I suppose it is tempting, if the only tool you have is a hammer, to treat everything as if it were a nail.
Maslow, 1966 (often referred to as “The Law of the Instrument”)
I’ve thought about it all day… and had five double espressos, (so I’m in the mood for a rant)… but try as I might I see no sensible rationale for Subsea 7 turning from an offshore contractor into a provider of Debtor-in-Possession (“DIP”) financing for a failed offshore company. I see no strategic rationale for this at all… When I say none I guess simplistically if you could buy some work then maybe, but I’ll come back to this, because what are you actually buying?
Subsea 7 and Chiyoda extending DIP financing strikes me as the final stage of lunacy before acceptance that the industry is going to be very different in the future from 2014. This deal looks like one put together by bankers (for the fees); lawyers, promising they can mitigate any losses structurally, and they probably can here (for the fees), and corporate development staff desperate to show they are “adding value” by buying some options. There is no industrial logic to this deal at all. The reason EMAS Chiyoda is in Chap 11 is because there was insufficient demand for what they offered, and when they did manage to win work and deliver it, the end product was substandard and normally over budget. It’s that simple.
The hardest thing to do sometimes is nothing, which is what needed to happen here. When a market contracts capacity needs to as well, and the weakest, most inefficient, and poorly run companies need to go. Schumpeter rightly called this “gales of creative destruction”. And boy did EMAS Chiyoda need to go. Everyone at Subsea 7, and particularly the Directors, have better things to do than try and be too clever here and spend time, and money, on an angle that is opaque when the answer is blindingly obvious. This is a deal being done because it can and because people need to be seen to be doing something. When you’re a banker, a lawyer, or an corporate M&A person, the answer is always a deal, no matter how complicated, or frankly illogical. This was a deal done because a hammer thinks it can see a nail.
Economists have put a lot of effort into studying organizational change at the population level in a field known as “organisational ecology”. I am a subscriber to “Red Queen” theory:
which highlights the relative nature of progress. The theory is borrowed from ecology’s Red Queen hypothesis that successful adaptation in one species is tantamount to a worsening environment for others, which must adapt in turn to cope with the new conditions. The theory’s name is inspired by the character in Lewis Carroll’s Through the Looking Glass who seems to be running but is staying on the same spot. In a 1996 paper, William Barnett describes Red Queen competition among organizations as a process of mutual learning. A company is forced by direct competition to improve its performance, in turn increasing the pressure on its rivals, thus creating a virtuous circle of learning and competition.
Simply put EMAS Chiyoda was “maladapted” for the new economic environment. [The best paper ever on revolutionary change and organisations is this one on the “Punctuated Equilibrium” if you are interested. Offshore oil and gas has definitely been through a period of stasis followed by a punctuated equilibrium.] Anyway…
Firstly, Subsea 7 really doesn’t need an more vessels: they have 33 committed vessels at the moment, a relatively poor order book given the fixed cost commitments, and no capacity issues.The current committed fleet cover every possible industrial, and geographic, permutation the most pedantic engineer could dream up. Subsea 7 needs a vessel like the Lewek Constellation like I need to be left at home with the kids indefinitely: it just wouldn’t be good for either party. Don’t worry about someone else being dumb enough to take it at any price, there has been a huge capacity and capability increase in shallow and deepwater pipelay in the last 5 years, the top 6 players are fine for the next 9 shale revolutions. Anyone taking on that vessel is assuming a liability certainly, and maybe an opportunity: it’s the banks problem don’t make it yours.
The reason 2014 was boom was because there was insufficient supply combined with high demand. While demand might recover the supply is now fixed, so even an increase in demand won’t make an EPIC pipelay resurgence a boom (and no independent data suggest this is likely anyway). I get Boards need to think of the future, but surely the most logical strategy here it to back yourself for margin expansion: if the market recovers try and recover some of the equity lost in the last three years? The solution to a capacity problem probably isn’t another cheap vessel.
Yes, the Lewek Constellation is a really capable ship (although built in Vietnam at Triyards so you’d want a good survey before taking ownership), but I am about to share a shock revelation with you: there are loads of really capable ships with no work at the moment, and they cost a lot to run. In the last Subsea 7 results backlog was down nearly USD 1bn… as a general rule going long on fixed assets with a high running cost while you’re order book is shrinking is a bad idea.
If Subsea 7 want to do something positive with the EMAS Chiyoda vessels I suggest they team up with McDermott, Technip, and Saipem for an en bloc deal with the banks and sink them somewhere. That is likely than being a better investment than getting some of this tonnage “cheap”. The Constellation would be a far safer, and more interesting, dive than the Thistlegorm and potentially more value accretive this way. (Competition authorities please note this should not be construed as investment advice or an inducement to collusion).
Should Subsea 7 really believe it has insufficient pipelay capacity in Asia it should go to Petrobras and strike a deal to remove one of the flexlay vessels from the region (which are far more capable than the EMAS Chiyoda fleet). Operationally they are perfect for Asia, and they might make more money this way that getting it redelivered under a technicality, which PB seems prone to at the moment. Subsea 7 need to harden-up, back themselves competitively, and realise some vessels need to leave this market. Pipelay is hard: jobs are bid a long time in advance, you need a lot of working capital, even tendering is expensive, and in this market E&P companies are going with the safest options etc.: the chances of an upstart picking up the EMAS Chiyoda vessels and winning sensible work at a decent margin in literally trivial.
The other major problem, far greater actually, is that it is well known at a project level that the engineering EMAS Chiyoda has been doing, for at least the last twelve months, is some of the shoddiest ever seen in the industry. Subsea 7 needs projects, not capacity, and any short-term vessel needs can be met on the charter market. What the Subsea 7 backlog definitely doesn’t need is a commitment to deliver projects bid by a company tendering where the management were telling the engineers they must “win at all costs” to keep their jobs. Subsea 7 wants to be really careful about accessing this work because if the contracts are simply novated across they have brought backlog without any controls over how it was bid, from a firm with a history of losing money on offshore delivery. If they aren’t novating the contracts why bother supplying financing? E&P companies take a huge risk when awarding lump sum in that progress payments are effectively unsecured creditors, and on big projects, like Jack St Malo, this is a material number. But much of the offshore work is vessel specific anyway and that takes us back to the problem that Subsea 7 doesn’t need to help the customers, or creditors, by chartering these vessels to deliver the projects. This is just a bad idea.
Subsea 7 could offer to help due diligence the bid project work, or maybe adapt it to their vessels for free (but that just dilutes margin), but honouring EMAS Chiyoda contracts would be an act of commercial madness in all but the most exceptional circumstances (and a clear incentive mechanism is created here for the people from Subsea 7 who negotiated these agreements to encourage the company to take these risks to prove they struck a good deal: it’s a personal asymetric payoff which should always make you cautious).
The real solution here is just to let EMAS Chiyoda go to the wall. I feel terrible for the staff, but unfortunately the world has changed and there is simply no industrial logic for its continued existence. No one needs the assets, or the second-rate, uneconomic, but exceedingly cheap (in all senses) solutions it offered. The industry will be a better place with it gone and instead of trying to work out some really clever angle to this Subsea 7 just need to help it happen.