The scale of the challenge…

Deliveroo lost £129m in 2016 – more than its revenue. It does not have a business model – basket case. Investors will lose everything.

Luke Johnson, Risk Capital Partners

There’s still too many DSVs in the North Sea, even with an upturn, but that’s my guess. Perhaps the scrappage and departure of the Sapphire will reset the NS market to something sustainable for when the market recovers, but I have my doubts.

I’m interested to hear your prediction beyond year 1, where there’s the shuffling of cards (market share), year 2 where the slush fund is running low and we possibly come full circle again?

Email from senior exec at a North Sea contractor

The scale of the challenge the new owners of Bibby Offshore have is revealed in the Q3 financials that were released on the same day as the takeover:

BOHL Q3 Highlights

A quiet November/December and they will lose more than revenues. Or actually in Total Comprehensive Income they have managed this trick:

Q3 2017 Financial Results.png

Now it isn’t a fair comparison because the charters on the Ares and Olympic Bibby are well above market rate and will substantially change the performance of the business when they have ended (one has). But the point is it is not the bond alone that killed Bibby: it was going long on expensive vessels with a neglible equity cushion and a complete rigidity in the business model therefore to reduce costs when the market changed. But then again the Polaris and Sapphire were valued at USD 220m! in 2014 and they still look way to high on the books. Non cash charges are fine if you don’t have liquidity issue but they are very real in measuring economic return.

What I like (sic), and they aren’t the only people guilty of this (I have named others doing it as well) is the Orwellian use of English (although it’s more Catch 22). On summarising these results, which entailed handing the business over to the creditors, the following sentence appears (emphasis added):

The recapitalisation of the business together with the improving market outlook, reflected in the growing summer campaign, means the Group is well placed to weather the current market conditions and to capitalise on new opportunities.

A mere four lines later, 4!, just 4, comes this:

Despite the seasonal increase in activities the pressure on margins has not eased, impacting total revenue. Revenue also reflects the mix of work, which includes further air diving projects in shallower waters, which command lower day rates.

They have less than 50 days for next years booked and over 1000 days of inventory.

Seriously! Make it stop. Please make it stop…

Bibby has a really simple business model: you sell boats days and some associated engineering. One of the two variables has to change: days or the price. If one of those is declining, or you have to reduce the other in price in order to sell more days, then it is sophistry of the highest order to claim an improving market outlook. I was just waiting for the quote “and we are doing record amounts of tendering”.

As the analysis below will make clear the emergency rights issue that a “leading bondholder” has underwritten gives the business, at current cash burn rates, around six months working capital as the best case assumption. This is not a war chest for acquisitions this, is simply survival money while options are assessed and some quick wins on the cost side are made. I don’t have any inside knowledge at all of what will happen here, the thoughts below I believe to be directionally correct, but the one thing I definitely know for certain is this: the money going in will not be willingly frittered away in OpEx while the business simply waits for the market to return. However, the winter months are ruinuously expensive for boat owners with without work…

The cash flow makes clear Bibby had burned through £10.5m in cash in what should have been the best quarter of the year for 2017:

Q3 2017 cash flow.png

The closing cash balance at Sep 30 gives the game away: Bibby had drawn down on the revolver and that is simply insufficient for working capital purposes. It is very hard to see how the November payroll could have been made on those numbers as another 6 weeks of losses (by the time the creditors rescued the business) must have meant an actual cash positon of less than £2m. But what is really apparent is how much worse the business is performing than last year: £58m in operating losses YTD versus £26.8m last year! If it was a horse you would have shot it!

Those losses were driven not only by the Olympic Vessel charters entered into at the top of the market but by the Sapphire utilisation at 3%. Fully crewed and maintained in port waiting to win the BP Trinidad work that went to Nor (a move I accept I said would never happen), and a US office that inexcusably had 19 people in it until August and is now on it’s third ex-pat manager as the company struggles to define its market position now it is not proceeding with a Jones Act vessel. The fact is Bibby have taken the Hotel du Vin to a market where customers resent the prices at the local Holiday Inn, and you can offer all the upgrades you want, but it just won’t work without a base level of demand that isn’t there. The US business model is broken  and that is an intractable issue for the new owners.

The £50m the emergency rights offering puts in will need to cover a variety of new expenses: consultants (and there will be a lot), transaction expenses (tier 1 law firms etc), working capital banking facilities (say £5-10m) etc. This is unlikely to be the only injection made to keep the firm solvent if the new owners are serious about keeping the business going.

The big outstanding commitments relate to vessel costs and things like offices (Atmosphere 1, Houston, ROV hanger) all of which were entered into at the top of the market. Olympic are no doubt nervous because their charter on the Olympic Bibby goes into Q2 next year at a rate of c. $35k per day (c. $1m per month). I suspect the Scheme of Arrangement the bondholders are using here will allow them to take the assets to the Newco and leave residual commitments to Oldco Bibby should they want. The communications have promised trade suppliers will be paid, and that is certain, but when the new corporate structure emerges a conversation will be held about how much shareholder support will be provided to the BOL/BOHL (the answer is likely to be none i.e. these are the entitites that will be liquidated) and all the contracts will be moot. All the smaller trade creditors who are nescessary for trading will clearly be fine but I am not sure about Olympic and property commitments at all (and it would have the nice effect of getting rid of the Trinidad tax issue).

