Corporate finance Borr Drilling style…

One of the more curious corporate finance transactions took place earlier this year when Borr Drilling, an enormously leveraged rig company when financial commitments are taken into account and using its revolver for working capital, then purchased 1.5m of its own shares at NOK 35.50. As can be seen above the shares have since declined 18% and are now worth NOK 29, which is signficantly below the price they last raised capital at ($4.6/ ~NOK 39).

In the scheme of things the loss isn’t that much money,  it’s really a question of whether for such a  (sic) “high-growth” company is depleting liquidity to buy back shares the best use of its capital? I noted at the time this was close to extraordinary for a company that needs to raise hundreds of millions of dollars (not a misprint) in capital over the next three years to remain a going concern ? In which case why are they doing it?

For what it’s worth my own view is I think the Management and the Directors of Borr understand how deeply in financial trouble they are: the market simply isn’t coming back to anything like what they and their original backers planned. Without a massive increase in demand the entire investment thesis is flawed and the company has no reason for existing in a very real sense. By embedding leverage in the shipyard delivery times as well as the bonds, and using a revolver for working capital, Borr requires the market to come back strongly and for them to activate a vast number of warm-stacked units in this hypothetical demand pickup… just for Borr to remain solvent, yet alone make an economic return. As an external observer reading the public anouncements it feels like a degree of panic is setting in.

As the Borr Drilling prospectusin early 2018 made clear this is a highly competitive business:

The profitability of the offshore drilling industry is largely determined by the balance between supply and demand for rigs. Offshore drilling contractors can mobilize rigs from one region of the world to another, or reactivate cold stacked rigs in order to meet demand in various markets.

The shallow water segment of the drilling industry is particularly competitive with no single contractor having a dominant market share. Competitive factors include price, rig availability, rig operating features, workforce experience, operating efficiency, condition of equipment, safety record, contractor experience in a specific area, reputation and customer relationships. [Emphasis added].

Particularly competitive” with “no single contractor having a dominant market share” tells you how absurd the plan here is, and how much alternative investors wanted to believe in an outcome they knew to be economically illogical. Market share and competitive factors are directly related to profitability. With no fast growing market this company is simply a financial time bomb. Yet as recently as September Borr’s Chairman stated:

“We have an ambition to return a significant part of cash back to shareholders quickly … if we don’t pay dividends in 2020, we have failed,” Troeim told Reuters.

I’ll bet my house that doesn’t happen. [Actually that isn’t strictly true because Troeim could clearly afford to take me up on that and my domestic happiness would be rapidly curtailed if I started playing in the futures market with matrimonial property… But you get where I am coming from].  But the dividend comment springs from the same belief that the current market is some mis-pricing anomaly rather than a deep structural change in the oil market.

Now for plan B. A rights issue that would heavily dilute shareholders is the most logical fundraising strategy here, but finding more hedge funds to by your stock when it keeps on going down 30% is not easy. I just cannot believe Schlumberger are going to carry on committing capital to this venture on a proportionate basis. Debt? really? With no backlog or even utilisation?

The idea that this slide seems to highlight ,that banks or other debt providers would lend against the unencumbered rigs when they have absolutely no work available, seems so very 2012, quaint almost:

Built to last .png

The title of this slide is surely begging irony? The whole Borr business plan relies on growth significantly faster than the market when the market has extreme overcapacity from well capitalised (and desperate) competitors, and financing this by borrowing against rigs with no work or backlog. What could go wrong? See more here.  Borr management have done a lot, struck deals, brought kit etc., but the possible economic value creation is a simply a vastly leveraged play on a never appearing demand boom. It is a microcosm of offshore investment sentiment and a stubborn willingness to accept the scale of change shale as wrought on the market. At some point the business case must be a logical inconsistency if shale keeps growing at current rates? I’d suggest that point was passed a while ago.

The blow-up here is unlikely to be as dramatic and spectacular as something like EMAS because the perceived asset value is so high. But the scale of the amount of capital that needs to be raised, and the likely time period before it could be returned is so long, that each additional round of funding here is likely to be very expensive. Something “the market” seems to be belatedly waking up to. Borr Drilling is the ultimate measure of investment risk and sentiment in the alternative investment community in my opinion and serves as a useful barometer for how to perceive market risk.

I think Borr were trying to use the share buyback as a small signal to keep the share price high and to cut the dilution effect that will be imposed on the insiders who hold a large amount of the shares. I think the reactivation of 4 rigs speculatively was literally a gamblers last-roll as there have been no updates since about possible work for these units. A signalling event spectacularly mis-timed given the decline in the price of oil.

Share buybacks, particularly open-ended purchase programmes like the one Borr is engaged in, are extremely well-studied. There is evidence that managers can time the market (i.e. buy the shares cheap) and that smaller firms do this better than bigger firms… but you can also see “Share repurchases as a potential tool to mislead investors“, which is close to what I think happened here, although I temper this a view that offshore seems to have a number of people who see a declining oil price as contrary to some law of nature.

The fabulously optimistic Rystad Energy (more recently here and in direct contravention to DOF on AHTS, (who like actually own boats)) predict higher rates, proof that maybe you can build a great information business without having great information… a skill I grant you.  But there is no question now that most rational participants are coming to grips with the fact that the subsea and offshore market isn’t going to “recover” next year and that leaves Borr Drilling with an enormous funding hole to cover. Borr is the ultimate leveraged play on the “market recovery and scrapping” thesis, a momentum play that has lost inertia, and slowly the (hot) air seems to be draining from this balloon and the market sentiment in general.

 

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s