While there are some indications that bidding activity has started increasing ever so slightly in the offshore drilling space, it's largely a foregone conclusion that 2017 will be one of the worst years the segment has endured in decades. This reality is set to create further pains for a number of offshore drilling companies, and that could very well include Seadrill Ltd. (SDRL), which has at least eight more vessels set to come off contract by the end of July.
Seadrill must address its debt situation before it can really move forward. Image source: Getty Images.
With that in mind, it may seem that the obvious answer to "what is the most important thing Seadrill must accomplish in 2017?" is getting its fleet back to work. And in the longer term, yes, that's unequivocally important. But Seadrill's biggest threat right now is $3.1 billion in debt that must be repaid, refinanced, or otherwise renegotiated, between now and the end of September.
Let's take a closer look at Seadrill's debt situation, what management has told us about its progress, and what investors should expect.
April is expected to be a big month for debt negotiations
In all, Seadrill has $3.18 billion in debt maturing in 2017, and a significant portion of that must be dealt with before the end of July, with three major secured credit facilities totalling $2.85 billion maturing before then. The good news is that the company has already had success with the bankers that hold this debt, having reached agreements in April 2016 to defer these same credit facilities to the upcoming dates.
So what's the holdup in pushing them further back? In short, Seadrill's overall debt picture is diverse and complex, and management's goal is, according to comments made by CFO Mark Morris on the most recent earnings call, to renegotiate essentially all of its debt expiring in the next three years. Morris put it thusly:
We are in an advanced stage with our banks on the overall terms and structure of an agreement that will help us put through the recovery by extending our secured credit facilities out to the 2020 and 2023 time frame, reduce fixed amortization and cash debt service costs, amend our financial covenants, and ensure we can operate effectively and benefit from our scale. Importantly, it must also create a structure that will attract new capital and facilitate an agreement with our bondholders. We have initiated dialogue with an ad hoc group of large bondholders through their advisors and also with potential providers of new capital. These discussions are ongoing, and we will keep you updated as and when we have something to announce.
Where this gets complex is that Seadrill's debt situation goes beyond its direct consolidated debt, and includes the debt of two of its subsidiaries, North Atlantic Drilling, and Seadrill Partners LLC, both of which Seadrill Ltd. has had to sign on as guarantors for. It also includes, as Morris described, bondholders. Case in point: Seadrill has nearly $900 million in bond debt maturing in September.
Seadrill doesn't have the capital to deal with its upcoming debt expirations. Negotiations with its creditors are intended to fix that, but it's not clear how much shareholders will be affected. Image source: Getty Images.
In addition to the $3.18 billion in debt maturing in 2017, Seadrill has $2.37 billion coming due in 2018, and $3.38 billion in 2019, and all of these amounts include a mix of both secured and unsecured term loans, revolving credit facilities, and bonds, held by multiple banks, financial organizations, and individuals.
CEO Per Wullf, however, said that "we expect to conclude our plans by April 2017." He also stated that so far, its banking partners have been amenable. The question is how things will work out with bondholders.
What should investors expect?
It's a little tough to call at this stage, but the most likely scenario will include refinancing of the company's secured and unsecured term loans and revolving credit facilities, without the banks having to take any severe haircuts and simply pushing back debt maturities several years. After all, Seadrill's drilling vessels, which secure the vast majority of the existing debt, remain high-quality assets that should remain competitive in the marketplace for many years to come. This is one area where its very new, high-specification fleet is certainly a competitive advantage as compared to operators with older, less-viable drilling vessels.
When it comes to the bonds, it could be another story, and I'm relatively certain that the company will be forced to issue stock to satisfy at least a portion of that part of the debt. One of the wild cards is Seadrill founder and largest shareholder John Fredricksen, who has reportedly been part of the package that has been presented to debt holders as standing ready to lend as much as $1 billion to the company. And while his $1 billion would certainly help absorb some of the upcoming debt expiries, the big question is whether existing bondholders or new investors will be willing to pony up and purchase new bonds.
There could be big reward investing in Seadrill now. But the risk of permanent losses can't be ignored. Image source: Getty Images.
The reality is, it's not very likely that Seadrill's banks will extend more credit to the company -- at least not in large enough amounts to erase the existing bond maturities. This is doubly true when you remember that Seadrill still has some $4 billion in newbuilds still scheduled for construction, including seven set for this year though management has made it clear it will not take delivery on any newbuilds without a drilling contract in place.
Looking ahead
As much as Seadrill's stock has gotten very cheap, at least on a book-value basis, this is where the risk resides. While it seems very unlikely that the company won't be able to rework its debt situation (and continue to defer newbuilds), it is likely that a lot of new shares will get issued as part of that reworking of debt. Add in the reality that offshore activity isn't likely to pick up before near the end of 2017 at the soonest, and there's plenty of time for Seadrill's stock price to move around a lot before there's a clear path forward.
So if you're thinking about buying shares of this company (or almost any other offshore driller), keep those things in mind. I think there's a lot of upside in the long term, but acknowledge the risk and buckle in.
