Source: Seadrill Ltd
When I saw that Seadrill (SDRL) had completely obliterated its dividend, I, like most of its investors, was shocked and upset. Just 90 days prior to the announced cut, the company told us that the dividend not only was, "sustainable until at least the end of 2015" but that the company's board felt, "increasingly comfortable that this period can be extended well into 2016 without any significant recovery in the market." Those statements gave me the confidence to take advantage of the drop in Seadrill's stock to buy more shares.
Then just 90 days later this happens: "In light of the changes that have taken place since our last report, the Board has taken the decision to suspend dividend distributions for the time being." That statement from the company led to a more than 22% sell-off in the stock on the day it made the announcement. It was a stinging blow to investors that had confidence that the company's management team knew what they were doing and could guide the company through the current storm in the offshore rig market. Boy, were we wrong.
Or, maybe, in the grand scheme of things the dividend cut really is the best decision for the company going forward. That's why I wanted to take some time to drill down into the company's plan for redemption to see if it makes sense for investors to keep holding on to hope.
What Seadrill plans to do with our dividends
By completely obliterating its dividend Seadrill will save roughly $2 billion over the next year. It plans to use some of that money to buy back up to 10% of its now highly discounted stock. With is market capitalization around $6 billion right after its dividend slashing induced sell-off, that would suggest the company can plow $600 million into buying back its stock.
Incidentally, that sell-off alone potentially saved the company $400 million on the stock buyback as it would have cost the company $1 billion to take out 10% of its shares the day before the announcement. That being said, any way we look at it, a 10% stock buyback is meaningful as it means any future dividends would be paid across fewer shares. Because of this, the buyback can potentially create very meaningful long-term value for those investors that continue to hold the stock.
After the buyback, Seadrill will likely be left with about $1.4 billion in dividend savings, which it said it plans to use to pay down debt. As of the end of the third quarter, its total long-term debt stood at $11.4 billion. So, Seadrill could reduce its debt by 12% before we factor in nearly $4 billion in unfunded yard installments the company has on its newbuild program over the next two years, which is noted on the following slide.
Source: Seadrill Investor Presentation.
Seadrill plans to fund its yard installments by accessing the credit markets to finance about 70% of the value of its rigs. However, those markets have tightened up a little bit as the company said that, "the financing market has become incrementally worse, and although Seadrill still has significant access to funding, some markets have become unattractive." With $1.6 billion in unfunded yard installments due next year, Seadrill's dividend savings provides it with plenty of flexibility to fund most of those rig commitments with cash, which is a big deal if the credit markets really tighten up.
Said another way, what Seadrill is doing is ensuring that it survives the downturn in the offshore rig market. It did not want to be faced with having its liquidity dry up when it had commitments to fund newbuilds. So, by ending its dividend for the time being the company has assured itself of being able to fund its commitments. While survival alone won't create any value, the company's plan is to first survive and then thrive. It's the post rig-storm thriving that could create value for investors as the company could then use its extra credit capacity to take out weakened rivals.
Investor takeaway
Seadrill's decision to end its dividend is one that caught a lot of investors off guard as the company led us to believe it was safe for at least the next two years. However, the market changed so fast that Seadrill needed to react in order to not only survive the downturn, but to thrive when it emerges out of the other end. While the dividend cut hurts, Seadrill's plans for that cash should lead to a stronger future for investors that stick with the company.
