Earlier this week, Seadrill (SDRL) announced it would be issuing $1 billion in convertible bonds, adding to the already substantial pile of debt that the company has. Additionally, the company extended an offer to holders of 2017 convertible notes, offering to pay a 10% premium in cash and convert the notes to shares at an effective $27.68 per share. Needless to say, the market didn't respond to this in a positive manner and shares were sent down more than 6%. The company abruptly changed course, cancelling both the debt and conversion offering, likely due to pressure from large shareholders.
Frankly, this latest move has me concerned, and now I'm considering whether I want to remain invested in Seadrill. With the growth in LNG exports just around the corner, I'm looking closely at GasLog (NYSE: GLOG) and GasLog LP Partners (NYSE: GLOP) as alternative investments. Let's take a closer look at my concerns, and why I'm considering these two alternatives.
Erratic decisions by management a real concern
One of the big concerns with Seadrill is the projected softness in demand for offshore drillers over the next couple of years, but frankly, that's not a major concern for me. As I wrote here, the risk is there, but Seadrill's new, high-spec fleet should allow it to continue to grow and remain profitable, as the offshore market becomes more bifurcated between low-demand, low-spec ships and the high-spec fleets like Seadrill's, which should have strong demand.
My concern with Seadrill isn't even the mountainous pile of debt -- more than $14 billion today -- that the company has accumulated through its newbuild program. My bigger concern is the fact that management went so far as to announce a new debt issuance, and extend an offer to holders of other debt to convert to shares early, before abruptly changing course. How did this get played out in public? A company can't go into $1 billion of debt issuance so casually, can it? And the early conversion offer? What a terrible deal for existing shareholders.
Why the early conversion was a bad deal for shareholders
In short, the conversion deal was highway robbery for shareholders. Not only would note holders get their debt converted to shares at a nearly 30% discount to market value, they would also receive a 10% cash payment for converting early -- an offer that note holders would be crazy not to accept. It gets even better.
Seadrill's dividend yield is over 10% today, versus the notes' 3.375% interest payment. What that means is that the debt service cost is lower -- by nearly three times -- what it would cost to add these new shares to the dividend pool.
Add it all up, and existing shareholders would see a 5% dilution of their ownership, and Seadrill would see its dividend expense increase by almost $100 million per year, while debt service would only decrease by around $22 million. This is in addition to the $65 million in cash paid to early note converters. Great deal for note convertors, but awful, awful, awful for shareholders.
That's not even considering the additional $1 billion in debt that would cost up to $25 million in annual interest payments.
Why GasLog and GasLog LP Partners?
The things that attracted me to Seadrill are present in GasLog and its MLP, GasLog LP Partners, with the exception of Seadrill's crazy-high dividend. The U.S. will begin exporting large quantities of LNG in the next couple of years, and the LNG tanker industry doesn't have enough capacity to support the added demand that will be present for American exports.
Much as Seadrill has been building out massive quantities of newbuild, high-specification drilling rigs over the past several years, GasLog is doing the same thing with LNG tankers. Almost half of GasLog's fleet is in some stage of construction, and most of those newbuilds will begin hitting the water at around the same time Cheniere Energy's Sabine Pass export terminal comes online in late 2015.
GasLog and GasLog LP Partners -- the MLP that GasLog is general partner of -- should be one of the best growth opportunities in LNG shipping over the next several years, and based on demand, I expect both to add significant debt as even more newbuilds are ordered. GasLog's dividend is only around 1.7% based on today's share price, but GasLog LP Partners -- which is very newly formed -- will yield closer to 5%, so it's a better income choice but comes with the tax complications of owning an MLP, where dividends are actually distributions, and shareholders are actually unitholders. Typical capital gains taxes don't apply, because distributions are counted as regular income to unitholders, as the MLP itself isn't taxed on the income, and it must pay out at least 90% of income to unitholders and the general partner.
So understand the tax complications before you invest.
Final thoughts: I'm still considering my decisions
Honestly, I'm not convinced that I'll sell my Seadrill stake, because it is a good call that management changed course. However, my concern over these erratic decisions -- and it playing out in the public -- are very real. I expect a company with the debt load Seadrill has to be very disciplined, and this near-fiasco isn't something that makes me confident in the management team.
As to GasLog and the MLP GasLog LP Partners, I'm still doing my research, but I like what I've seen so far. If I do decide to sell all or part of my Seadrill stake, I'll very likely invest in one or both of the two.
