Devil take the hindmost…

“They run all away, and cry, ‘the devil take the hindmost’.”

Philaster

You can’t make this up: the above slide from the latest SolstadFarstad results sums up the problem: in putting together 3 companies to create a “world leading OSV company”, before they can even get the first annual report out, they have to admit that one of the three is insolvent and  another of the three has a serious covenant breach. This was always a triumph of hope and complexity over a serious strategy.  Having spent NOK 986m in Q1 to get NOK 875m in revenue, a NOK 469m loss after adding back depreciation, a financial highlight was considered a NOK 12m saving in overhead due to synergies! Personally I would have forgone the NOK 12m in synergies to not have two subsidiaries in default that threatened the entire company’s solvency? You don’t get any sense from the public announcements that anyone has a handle on how serious this is.

If there was any value in it stakeholders might want to have an honest look about what got them to this point? In reality I don’t think it is anything more complicated than wanting to believe something that couldn’t possibly be true: namely that at the back end of 2016 the market would recover in 2017. Not confronting that meant not having to come up with a proper financial structure for this enterprise, but really it meant not having to liquidate Farstad and Deep Sea Supply. But it also means that management and their financial advisers were unable to structure a credible 12 month business plan to be accurately reflected in the transaction documentation. This a serious failure and any realistic plan forward needs to recognise this. Talk of SolstsadFarstad being part of industry consolidation, as anything other than a firesale by the banks, just isn’t serious either.

Prospect theory, an area of behavioural finance that recognises people overweight smaller chances of upside rather than accept losses, and the disposition effect where people hold losing investments for longer than they should, seem apt for the lending banks  and management here as an explanation. But the current plan of getting waivers from the banks and waiting for the market to recover is clearly not a serious plan either.

SolstadFarstad will not survive in its current form. There is absolutely no way the assets are worth NOK 30bn (under any realistic valuation  metric be it cash flow, economic, or asset) and no way that they can ever hope to pay the banks back NOK 28bn, without even worrying about the bondholders. The scale of increase in day rates in a few years time would have to be so extreme it just isn’t credible, and every year day rates stay  low requires you add back the forgone assumptions about their increase on a future year increase. The assets are aging and maintenance costs are going up. SolstadFarstad is like a zombie bank where it has no capital because no one will lend it any money to grow (wisely) but it cannot get any equity because the debt is so high. The only chance of survival would appear to be a massive debt haircut, I don’t know what the number is but I would guess at least NOK 15-18bn, and then to get new equity in and come up with a sensible plan.

However it isn’t just money. I don’t think I have ever seen a major merger go wrong so quickly and then have senior management so blithely unaware about how serious the situation is.  The timing on the Deep Sea/ Solship 3 announcement being just one example. A good study here shows management who look beyond the external environment are more likely to survive significant industry change.

One very simple fact of the environment changing is was made by Subsea 7 recently:

John Evans

Yeah. So, what we’re seeing in the market today is the return to the seasonality we saw five to six years ago where the North Sea was relatively quiet in quarter one and quarter four. It’s really, really straightforward that, you know, the weather conditions are particularly extreme in those periods, and therefore then, clients are not looking for their work to be performed during those periods. During the high point in the market, we work right away through those periods and clients were prepared to pay the additional cost to get their first production online faster. Our aim is that we will see in quarter one and quarter three our active fleets and we’ll be back towards a reasonable level of utilisation in line with previous percentages for active fleet utilisation. But then we expect to see again the corner of sea market going relatively quiet in quarter four. So that’s what we really see and in terms of seasonality for us. [Emphasis added].

SolstadFarstad used to charter ships on a 365 basis. Now it has a large number of vessels that take time risk on some other company’s projects. These vessels are going to have less utilisation than before because 2 of the 4 quarters of a year are quiet. Unless there are very high day rates, which there aren’t, a ship that works 50% of the year is worth less than one that works 100% of the year. SolstadFarstad, Bourbon, Maersk, all these similar vessel owners are dealing with a fundamental change in the market and therefore the economic value of their asset base is dramatically lower given the fixed running costs. SolstadFarstad pretending they can ever make the banks whole in such a situation is absurd. A major restructuring gets closer by the day.

[Book recommentdation: Devil Take the Hindmost: A History of Financial Speculation]

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