Offshore Drillers Feeling the Urge to Merge

Earlier this month, Foolish colleague Josh Wilburn posed the question "What Will Seadrill Buy Next?" That's proven a very timely one, as Pride International (NYSE: PDE  ) is now reported to be seeking strategic alternatives, with Seadrill (NYSE: SDRL  ) and Ensco (NYSE: ESV  ) tipped as the two most likely merger partners. Apparently, Noble (NYSE: NE  ) had a look as well, but passed on pursuing a deal.

Speculation surrounding a sale of Pride is nothing new. Seadrill built a roughly 10% stake in the company back in 2008, and holds it to this day. Pride has only increased its attractiveness as a takeover target by jettisoning its undesirable mat-supported jackup business, Seahawk Drilling (Nasdaq: HAWK  ) , last year. That spinoff left the firm quite leveraged to the deepwater drilling market, which has a very bright future, barring an unexpected collapse in oil prices.

Ensco and Seadrill have squared off in the recent past. In May, Ensco made a partial tender offer for the shares of Scorpion Offshore. Seadrill trumped this offer (with a modest 1.25% per-share premium), and picked up the company.

Ensco has shown itself unwilling to get into bidding wars, and Seadrill is by far the more aggressive industry consolidator. The company's chairman has even spoken about combining with industry heavyweight Transocean (NYSE: RIG  ) , making clear that no target is too ambitious. I would definitely tap the latter company as the most likely Pride partner. Pride itself has said that Seadrill's high-quality assets would be a good strategic fit.

Speaking of strategic reviews, the struggling Seahawk has launched one of its own this week. After floating the idea of raising cash to buy international rigs a few months ago, the company now says it's looking at other options, including "transactions involving a sale of assets, a recapitalization, or a sale or merger of Seahawk."

It's hard for me to imagine any current operator wanting to buy or merge with Seahawk, given the near-term drag on performance. A financial sponsor of some sort, like an energy-focused private equity shop, might see the merits of eating some losses with an eye to a rebound a year or two down the line. As I've outlined in the past, Seahawk's earnings power under such a scenario could make the shares worth more than $20 per share.

The problem is that such a rebound would require a return of demand for the drilling of shallow-water Gulf of Mexico wells, and not of the deep-shelf variety that McMoRan Exploration (NYSE: MMR  ) is targeting. Given the abundance of onshore gas drilling targets unlocked by independents in recent years, it's not clear that there's going to be a ton of demand for Seahawk's rigs anytime soon.

Fool contributor Toby Shute doesn't have a position in any company mentioned. Check out his CAPS profile or follow his articles using Twitter or RSS. The Fool owns shares of Ensco and Noble. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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