August 19, 2009

Value Idea: Pride's Spin off

Forced Sellers:
I think this will be dumped by investors because they will want Pride high margin business in the deep water drilling and not the shallow-water low margin and limited growth business. But the $64,000 question is are they forced sellers due to non economic reasons or are they justified in their actions?

Industry Fundamentals:
lower utilization rates and pressure on daily rates. Oil finds moving to deeper waters, which seahawk fleet is not capable of operating under. Their biggest customer are requiring more depth capable rigs, which prices them out of more business.

The disparity between the US Gulf of Mexico Shelf and deepwater rig markets continues to widen. Earlier this year, the jackup market reached its lowest level in 33 years, according to ODS-Petrodata figures, and slid downward from that point. Drilling contractors continued their exodus from the Gulf whenever possible, moving jackups to more lucrative areas. Despite a slowdown in some jackup markets, eight rigs will have mobilized from the Gulf by the end of July. As far as the deepwater Gulf, most people consider it a growth market. As many as 17 new-build deepwater rigs are scheduled to enter the region by the end of 2010. More deepwater rigs could mobilize there for a few wells, then mobilize back to other markets during this period. As a result the utilization rates have been coming down steadily over the last few quarters.
Rig TypeCurrentMonth Ago6 Months Ago1 Year Ago
Drill Barge90.0% (9/10)90.0% (9/10)90.0% (9/10)90.0% (9/10)
Drillship90.5% (38/42)92.7% (38/41)79.5% (31/39)78.4% (29/37)
Jackup74.9% (275/367)74.9% (274/366)82.5% (296/359)91.0% (312/343)
Semisub80.2% (134/167)82.5% (137/166)82.7% (134/162)83.9% (130/155)
Submersible50.0% (1/2)50.0% (1/2)100.0% (2/2)100.0% (2/2)
Tender80.8% (21/26)76.9% (20/26)92.3% (24/26)88.5% (23/26)

Natural gas prices are weak and depressed. There is plenty of supply and surplus inventory to keep the pressure on prices for awhile. I do not want to try to forecast or predict the direction of natural gas because what if my baseline forecast did not materialize. Natural Gas prices are called the "widow maker" for a reason, they are very hard to call.

Overcapacity in the sector. There are several deliveries to take place for shallow water rigs. During the past several years, the supply of available jackup and semisubmersible rigs has been unable to meet the increasing demand of oil and gas companies on a global basis. As a result of this global supply and demand imbalance, various industry participants ordered the construction of over 180 new jackup and semisubmersible rigs, over 60 of which were delivered during the last three years. Approximately 60 additional jackup and semisubmersible rigs are scheduled for delivery in 2009.

The new rig deliveries scheduled for 2009 include over 30 jackup rigs, the majority of which are not contracted for work upon delivery from the shipyard. These new drilling rigs will increase supply and likely reduce utilization and day rates as rigs are absorbed into the active fleet, especially in light of the recent decline in oil and natural gas prices and jackup rig demand. However, the current supply of jackup rigs is limited and it is time consuming to move offshore rigs between markets. Accordingly, as demand changes in a particular market, the supply of rigs may not adjust quickly. Utilization and day rates in specific markets could fluctuate significantly while utilization and day rates in other markets may be relatively unaffected. Additionally, several rig construction cancellations have been recently announced and the tightening credit market has created substantial uncertainty as to whether construction of other rigs will be completed.

Ok, you would say that weak industry fundamentals are cyclical and should adjust. Then seahawk would give you great risk/ reward proposition, assuming its price will fall to below liquidation value of its assets, which more likely it will. In this case company fundamentals has to be flawless to get me interested.

Company Fundamentals:

  • Potential of fines regarding bribery charges and accounting irregularities, however there is limit to the fines paid to $1 million, any excess pride will take care of it.
  • Mexico Oil company account for 60% of SeaHawk gross revenue. One customer dominate their business. This was not a problem when the company was a division of Pride but on a stand alone basis is very risky.
  • accounting is a bit aggressive:
    • changes to depreciation expenses by extending the useful lives of rigs, which means a boost to their earnings as depreciation expense get smaller. This annoys me to no end when companies change their depreciation policies or assumptions. It makes comparisons difficult and obviously management motives to boost earnings by hook or trick.
    • already there is investigation for accounting irregularities by pride into Seahawk division.
  • no debt and clean balance sheet, which a very good in this environment.
  • SeaHawk Jackup rigs are shallow in the 200-250 feet range which does not work in the current industry dynamics. Their biggest customer are requesting deeper and deeper rigs, which prices Seahawk out.
  • very capital intensive business. in order to expand more capex need to spent to buy new rigs. most free cash flow will go to acquisition of new PPE.
  • most of its rigs are idle they have 40% utilization rate.
  • most rigs are old so it may require some capex going further
  • no unique competitive advantage that is very apparent that will distinguish their operations from others.

SeaHawk's president and CEO was CEO of Hercules offshore, similar business to seahawk. He left the company in June 2008 and the company took a big impairment expenses due to large acquisition done on his watch, $2.3 Billion in cash and stock. As a result of the acquisition, Hero balance sheet is over leveraged and impairment charges mounted when the turn in the economy came.

Investment returns over his tenure were not overly outstanding.

ROE11.35%19.13% 38.98% 11.35% (73.37%)

He spent $660.1 million in capex, not including the merger deal, cumulative over the 2004-2008, and generated $618.9 millions in cash from operations during the same period. During the same period cumulative earning were partly at $291.2 million, and if you include 2008 results it would be a significant loss.

Management Compensation Plan

This is a bright spot, somewhat, as the good chunk of compensation is in form of equity. I say somewhat because not all long term incentive compensation is equity. The better alternative is to have 100% of their long term compensation in restricted stock. From their filing:
The beginning value of the initial equity award is $4,800,000 for Mr. Stilley, $1,000,000 for Mr. Manz, $690,000 for Mr. Cestero and $575,000 for Mr. German. ....50% of the equity compensation will be in the form of restricted stock.
Competitive Position
The company is second lowest cost operators in the GOM region. Hero operates better cost structure than Seahawk. According to my analysis the operating the costs per available day is

BusinessNotesOE per avail Day
Seahawkonly GOM locations$49,634
Hercules Off shorevery similar business to Hawk but diversified geographically~$28,000
Ensco International Incorporatedshallow water but more specialized assets/ fleet. their GOM fleet water depth is 250-400 ft $50,175
Rowan Companiesshallow water but more specialized assets/ fleet water depth 250-500
DOdeep water rigs- not very applicable

Nobeldeep water rigs- not very applicable~$63,000
RIGdeep water rigs- not very applicable (55 standard jackups with depth from 250-400)

There are so many strikes against the spin off and not too many positives even if valuation are ridiculously cheap, which I did not need to perform. This is a leveraged play on the prices of natural gas, which is very hard to call: will it stay depressed or take off? Weak sector fundamentals and potential liability and fines all are external to the company and can be manageable by good management team. However, I have my doubts about the new CEO hi track record in Hero is not encouraging. If there is any contrarian play on this name, I do not see it. I will pass on this spin off.


bsivia said...

I would agree with your assessment. There are many quality high margin, high ROC drillers trading for way less than they are worth, as you said 5-9x earnings. That would be a better play than this.

Having said that, the Cablevision/MSG situation seems intriguing.

Sami said...

The MSG spin off should be a good one. I do not think they have set a date yet, have they?. I am beginning y work on it.

There is also Carefusion a spin off from Cardinal. However I fail to see any "unaatractive factor" in it so far. Maybe the leverage but that still reasonable. so if it sells off it would be good pick up.