalents Current assets Property, plant and equipment 1,524 1,627 1,820 2,206 2,359 2,093 2,039 1,977 1,867 1,827 Goodwill Other intangible assets Defferred tax assets Non-current assets 2,062 2,177 2,353 2,706 2,834 2,391 2,366 2,307 2,197 2,157 Total assets 3,035 3,137 3,276 3,544 3,563 2,914 2,817 2,849 2,668 2,501 Equity and liabilities 3,035 3,137 3,276 3,544 3,563 2,914 2,817 2,849 2,668 2,501 Total equity to the parent 1,755 1,772 1,912 2,066 1,910 1,464 1,359 1,216 1, Minority interests Total equity 1,755 1,772 1,912 2,066 1,910 1,464 1,359 1,216 1, Trade payables Other payables and accruals Short-term debt Total current liabilities Long-term debt ,020 1,160 1,100 1,132 1,265 1,243 1,194 Pension liabilities Other non-current liabilities Total non-current liabilities ,088 1,243 1,152 1,211 1,358 1,336 1,286 Total liabilities 1,280 1,365 1,364 1,479 1,653 1,450 1,458 1,632 1,620 1,601 Total equity and liabilities 3,035 3,137 3,276 3,544 3,563 2,914 2,817 2,849 2,668 2,501 Key metrics Net interest bearing debt , ,008 1,089 1,151 1,271 13

14 Valuation ratios (USDm) e 2018e 2019e Enterprise value Share price (USD) Number of shares (m) Market capitalisation 3,236 2,380 3,710 2,529 1, Net interest bearing debt , ,008 1,089 1,151 1,271 Adjustments to NIBD Net interest bearing debt adj , ,008 1,089 1,151 1,271 EV 3,516 2,798 4,144 3,206 2,267 1,858 1,738 1,550 1,613 1,732 EV adj 3,516 2,798 4,144 3,206 2,267 1,858 1,738 1,550 1,613 1,732 Valuation EPS EPS adj DPS P/E P/E adj P/B Average ROE -0.5% 1.8% 10.1% 12.0% -2.0% -31.3% -20.5% -13.1% -14.9% -15.1% Earnings yield adj 2.3% 1.5% 5.0% 10.0% 2.8% -14.5% -30.0% -21.1% -23.2% -20.2% Dividend yield 0.0% 0.0% 1.1% 2.4% 6.4% 2.3% 0.0% 0.0% 0.0% 0.0% EV/SALES EV/SALES adj EV/EBITDA EV/EBITDA adj EV/EBIT EV/EBIT adj EV/capital employed EV/NOPLAT EV/OpFCF (taxed)

15 Key accounting ratios e 2018e 2019e Profitability (%) ROA ROCE ROCE after tax Return on invested capital (%) Net PPE/revenues Cash flow ratios (%) FCF/revenues FCF/market capitalisation CFO/revenues CFO/market capitalisation CFO/capex CFO/current liabilities Cash conversion ratio Capex/revenues Capex/depreciation OpFCF margin Total payout ratio Leverage and solvency (x) Net debt/ebitda Total debt/total capital (BV) LTD / (LTD + equity (MV)) Cash conversion cycle Receivables turnover days Credit period

