Last August, I told you that Seahawk Drilling (Nasdaq: HAWK) was for the birds. So far, that's proven the correct call, as the stock has seriously underperformed offshore drilling peers like Rowan Companies (NYSE: RDC), Ensco (NYSE: ESV), and even Hercules Offshore (Nasdaq: HERO). The shares have fallen by more than 20% during a period of market buoyancy that has lifted most boats.

I'm not here to gloat. I want to reassess my stance now that the shares have dropped by a meaningful amount. I went through a similar exercise recently with A-Power Energy Generation Systems. All things being equal, it makes sense to become more positive on a stock as the price falls. For a company like Seahawk Drilling, which has significant tangible asset value and zero debt, the business is obviously worth something. Our goal, as always, is to figure out what we would pay to own a piece of this business.

Seahawk leaves the nest
Seahawk came public last year as a spinoff from Pride International (NYSE: PDE), a driller that's positioned itself as a deepwater-focused outfit. In a spinoff, all of the shares are distributed to existing shareholders of the former parent. Investors who've read their Greenblatt know that this can spell opportunity.

In the case of Pride and Seahawk, I would argue that most investors owned Pride for its deepwater fleet and care little about the jackup rig business that was transferred to Seahawk. Deepwater fundamentals look far stronger, especially once we get beyond the near-term bump in the global fleet. The jackup market is super-volatile, and may be experiencing a secular decline (as opposed to a merely cyclical one). Given the respective outlooks, you can hardly blame investors for dumping Seahawk shares.

At the time of the spinoff, some investors and analysts made a case for Seahawk based on this redheaded-stepchild effect. Were they wrong, or just too early? Now that shares have sold off a fair amount, let's take up the all-important question of valuation.

Fun with multiples
The price-to-earnings (P/E) ratio has a lot of fans, based on its simplicity. With a cyclical company like Seahawk, this ratio is particularly useless, so forget it. At a minimum, you want to try to ballpark a level of midcycle earning power (the cash earnings that Seahawk can generate in a "normal" year, if there is such a thing), and place a fairly low multiple on that, to compensate for extreme cyclicality.

Seahawk is currently at a low ebb in the cycle. Out of 20 rigs, only eight are contracted, and at pretty meager dayrates. The company was cash-flow negative in its first few months as an independent entity, and has warned that it may consume cash again in 2010 if things don't improve.

A rebound in natural gas prices would certainly get things moving in the right direction. If you believe that full-cycle drilling economics dictate $6 to $8 natural gas prices, as Chesapeake Energy (NYSE: CHK) has suggested, then there's certainly room for improvement in jackup rig utilization and contract drilling rates.

Assuming that Seahawk can achieve midcycle utilization and dayrates of 75% and $45,000, respectively, I would expect normalized earning power of around $30 million in annual after-tax operating cash flow. At 80% utilization and $65,000 per day, my estimate jumps to $84 million. It appears investors were pricing in the latter at the September highs of around $35 per share.

Taking the midpoint of these cash flow estimates and applying a multiple of five yields an intrinsic value estimate of around $24 per share. This estimate, which represents nearly 30% upside from today's price, is extraordinarily sensitive to utilization and rig rates. My confidence in its accuracy is low, but it's a starting point.

Is that the floor or the ceiling?
Investors looking for strong downside protection -- always a wise starting point -- definitely ought to consider a company's tangible asset value, or liquidation value. In Seahawk's case, the question is: How much cash could you expect to get for the rigs and other assets in an orderly liquidation?

In a recent presentation, Seahawk pegged its fleet value at $377 million, or $18.9 million per rig. Ensco recently sold two jackups for $95 million combined, but those were rated for 300 feet of water depth. Seahawk has only one such rig. On the other end of the spectrum, Hercules Offshore sold a pair of uncompetitive rigs last year for $12 million combined. Seahawk's average rig value no doubt lies somewhere in between.

Elsewhere in its presentation, Seahawk reported that 200-foot, mat-supported, cantilevered jackups are fetching around $21 million, while 250-foot, mat-supported, slot-type jackups (don't ask, it's boring) are going for $17 million. The company's fleet includes nine of the former and six of the latter, so that gets us to $291 million. Four of the remaining five rigs are more capable cantilevered rigs, while one is less so. Thus $377 million for the whole fleet seems like a reasonable figure. That translates to around $32 per share.

At present, Seahawk would seem to be worth more dead than alive. Of course, that's assuming that the company could sell its entire fleet at the drop of a hat. With larger peers like Transocean (NYSE: RIG) moving away from the shallow water, I don't see a natural buyer at non-fire-sale prices.

The Foolish bottom line
The idea of an immediate, orderly liquidation at the going rate strikes me as unrealistic. I prefer to stick with my $24/share cash flow-based estimate, and would probably demand a 40%-50% discount to that number, in order to give myself a nice big margin of safety.

Chesapeake Energy is a Motley Fool Inside Value choice. Try any of our Foolish newsletters today, free for 30 days.

Fool contributor Toby Shute doesn't have a position in any company mentioned. Check out his Motley Fool CAPS profile or follow his articles using Twitter or RSS. The Fool owns shares of Chesapeake Energy. The Motley Fool has a disclosure policy.