Investors have become increasingly concerned that offshore drilling giant Seadrill (SDRL +0.00%) has bitten off more than it can chew given current market conditions. It has a whopping $12.3 billion in debt on the balance sheet, expects to spend nearly $6 billion between 2014 and 2016 expanding its fleet, plus an almost 15% dividend yield.
That sounds like a lot for any company, and Seadrill's operations don't spit off that kind of cash each year, but one of Seadrill's subsidiaries may have just signaled how it can provide its parent company enough breathing room to pay for all of its obligations. Here's how it could work.
A look at what Seadrill is spending on new rigs thru 2016. Image source: Seadrill.
Seadrill's cookie jar
When Seadrill spun off its MLP Seadrill Partners (SDLP +0.00%) it created a less risky way for investors to play in the offshore drilling market. But it also created a way for Seadrill to cash in on assets if it needed the cash.
When Seadrill drops a rig down to Seadrill Partners or one of its subsidiaries it is paid cash for the ownership that company is buying and Seadrill still keeps some exposure to the unit. This took place in March when Seadrill Capricorn Holdings LLC, which is 49% owned by Seadrill and 51% owned by Seadrill Partners (which in turn is 51.1% owned by Seadrill), bought the West Auriga rig for an implied price of $1.24 billion. Given the complex ownership structure, Seadrill's cash proceeds from the sale was $350 million and it still has about 3/4 economic interest in the rig.
Seadrill's corporate structure, which is complex but provides flexibility to management when funding is needed. Image source: Seadrill.
Given the fact that a new ultra-deepwater rig costs around $600 million this is a sweet deal for Seadrill. For Seadrill Capricorn Holdings, it gets a rig with a $1.2 billion contract through 2020, which is the point of the structure of that investment vehicle.
In this respect, the Seadrill Partners MLP is like a cookie jar for Seadrill. If it needs cash it can push assets down to it and related subsidiaries, take out cash from a high priced sale, and still benefit from the long-term profits of each rig.
Seadrill's new ultra-deepwater rigs could fetch a high sale price if sold to subsidiaries. Image source: Seadrill.
Why the cookie jar could be open again
So, why is this important today? The answer comes from Seadrill Partners' announcement that it plans to sell 8 million common units for "general company purposes, which may include acquisitions, repayment of indebtedness and working capital purposes."
I find it more than coincidental that the proceeds of this stock sale given yesterday's closing price of $30.62 would yield Seadrill Partners nearly $240 million and likely closer to $280 million assuming a standard overallotment of 15%.
Given the fact that Seadrill Partners had $523.3 million in cash on the balance sheet on June 30, subsequently spent $373 million buying a 28% interest in Seadrill Operating LP, it should still have $150 million plus any operating cash earned since then. In other words, it doesn't need more cash to operate its business unless it's looking to acquire a new rig.
It just so happens that Seadrill owns another rig named West Vela that has a nearly identical contract to West Auriga that could be pushed down to the MLP in some way for a similar price. I think it's likely that this or another rig are pushed down to generate more cash at the Seadrill level to pay for the outlays I've outlined above.
Why Seadrill has many options available
The market may be in a sort of panic over the money Seadrill is spending on growth and dividends but we need to understand that the corporate structure gives Seadrill many options to raise cash fairly quickly. It can push assets down to subsidiaries, sell shares in subsidiaries on the public market, and it's generating positive cash flow each quarter if you don't include the dividend.
I think it would be wise to lower the dividend by at least 50% to pay for capital expenditures and debt, but Seadrill doesn't seem to be interested in that at the moment. So, as long as dayrates stay high, debt markets remain open, and Seadrill's subsidiaries are able to act as a piggy bank Seadrill should be able to pay all of its bills.
Don't forget that its founder and largest shareholder John Fredriksen also just bought about $56 million in the company's stock, increasing an already massive bet on Seadrill. I, for one, think he knows the company has a lot of funding options for the future, and the MLP cookie jar is just one of them that will come in handy if the next few years are rough for the offshore drilling market.
