In a previous article I introduced income investors to John Fredriksen, self-made billionaire and a modern day Poseidon. I outlined how this humble son of a Norwegian welder worked his way up the ship-brokering ranks and eventually built one of the largest seaborne empires in the world -- with $14 billion, he's the 78th-richest person on Earth).  

Fredricksen's citizenship in Cyprus, where dividends aren't taxed, is why all the companies that he has founded or taken major stakes in have sky-high dividends. This article will highlight three of my favorite Fredriksen companies: Seadrill (NYSE:SDRL), North Atlantic Drilling (NYSE:NADL), and Seadrill Partners (NYSE:SDLP). These three are among the highest-yielding offshore drillers, and they show Fredriksen's genius at creative financial deals that enable his companies to have both generous yields and solid, sustainable dividend growth.

John Fredriksen and offshore drilling: match made in heaven
The investment theses for all three companies are composed of three parts. 

The first two are major global economic megatrends; the world's growing demand for oil and the subsequent boom in offshore oil drilling. The third involves Fredriksen's influence on the boards of these companies (for example, he owns 21% of Seadrill).

Consider these facts:

  • According to a recent study by Morgan Stanley and Rystad Energy, by 2035 the world's demand for oil will increase by 13%-26%.
  • Oil prices are expected to average $125-$150 per barrel.
  • Global exploration and production budgets (from oil companies) in 2013 were about $650 billion and expected to grow over the long term. (Note the 15% compound annual growth rate over the last 11 years.) 
  • Ultra-deepwater, or UDW, drilling is projected to see 19% CAGR through 2030, compared to just 1% for conventional land-based drilling. 
Despite recent analysts concerns about a short-term glut of UDW rigs and falling dayrates, the fact is that by 2020 165 more UDW rigs will be needed than exist now or are scheduled to be built, meaning long-term dayrates will rise. This places Seadrill, Seadrill Partners, and North Atlantic Drilling into position to maximize long-term growth from these megatrends. Fredriksen's involvement adds an extra kicker to long-term market outperformance. 
 
This is because Fredriksen is essentially the Tony Stark (Iron Man) of offshore drilling. He loves fast growth, high dividends, and state-of-the-art equipment, and possesses a genius for creative financial deals that enables him to reach all three goals simultaneously. Where other drillers try to build new rigs using cash flow, Fredriksen's company's aren't afraid to use lots of cheap debt.
The company has no difficulty servicing its debts, with an EBITDA-to-interest ratio of 9.2 and EBITDA expected to grow at 20% CAGR through 2016. Fredriksen also has two other sources of funding that his competitors are just now starting to emulate. 
 
I am referring to Seadrill's nearly $1.2 billion investment in three other companies: SapuraKencana (8.18% stake), Sevan Drilling (50.11% stake), and global oil services company Archer (39.9% stake).
 
Fredriksen's most ingenious method of alternative financing includes Seadrill spinoff North Atlantic Drilling and master limited partnership Seadrill Partners. Seadrill owns 70% of North Atlantic and 53.2% of Seadrill Partners.
 
Seadrill acts as the parent company to North Atlantic and the general partner of Seadrill Partners. It uses its massive access to cheap debt to build state-of-the-art, six-generation UDW and harsh environment rigs for which it often arranges long-term, highly lucrative contracts ahead of completion. It then sells these to its subsidiaries. In the process it recoups the cost of the extra debt, but now North Atlantic and Seadrill Partners have additional, highly profitable rigs to generate income.
 
North Atlantic can then raise its dividend, 70% of which goes to Seadrill. Seadrill Partners has bought five rigs from Seadrill for nearly $4 billion, but at terms that are still accretive to unitholders (distributions have been raised 31% since the IPO and another 6%-7% raise is planned after the completion of the last dropdown). Seadrill not only benefits from these higher distributions, but also receives incentive distribution fees from its MLP (50% of marginal distributable cash flow above a distribution of $0.4456 per unit per quarter).
 
In this way Fredrikson's offshore drillers create mutually beneficial financing arrangements that allow them to grow quickly while maintaining high, safe, and growing yields. 
 
Foolish takeaway
John Fredriksen is a modern day Iron Man of offshore drilling and an income investor's best friend. His three offshore drillers offer long-term investors an opportunity for high income, sustainable yet quick dividend growth, and capital gains to boot. All three are massively undervalued due to short-term concerns about the industry, but two major megatrends mean long-term market crushing total returns are likely for many years to come.

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Adam Galas has no position in any stocks mentioned. The Motley Fool recommends Seadrill. The Motley Fool owns shares of Seadrill. Try any of our Foolish newsletter services free for 30 days. 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.