EZRA fate depends on more than debt write off… it would need significant capital

“Don’t cry because it’s over, smile because it happened.” 

– Dr Suess

An update on the EZRA situation in the Straits Times this morning deals with one part of the EZRA problem:

Much of the company’s fate now hinges on the willingness of its creditors, including bondholders, to write off – whether partially or in full – its massive debt.

Which is true as I have said many times before here, but this would be nowhere near enough. What EZRA would need in addition to a massive debt writedown is a gargantuan injection of equity to fund the company through until profitability. I don’t what the exact number would be, but it is in the tens of millions, and I suspect that number is scaring the banks now. It would also need a completely new leadership team, but I will treat that as a given.

As the article rightly points out the banks exposure is to the high-end vessels like the Lewek Constellation. An engineering marvel it may be, a liquid asset that could be sold at anything like book value, it is not. I often talk here about asset specificity, which the offshore industry and their financial providers spectacularly mispriced in the last boom, but the Lewek Constellation is also an example of a complementary asset: the return on the asset increases the marginal return to another (or its owner). In the hands of a contractor wanting to do deepwater pipelay it’s a very valuable asset, but the reverse is also true, without the right owner such a specific asset is actually close to valueless. Intuitively we know this to be right about the Lewek Constellation, there is nothing else that can be done with that vessel without enormously expensive modifications. Banks should have had a much lower loan-to-value ratio on the vessel, in effect it was a project that was entirely equity risk should it go wrong, because even to hold it at port costs ~USD 15k per day, and it will take months to sell at a fraction of its build cost (unless Subsea 7 are silly enough to buy it) as the Ceona Amazon did.

There was a straight asymmetric payoff for EZRA shareholders here where they put up a fraction of the value of such a complex asset and received all the benefits if it worked and the banks were left holding an unsellable asset with high running costs if it didn’t. It is also clear, and this should be a warning to anyone thinking of funding this, that EZRA massively underestimated how long it would take the vessel to get decent utilisation, and therefore how much capital would be required to fund the roll-out of the Lewek Constellation. A new contractor could realistically only hope to win one or two jobs a year with such a new specialised asset, the EZRA equity holders would have had to accept dramatically lower utilisation than anyone else, and therefore lower immediate payouts (dividends), for the prospect of a higher value firm in the future (if you were following MM theory). But that is equity risk and it is clearly a big number when funding a deepwater pipelay asset to challenge the world’s industry leaders.

But the banks behind EZRA have a choice: accept the loss now, or risk putting millions more in working capital into the venture in the hope that the asset values will increase enough, and the company can repay even more money in the future. Both are really bad options in the current market. Any new equity investor not already exposed to this company would demand market prices for the assets, which doesn’t help the banks at all, but to take an equity position (whatever for the semantic legal definition the capital injection took) to dig themselves out of a very deep hole is a real problem for banks. Equity risk has to be reserved at almost a 1:1 ratio under capital adequacy provisions at the moment, and for good reason: no one can tell when this market is coming back, and indeed if it will ever come back like before.

And even if the market turns a reconstituted EZRA would be competing against Technip, Subsea 7, McDermott, and maybe, longer-term, Saipem (for another blog day). This new company would require sufficient capital to convince the Board of any potential customers that they were the right partner for a large, strategically important, complex offshore field development that would cost in the tens-to-hundreds of millions of dollars. I don’t see anyone taking them up on such a remarkably unattractive offer, in this market, with a surplus of good assets and contractor capacity, you would be mad to willingly choose EZRA as your offshore development partner. All engineering and procurement work for long-term projects is effectively contractor specific and exposes potential E&P customers to becoming unsecured creditors should the new EZRA fail, so it would need a fortress-like balance sheet to convince people they will be here next year, or the year after, but would you hand over a key strategic project to a contractor who has just come out of Chap 11 and defaulted on a large number of people throughout the supply chain? I just don’t see it.

In addition, it would appear that the Norwegian arm is to be liquidated and contracting on this scale only works as a global operation. There is simply no industrial logic for a recapitalised EZRA.

If the banks want a lesson in how expensive a strategy of providing working capital in a depressed offshore market can be they need look no further than Nor Offshore and their two DSVs parked at Blyth. Having raised USD 15m last November, and making a big deal about how much financial flexibility this gave them, they now look certain to have to raise funds again at the end of this year as the entire amount will have been spent on working capital without any work being generated in 2017 (remarkably like 2016 for them).

Nor are desperately hoping that their combined bid with Oceaneering for the BP Trinidad work will come to them. I don’t see it. Bibby have the Bibby Sapphire in the Gulf, know the worksite etc. DOF have the DOF Achiever in the region as well. Would BP really bring a new DSV, with a new crew, that hasn’t dived in a year, and put it into a complex and tidal worksite? I rate their chances at less than 5% (and on a rational basis 0%). Unless Oceaneering has a remarkable relationship with someone at BP I don’t see it happening: at the end of the day a DSV puts people on the seabed and someone at BP would be accepting that if anything went wrong from a safety perspective they had taken a very risky option. And given the market BP would not save any money in doing something so risky. BP need the work done and they need it done safely.  Sure BP, try and get the price down, but who would risk their job to take such a decision? Safety first in everything we do right?

And even if Nor/Oceaneering won the work it’s a 20-25 day transit, 400k on fuel (which BP won’t pay for), and then sea trials, bell run trials etc. Madness. The Nor bondholders will be going backwards in cash flow terms given current day rates at OpEx only, just to get the boat moved. So they will be raising money at the end of the year, or selling the vessels for a lot less than they had hoped, when they raised the USD 15m last year. It is literally locked in because they have no other work and no hope of recovering their liquidity position given the market and their position in it.

Such a situation is magnified a hundred times for the banks involved in EZRA. Someone senior would have to agree to in effect provide enough working capital for at least 24 months to prove they were going to make it through, potentially offer refund guarantees against procurement and engineering etc. As Nor has shown there is no guarantee that conditions will improve in time if you simply sit back and watch. And Nor is bidding on short-cycle projects, most of the construction projects EZRA would have to tender take years to come to fruition and the tendering costs, which require vast engineering resources, are extremely expensive (particularly when you are starting with a pipeline of nothing). As I have said before as well there is no proof that EZRA was actually any good at contracting: the BHP project in Trinidad I believe was a significant loss maker, I have had many people tell me the engineering coming out of Singapore was substandard, and I spoke to someone about the work performed in the Med and they couldn’t have been more critical of the work standard. EZRA is a busted flush.

Investors, or potential investors, should remember my favourite maxim of The Great One: markets can remain irrational longer than you can remain solvent (and I am not even sure they are being irrational at the moment). People keep coming up with really complex theories about EZRA and yet I see it really simply: find me a rational investor who would pump hundreds of millions of dollars into a new subsea contracting company at the moment, in an oversupplied and fiercely competitive market, with an uncertain future, and the industry as whole operating at negative economic value? Until you can find this mythical institution there will be no EZRA. The working capital costs of offshore contracting are so high that only a fool backs a business model with no clear path to decent utilisation.

The solution here is clearly for the banks to approach another contractor with a deal that would preserve asset value while taking capacity out the market. Maybe the banks swap the assets for a stake in Ocean Installer? Let Subsea 7 take the specialist vessels for nothing and some warrants? Save face somehow through financial engineering. Because the truth is the assets really are worth collectively hundreds of millions less than book value in the new environment and no one wants to be exposed to the OpEx of them. Pumping a company with a poor industrial strategy and futile market position full of working capital is the last thing the industry needs, and frankly won’t help the organisations that do it in the long-run.

 

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