But this is the easy part in a way. There will clearly be an urgent and deep effort to slash costs in a way there hasn’t been before. Engineers, Bus Dev, people that add real economic value can expect this to be a better place to work. But there are 5 PAs in Aberdeen for business on target for £80m turnover and a Risk and Business Continuity Department that has about 5 people per vessel! All good people to be sure but just not sustainable in any shape or form. I suspect when these consultants walk into the Houston office and get presented with a spreadsheet with $9 trillion of possible tenders and zero purchase orders for 2018, 11 people, a boat at 3% utilisation (according to the Q3 report), and an expensive ex-pat ex-COO, there is going to be a quick call back to the UK about WTF is going on? Some of these things are a direct reflection on current management which will only increase tension with the new owners.

The real problem though is how you get your £115m back…

Let’s assume you need to sell out at 8x EBITDA (Acteon went for 10x in the boom but they were lighter CapEx and had more booked revenue); that means you need to get EBITDA to about £14m from its current level. The scale of this challenge becomes clear if you have a look at BOHL bond prospectus, which for all of us in offshore was a different era:

BOHL Prospectus EBITDA

Basically the “new Bibby” needs to look something like old Bibby between 2011 and 2012. which handily we get some stats on:

BOHL prospectus operational data.png

In 2011 Bibby were delivering their biggest ever construction project: Ithaca Athena hence the reason other project revenue is so high (that and mob fees were high) and it is also woth noting that the Topaz worked much of the year on that project. Now the fact is companies like Ithaca, Premier, Enquest have given up development for debt repayment so these projects just aren’t there, and with Technip and Subsea 7 in hunger mode no one is winning small development projects outside that duopoly. But DSV rates in 2017, prior to the Boskalis entry, were about 2011 levels at the end of 2016 but utilisation is way down.  Bibby administration costs were on £10.4m for the 2011 year whereas this year they are on target to be 70% higher at £17.5m.

But admin costs while part of the problem aren’t the core of it: the decline in revenue, and therefore the scale of the business is:

BOHL Pros P&L.png

If Bibby does £80m in 2017, and that is a very big if at this point, the business will be 70% smaller in revenue terms than 2014. Subsea 7 by contrast has seen revenue drop from c.  $6.8bn (2014) to c. $3.8bn for 2017, which is only a drop of 45%. I have said it before that the smaller firms have not only lost market size but market share as the market has contracted and that is unsustainble. You can see the effect that scale has because despite having seen its turnover drop by such a large amount, even with such high fixed costs, Subsea 7 kept its fleet utilisation at 78%, and then generated $250m in EBITDA and even Net Income came in at $111m. One business model is sustainable and one isn’t.

If you look at the types of projects heading for FID at the moment they are disproportionately complex and expensive projects that mean this trend is likely to continue. Its not just a Bibby problem: OI, DOF Subsea etc all suffer from the fact that they were marginal capacity working on smaller projects that added marginal production. Production and capacity at the margin is expensive and therefore it is no surprise these business models suffer disproportionately in a downturn. [What I mean by marginal capacity/production is that these were the extra units added as the existing industry and companies hit their production frontiers. This new capacity/production is added but at a higher per unit cost as suppliers etc push up prices to reflect increasing demand].

I guess the positive side of this is it shows how much operational leverage the business has: fixed costs are so high that a small addition to the day rate and/or the number of days worked and the results drop straight to the bottom line. The downside is it looks like 2013 and 2014 were an aberration in terms of day rate and utilisation and that actually the industry was in a nice little equilibrium in 2011 with day rates that made projects work for E&P companies and kept everyone in profit, and maybe that is as good as the industry can hope to get back to (before the Harkand/Nor/Boskalis DSVs arrived but with the DiscoveryKestrel and Oriella.

A major structural change has also occured in the market: in 2011 you could not get your hands on a CSV with a 250t crane for almost any money. Rates for these vessels was c. £130-150k and this was purely a supply shortage. Therefore you simply added a mark-up on those boats for all work undertaken. I doubt any other class of vessel has been so over built now and they are all in lay up (the Boa vessels) or doing windfarm work for €20k per day (Olympic). The other project revenue flatters the margins made on non-DSV projects because anyone who had access to a vessel in those days just placed a large mark up on the vessel (a number that was already high).

Now everyone (Reach, M2, Bibby Offshore, James Fisher) is a “boatless” contractor. This de-risks the fixed costs but obviously at the reduction of margin. In Asia there used to be a number of “boatless contractors”, running around organising bid bonds and all the other associated issues that come with trying to fix a schedule. One of the many problems is that because everyone can do it the profitability on it is very low and you actually take quite a bit of project risk to get this margin because you often go lump sum and the vessel operator gets paid every day.

