Seadrill's Bungled Debt Offering

An offshore rig. Source: Skytruth.

On Tuesday morning, Seadrill (NYSE: SDRL  ) announced it would issue $1 billion in bonds with an option to convert into common equity shares. Typically, this kind of action does knock Seadrill's stock down by a few percentage points, but Tuesday's reaction from the stock market was remarkable: Shares of Seadrill dropped by over 5%. 

As a result, management cancelled its debt offering, saying that although the order was covered, the drop in equity pricing made the price of debt unattractive. Indeed, Seadrill was looking to issue low-cost debt out of a sense of opportunity, not need.  

Seadrill has several other avenues in which to raise funds, such as dropping down assets to its master limited partnership, Seadrill Partners (NYSE: SDLP  ) , or taking out credit facilities that name individual rigs as collateral. Still, the point is probably moot, because Seadrill did not absolutely need the liquidity, anyway.

Since Tuesday, Seadrill shares have recovered about half of what they lost. Those who believe Seadrill is a great bargain right now should keep in mind that, as recently as April, shares were almost 20% lower than where they are now. Just a few months ago, the offshore rig-leasing giant was yielding nearly 12%. Today, Seadrill yields about 10.3%. 

A Seadrill rig at night. Source: Wiki Commons.

I believe the market's seemingly visceral rejection of Seadrill's bond offering was yet another way of telling management that the company's complicated debt structure is not in fashion. For example, a quick check of rival Ensco's (NYSE: ESV  ) debt structure shows some big differences: Ensco has no rig-based credit facilities. It also has no master limited partnership by which to finance corporate activity.

Furthermore, Ensco's dividend to earnings per share ratio is in the low 50% range, whereas Seadrill typically pays 100% of its cash flow in the form of dividends. It's little wonder, then, that Seadrill's weighted average cost of debt is often one or even two percentage points higher than that of Ensco, despite the two companies having similar debt maturity horizons. 

While U.S. financial markets may not care too much for Seadrill's capital structure, the company's fundamentals continue to be sound. Management commented in May that it expects ultra-deepwater day rates to dip below $500,000, but Seadrill's most recent contract for one of its new ultra deepwater rigs, the West Jupiter, netted a dayrate of just over $600,000. This suggests that the expected decline in dayrates may not be so bad for newer, ultra deepwater rigs.

In addition, although Seadrill has no margin of safety for its dividend, the company typically locks in rig contracts for at least five years, and it therefore has good cash flow visibility. Management previously said that it is completely certain Seadrill's generous dividend will be sustainable until 2016, and it will probably continue to be so unless the ultra-deepwater rig market slumps for the long term. 

Foolish takeaway
Seadrill's bungled debt offering is not a sign that the company is in any kind of financial distress, and the long-term investor should therefore not be too concerned. The company's high cash flow visibility ensures a secure dividend for at least the next 18 months, and management will most likely not have to cut the dividend unless ultra-deepwater dayrates decline for the long term. 


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  • Report this Comment On July 11, 2014, at 1:22 PM, TMFVelvetHammer wrote:

    Good article Casey.

    However, I'll argue that there isn't reason to be concerned. Refinancing the rigs to gain some liquidity is immensely better for investors than the early-conversion offer that would have diluted investors by as much as 5%, IN ADDITION to the fact that further FUTURE DILUTION was the currency that would pay for it.

    I'm still troubled by management's actions, though I'm not selling for now, since there was a relatively non-damaging outcome.

    But I'm a lot less confident in this management team than I was a week ago.

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