Shares of troubled offshore drilling contractors Seadrill Ltd. (SDRL) sank hard in April, falling 58.7%, while shares of subsidiary Seadrill Partners (SDLP) also fell 12% in the month. While shares of Seadrill Partners rode volatile crude-oil markets down, falling by an amount similar to many other offshore drilling stocks, Seadrill's troubles are much bigger.
In a press release announcing that it had reached agreement with debt holders to extend the maturity dates on three credit facilities which were due to mature in the first half of 2017, the company included the following statement (emphasis mine):
While no definitive terms have been reached, based on stakeholder and new money investor feedback, as well as the Company's existing leverage, we currently believe that a comprehensive restructuring plan will require a substantial impairment or conversion of our bonds, as well as impairment, losses or substantial dilution for other stakeholders. As a result, the Company currently expects that shareholders are likely to receive minimal recovery for their existing shares.
In plain language, Seadrill was saying that it wasn't likely to find enough new money from investors to restructure its debt, and that was leaving it with no choice but to negotiate a restructuring of the company, giving debtholders a piece of the company in exchange for debt. And since common shareholders stand last in line behind bond- and debtholders and other creditors like vendors and suppliers, existing shareholders will likely end up with a very small -- or even no -- ownership in the company as part of its debt negotiations.
North Atlantic Drilling Ltd. (NYSE: NADL), a Seadrill subsidiary which specializes in harsh-condition and ultra-deepwater drilling, is also caught up in the same issues affecting Seadrill. One of the credit facilities in the Seadrill announcement quoted above is actually debt issued to North Atlantic Drilling, with Seadrill acting as a guarantor. And North Atlantic Drilling shareholders are, in essence, in the same boat as Seadrill's.
The odd thing with North Atlantic Drilling is that someone out there thinks there's potential for a recovery, with its share price shooting up more than 230% following a mid-April announcement of a $1.4 billion contract extension for two of its deepwater drillships.
Seadrill Partners has a better chance to participate in restructuring without the need to recapitalize and wipe out existing investors. According to a press release it issued on April 28, it temporarily suspended its distribution (MLP-speak for dividend) pending negotiations "with its lending banks to insulate itself from potential events of default by Seadrill Limited should Seadrill Limited require the use of in court processes, such as schemes of arrangement or chapter 11 proceedings, to implement its restructuring."
In its annual report (released on April 27), Seadrill Partners disclosed that it is working to insulate itself from Seadrill's default risk, primarily by removing Seadrill as a guarantor from its debt covenants, and to extend the maturity of those debt instruments out to 2020.
A couple of key points: Both Seadrill and North Atlantic Drilling are stating that Chapter 11 (or the European equivalent) proceedings are very likely, and that management expects current shareholders will get little to no recovery of their asset value. I would caution anyone not to ignore these statements at this stage, counting on a last-minute deal for a big cash injection and refinancing of the existing debt. Frankly, if that was going to happen, it probably would have already.
I'm not saying it's impossible, but I am emphatically stating that it's a significant risk to bet otherwise when management is saying bankruptcy is likely.
Seadrill Partners, on the other hand, looks like it has the best chance of moving forward without its investors getting wiped out. But even so, I would caution investors from investing in it at this time: As things stand, its finances and operations are very intermeshed with Seadrill's, and that creates some risk that it will be affected.
Factor in an offshore market that's still a big mess, with activity unlikely to pick up before 2018, and there are plenty of reasons to avoid any of the Seadrill-family companies right now.
If you're dead-set on investing in offshore drillers right now, I'd suggest looking at another group of companies, all in much better shape to reward patient shareholders willing to ride out the downturn.