And the elephant in the room is now Boskalis. It is pointless here to go on about the advantages an industrial player has in this game. There are 100 reasons why Boskalis is better positioned that the “New Bibby” going forward, and the first 20 are signficant. A much lower cost of capital for one, existing marine, crane, and other departments spread over a much larger fleet (lower unit costs), a serious position in renewables with full cable lay equipment etc.  When day rates were much higher everyone used to measure the cost of ancillary departments (i.e. crane) by looking at the cost to the vessel being out of service and the price was just increased, but that obviously isn’t the case now where these costs are material and need to be spread over a big fleet. Sometimes commitment signals count in economic situations and the fact is that Boskalis likely to be here in 20 years and the same just isn’t true of the New Bibby.

This really makes me question whether it is possible to have an economic model that is based solely on being a DSV operator, particularly a smaller one? For every other competitor to the “New Bibby” diving is an ancillary, but important, service to a broader offering. Boskalis probably only need to get 100-150 days per annum of pur SAT work to be cash flow positive on an asset basis if they use the rest of the time to back up the renewables fleet. Subsea 7 and Technip can cross subsidise limited construction work by keeping utilisation up in the IRM market at low day rates. If these operators commit enough capacity to a market in that situation where their breakeven cost is significantly lower the overall industry rates will be low. These three companies all know that the “New Bibby” will live or die by the North Sea SAT DSV rates, and all they need to do is keep these low for a period and the entire edifice is at risk.

Bibby worked from 2004-2012 because it was the “Healthy Dwarf” of the North Sea in SAT diving. The excess cash from this business was used to fund ROVs and develop other areas. But Singapore never worked beyond ROVs and neither did other ideas. It was an opportunistic business with a really good local market position that allowed it to try different things when the market was booming. But it patently does not have a magic formula that would allow it to grow in other markets or some sort of magic ingredient that is scaleable.The “land grab” was in fact made by DOF Subsea, Ocean Installer, and others who had access to what Bibby desperately needed: adequate equity/ CapEx ability in an extremely capital intensive industry.

When there have been four SAT dive companies in the North Sea only 3 have really made money: Bibby helped drive Harkand out of business, Bluestream didn’t last more than a season, ISS chartering the Polaris just allowed them to fill a six month charter in a peak period. It is very hard to see how Boskalis isn’t going to be a lot more than a “healthy dwarf”, and likely the first non-RMT unionised major contractor, and that really doesn’t leave a lot of space for anyone else.

If you look at the Bibby 2012 P&L above it also makes it clear that even when times are good, and Bibby dived over 900 days that year, and after tax it only made £13.3m, a rate of return on the asset base of 7.8%. The ROE (40%)looks high because of the leverage… which brings up the issue of risk: in this business model you go extremely long on some very specific assets, which have a huge volatility in value (as Boskalis can affirm), and match these against a series contracts that are short in duration and have almost no visibility, and must be competitively won… and that’s before you even get into execution risk. I know private equity firms love EBITDA (and the £55m Bibby did in 2014 is proof of that) but it is a really inappropriate number for an industry with such high CapEx requirements because the depreciation amount on the fixed asset base is a crucial number in how much real economic value is being created.

I get people can make a lot of money on counter-cyclical bets. That is the essence of the investment proposition: having the ability to make a bet like that. But the dynamics of any upturn in the North Sea, with vastly more tonnage than the last upswing, would seem to err more to there being too much tonnage and that will only lead to lower day rates. And there are far more North Sea class DSVs that can be drafted in to keep rates down than were previously available: Technip for example could just re-commision the Achiever as an IRM vessel, and at some point Vard are going to have to sell the 801.

So in answer to the question of what I see happening for the next few years I think there will be three serious players in the North Sea SAT market and a fourth company that maybe viable if the market booms. But that will be a struggle. Even if the price of oil doubled overnight the ramp up in logistical terms required in the North Sea would be immense before a serious impact in CapEx spend would be felt. Smaller companies would have to access financing, hire engineers, consultants, approve drilling, arrange interconnection agreements etc… all this before small scale subsea development CapEx came back at a meaningful level to affect the overall fleet demand and profitability. An increase in IRM spend just won’t cut it. The worst case scenario is someone like DeepOcean taking a DSV and using it as a split ROV/DSV for 6 months a year as IRM spend increases. At that point the Bibby business model is well an truly dead. But in the interim Subsea 7, Technip, and Boskalis can rapidly add capacity if the IRM market improves, in a way that simply wasn’t possible in the past and in a manner that is simply too credible and likely to ignore.

I am a long term believer in subsea and the meaningful amounts of production it will be responsible for going forward. But in the past when it was the marginal producer of choice for the oil market the whole industry was profitable, almost without exception, and that simply will not be the case going forward where the process of economic natural selection will far more brutal and will favour larger players.

One thought on “The scale of the challenge…

  1. So you’re saying the new owners are only going to focus on revenue securing and delivering people and let the support / leadership personnel go? Madness.

    FYI – 5 PAs for 10 directors seams pretty reasonable (unless you only need 3 directors that is)

    I like your line about there being ‘20 significant reasons Boskalis will be more successful’ (inspired), but it is in fact 24 significant reasons, and the first 10 relate to leadership and integrity


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