Over the past few years, offshore driller Seadrill Ltd. (SDRL) has made progress on cutting costs and reducing its debt load. Debt is down by about one-third from its peak in early 2014, the operating costs of its vessels has come down, and management has been able to get its shipbuilders to agree to delay and defer delivery of newbuilds multiple times. Management has also been able to get its debtholders to defer debt maturities on more than one occasion.
But it's looking more and more as if all of this effort could come up short. This single sentence in the company's most recent quarterly earnings release sums it up:
In the event a consensual restructuring agreement is not concluded or an agreement to an extension is not reached, we are also preparing various contingency plans, including potential schemes of arrangement or Chapter 11 proceedings.
Let's take a closer look at where things stand, and what investors should consider before taking any action.
What is happening with Seadrill?
In short, Seadrill has a significant amount of short-term debt due in the coming months, and it doesn't have the liquidity to pay it all off. The first big tranche of debt matures at the end of April, but it's far from the only maturity before the end of summer. All told, Seadrill has $3.2 billion in debt maturing before the end of 2017, with more than half of that amount due before July.
On one hand, management has demonstrated some ability to get its financial backers to work with it. The $450 million senior secured facility maturing in April, for instance, was originally set to come due June 20, 2016, but the company was able to reach an agreement with its lenders not once, but twice, to push that maturity back. So there's an outside chance that its lenders could agree to another extension.
On the other hand, if it were just this single debt instrument, the company would probably be able to deal with it. Instead, it's only a small piece of the pie. An additional $400 million senior secured facility comes due on May 31, and a $2 billion senior secured facility matures on June 30.
The balance due on the three facilities at the end of 2016 was $1.22 billion, while the company had $1.37 billion in cash and equivalents. And no, it's not really an option to use that cash to pay off its near-term debt. Two reasons.
First, Seadrill's other debt agreements will have certain capital requirements. If the company were to wipe out all of its cash to pay off short-term debt, it would be in violation of those agreements and place itself in default. There's almost zero upside to taking this path. Second, the offshore downturn is far from over. Seadrill would be better served to maintain its cash holdings and continue to negotiate with its debtholders on a restructuring in good faith.
Any way you slice it, Seadrill is quickly running out of time to reach an agreement with all of its debtholders before its first maturity in April. If the company defaults on that facility, it will probably put the company in default on all of its other debt instruments as well. Hence management's warning about Chapter 11 as a possibility.
Seadrill's biggest shareholder is no guarantee of safety
Many investors have looked at Seadrill's founder and biggest shareholder, John Fredriksen, as providing a measure of safety for other common investors. However, that's not necessarily the reality.
Fredriksen very well could decide that he would be better off to lose his common stake -- or at best see it significantly watered down -- in a reorganization, while profiting from buying assets on the cheap, investing more cash and taking a common interest in a reorganization, or simply focusing on his new offshore asset holding company, Northern Drilling to build a new opportunity for himself.
Fredriksen has already started taking advantage of the downturn and Seadrill's ugly situation, with his Seatankers recently agreeing to buy West Mira, a newbuild Seadrill had been unable to afford to take upon completion from the shipbilder.
Sure, there's an argument that this move was good for both Seadrill -- by ending its legal dispute with a shipbuilder and removing a vessel it had no work for from the picture -- and Fredriksen. But the bigger point is, Fredriksen's wealth, connections, and influence in the maritime industry give him a place at the negotiating table, which common shareholders will never have.
And that means even if common investors (Fredriksen included) end up taking a bath on Seadrill's restructuring, Fredriksen is positioned to profit.
Seadrill continues to operate one of the most capable fleets in offshore drilling, and its management has made some progress with debt and capital requirements from newbuilds. And having Fredriksen in the company's corner has played a substantial role in this progress. But when a company discloses that Chapter 11 is on the table, investors simply can't ignore it.
Even with Fredriksen's influence likely to help reduce the risk that common investors will be left with nothing, the likelihood that it does happen is not zero. If you're risking money you can't afford to lose in Seadrill right now, you really need to consider that.