16 Important Information Company: Petroleum Geo-Services Coverage by Analyst: Jon Masdal Date: 28/07/2017 This report has been prepared by DNB Markets, a division of DNB Bank ASA. DNB Bank ASA is a part of the DNB Group. This report is based on information obtained from public sources that DNB Markets believes to be reliable but which DNB Markets has not independently verified, and DNB Markets makes no guarantee, representation or warranty as to its accuracy or completeness. This report does not, and does not attempt to, contain everything material which there is to be said about the Company. Any opinions expressed herein reflect DNB Markets judgement at the time the report was prepared and are subject to change without notice. The report is planned updated minimum every quarter. Recommendation structure and risk classification DNB Markets recommendations are based on absolute performance: Buy Hold Sell - indicates an expected return greater than 10% within 12 months - indicates an expected return between 0 and 10% within 12 months - indicates an expected negative return within 12 months The return-requirement bands above may be applied with some degree of flexibility depending on the liquidity and volatility characteristics of the individual share. High risk Medium risk Low risk - Volatility over 40 percent. - Volatility from 25 percent to 40 percent. - Volatility under 25 percent. Current 6 months volatility rates this security as HIGH risk. Investing in any security is subject to substantial risk. Return on investment may vary greatly. Careful consideration for possible financial distress should be accounted for before investing in any security. Price targets are based on a combination of several valuation methods such as discounted cash flow, pricing based on earnings multiples, multiple on book value, net asset value and peer comparison. Substantial material sources for coverage of this company include historical financial figures and communication with the company, and relevant third party information. Recommendations and historical target prices below may not compile all recommendations by DNB Markets, for further information please contact DNB Markets. Price, Rating, and Price Target History Petroleum Geo-Services (PGS NO) as of S : NR : NA H : S : S : S : S : H : Source: Factset Estimates (Prices) / DNB (ratings and target price) Conflict of interest DNB Markets/DNB Group has been giving investment-banking services or acted as financial advisor or manager/co-manager for Petroleum Geo-Services and received compensation from Petroleum Geo-Services during the last 12 months. DNB Markets/DNB Group may receive compensation for investment banking services or other products/services from Petroleum Geo-Services. Share positions in the company: Analyst* Employees** DNB*** Update Number of shares /07/2017 *The analyst or any close associates. **Share positions does not include administration and section FX/Treasury. ***Share positions as part of DNB Group. Holdings as part of DNB Markets investment services activity are not included. Recommendation distribution and corporate clients for the last 12 months Buy Hold Sell No_rec Total Number % of total 46% 29% 20% 5% DNB Markets client 16% 5% 2% 2% 59 16

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The name and address of the agent for service of process for DNB Bank ASA (DNB Markets) and DNB Markets, Inc. in the local jurisdiction is: Alberta: Blake, Cassels & Graydon LLP, 855-2nd Street S.W., Suite 3500, Bankers Hall East Tower, Calgary, AB T2P 4J8. British Columbia: Blakes Vancouver Services Inc., 595 Burrard Street, P.O. Box 49314, Suite 2600, Three Bentall Centre, Vancouver, BC V7X 1L3. Manitoba: Aikins, MacAulay & Thorvaldson LLP, 30th Floor, Commodity Exchange Tower, 360 Main Street, Winnipeg, MB R3C 4G1. New Brunswick: Stewart McKelvey, Suite 1000, Brunswick House, 44 Chipman Hill, PO Box 7289, Station A, Saint John, NB E2L 2A9. Newfoundland and Labrador: Stewart McKelvey, Suite 1100, Cabot Place, 100 New Gower Street, P.O. Box 5038, St. John's, NL A1C 5V3. Nova Scotia: Stewart McKelvey, Purdy's Wharf Tower One, 1959 Upper Water Street, Suite 900, P.O. Box 997, Halifax, NS B3J 2X2. Northwest Territories: Gerald Stang, Suite 201, Street, Yellowknife, NT X1A 1P8. Nunavut: Field LLP, P.O. Box 1779, Building 1088C, Iqaluit, NU X0A 0H0. Ontario: Blakes Extra-Provincial Services Inc., Suite 4000, 199 Bay Street, Toronto, ON M5L 1A9. Prince Edward Island: Stewart McKelvey, 65 Grafton Street, Charlottetown, PE C1A 1K8. Québec: Services Blakes Québec Inc., 600 de Maisonneuve Boulevard Ouest, Suite 2200, Tour KPMG, Montréal, QC H3A 3J2. Saskatchewan: MacPherson, Leslie & Tyerman LLP, 1500 Continental Bank Building, 1874 Scarth Street, Regina, SK S4P 4E9. Yukon: Grant Macdonald, Macdonald & Company, Suite 200, Financial Plaza, 204 Lambert Street, Whitehorse, YK Y1A 3T2. In Brazil The analyst or any close associates do not hold nor do they have any direct/indirect involvement in the acquisition, sale, or intermediation of the securities discussed herein. Any financial interests, not disclosed above, that the analyst or any close associates holds in the issuer discussed in the report is limited to investment funds that do not mainly invest in the issuer or industry discussed in the report and the management of which these persons cannot influence. 17