Tuesday, April 20, 1999
Price (4/19/99): $9 3/8
HOW DID IT FIND TROUBLE?
It's been a rough twelve months on the oil patch, even if the patch is under the ocean. One could randomly throw a dart at a listing of oil service companies and likely hit a name that has run into trouble over the last year. One of the large offshore oil service stocks that got hit hardest was R&B Falcon, a stock that saw over 75% of its value burned away over the past year.
An extremely weak oil and gas market, with oil prices scraping along at their lowest relative levels in years through most of 1998 and into 1999, has caused the oil companies to scale back production and exploration activities. For those who supply the services to these activities, the weakness in the oil market has been amplified.
Events at R&B also added to the company's woes. Falcon gorged itself with debt at the height of the market to fund an aggressive rig building program. With the price of oil sinking like an anchor, profitably executing the plan ended up being an uphill and losing battle. The cash needed to stay afloat suddenly became in short supply, and R&B was forced to lay off over 1,300 of its employees and contemplate selling off assets to stay liquid. The near-term cash-crunch was resolved when the company floated over $1 billion in debt securities at the end of March, but the company is still quite bruised from the experience.
While recent events, including a new agreement by OPEC to scale back oil production and the crisis in Kosovo, have caused the price of oil to perk up in recent weeks, the recovery has yet to flow down to the service companies. It will be a long and upwind flight back for Falcon to get anywhere near its former glory.
Houston-based R&B Falcon is one of the largest service providers to the offshore oil and gas industry. The company provides contract marine drilling and various other wildcat services around the globe. R&B's fleet includes one of the world's largest collections of rigs, barges, and a wide array of other marine oil drilling equipment.
R&B Falcon was formed in 1997 when Falcon Drilling and Reading & Bates merged. R&B also acquired Cliff's Drilling in 1998 in a stock-swap transaction. The company operates in every major offshore drilling area of the world, and 66% of the company's revenue comes from abroad.
12-month sales: $1032.6 million
12-month income: $102.8 million*
12-month EPS: $0.61*
Profit Margin: 9.96%
Market Cap: $1,812.9 million
(*Includes one-time gains and charges)
Cash: $177.4 million
Current Assets: $527.1 million
Total Assets: $3,709.3 million
Current Liabilities: $351.8 million
Long-term Debt: $1,866.2 million
Total Liabilities: $2,396.3 million
HOW COULD YOU HAVE SEEN IT COMING?
One of the problems with investing in the oil service industry is that the service companies are slaves to commodity prices even more than the oil companies themselves. While the oil companies can curtail production and keep their assets in the ground when weakness hits, the service companies may end up with expensive equipment sitting idle and depreciating. Furthermore, the weak oil prices have actually found the oil companies, not the service companies, in the catbird seat when negotiating contract prices.
In addition, predicting commodity prices is as tough -- if not tougher -- than trying to predict where the stock market as a whole is headed. So unless one was clairvoyant and able to predict the meltdown in the oil and gas market, finding this Trouble would have been difficult. Nevertheless, cyclical weakness is a common event in all commodity markets and should not come as a complete surprise. Just like tornadoes in Kansas, the extremely low prices of oil are tough to predict yet not unexpected.
One of the clues that should have been heeded were the falling margins at the company. Net margins spinning in an undeniable downward spiral often signals trouble ahead. Seeing a company continually pop up on the falling margins screen should give an investor pause for thought.
The full-steam-ahead spending spree of the company in early and mid-1998 should have also raised some eyebrows. With investing cash flow -- money spent on new equipment and other operational assets -- far surpassing operating cash flow it should have been apparent that R&B was a cash guzzler. Cash going out the door has eclipsed cash produced by roughly four times during 1998 even while the company was reporting positive earnings. Keeping tabs on and understanding the statement of cash flows can be just as, if not more, important than keeping an eye on the income statements.
WHERE TO FROM HERE?
While few will argue that the seas have been extremely rough in the oil service sector over the past twelve months, things are looking up. Between a new OPEC agreement and the situation in Kosovo, oil prices have rebounded a bit. Increased oil prices mean the oil companies will be more aggressive in getting their crude out of the ground and into the market, benefiting the service companies. While declaring that oil's trouble over may be a bit premature, there are certainly signs that things are looking up. But then again, the oil market has always been a volatile one, and any prediction about the future should be taken with a grain of salt.
R&B Falcon has also managed to survive its liquidity crunch through recently selling over $1 billion in new debt. The debt may give the company ample cash to play with in the short term, but the longer-term implications of having such a leveraged balanced sheet are far less certain.
Looking at the company's valuation, an investor may be tempted to bite after seeing the relatively low price-to-earnings and price-to-book value ratios. On the surface the company appears cheap, yet there are rocks underneath the surface in the form of nearly $3 billion in debt that muddy the true valuation picture. There was also a recent CEO change at the company that investors should consider.
While R&B's seas of trouble may be calming a bit, there are still some nagging questions about the company's aggressiveness and overall health. It is difficult to tell if the rust on R&B's ship is merely a surface blemish or a severe structural problem. Regardless, the one thing that is certain is that shareholders in R&B Falcon are in for an interesting ride one way or the other.
-- Paul Larson
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