Solstad has a solvency problem not (just) a liquidity problem…

The motions of Grace, the hardness of the heart; external circumstances.

Pascal, Pensee 507

“Lend without limit, to solvent firms, against good collateral, at ‘high rates’.”

Bagehot

I disagree with Solstad on this:

It has therefore been decided to commence negotiations with lenders and other stakeholders to improve the overall liquidity situation and to create a robust long-term platform for the Company.

Solstad doesn’t just have a liquidity problem it has a solvency problem. They may have enough broker valuation certificates to keep the auditors happy that the assets add up to the liabilities in a balance sheet sense, but in reality does anyone really believe that the fleet can service ~NOK 30bn in debt? Solstad fails a balance sheet test under a realistic set of assumptions. The fact is if the banks really thought they could sell the vessels for the outstanding debt and be made whole they would have done so long ago. This situation has been allowed to continue, despite clear evidence to the public protestations of its success, because the creditors have no good options. A liquidity problem can be solved with more short-term measures but a solvency problem is endemic and structural and requires a fundamental adjustment. Bagehot’s dictum of lending freely when in crisis relied on the collateral being of high quality and the crisis being temporary in nature, a situation that clearly does not apply here where there has been a structural industry shift.

I’m struggling to see why you would create Solstad today in its current form and my base view is if you can’t answer that question then you don’t have a viable business model in the current market. The scale of the credit write-downs that need to occur here to keep the business alive are just so large it is hard to know if Solstad are just good at PR or good at avoiding reality. I don’t know what the number is but the debt must need to be reduced somewhere in the range of NOK 15-20bn to make Solstad a viable business? The rump of Deep Sea Supply will never be a viable business. And then it needs equity…

The only way to get equity is to find an investor who is going to potentially get such a big return on their investment that the creditors get nearly nothing. There is probably someone willing to make that trade but it is a small pool and it offers the creditors nothing. Market sentiment, as opposed to the actual market, has worsened substantially since MMA pulled of the most successful OSV equity based solution. There is no guarantee that Solstad will survive this encounter with creditors intact and almost a certainty a very different beast will emerge. I am not even sure now splitting the subsea fleet from the supply tonnage will make much difference? The subsea fleet has a large number of marginal vessels that still need scale to survive and given many are being hawked out on windfarm work there is no guarantee their value will “recover” in percentage terms more than a supply vessel. And when some of them come of contract the day rates will also be dramatically reduced.

Systemically it will be interesting to see what happens here. The banks will be desperate not to be handed the keys to Solstad, but as Pacific Radiance in Singapore has shown getting someone to come in behind the banks in the capital structure is tough (with exceptionally good reason). The size of the write-offs the banks would have to take to induce this will make for some uncomfortable meetings in the coming days. Surely soon auditors will force companies to use market transactions (like the recent SDSD FS Arundel for $2.8m!) as the actual realistic value not this “willing buyer/willing seller” ruse?

Not everyone can survive a downturn on the scale we have seen. If the banks somehow, and it will be hard, find a way of keeping the money flowing then all it guarantees is that another company will go. And it will have to be another large “unthinkable” one at that, because there is simply not enough work, and unlikely to be for the next couple of years, for all the supply companies to survive.

The other missing piece of this puzzle is the changing financial structure of the industry and the huge amounts of equity that need to be raised to keep it viable. All the banks behind Solstad have no intention of lending to similar companies for the forseeable future, and every bank is the same, this is a systemic issue directly related to depressed vessel values. But as the contract coverage has shortened so the economic rationale for leverage has also disappeared: lending against a PSV on a 5 x 365 contract is very different to one on a 270 day contract. That sort of spot market risk is essentially equity risk and the average day rate needed to make this economically viable is significantly above current levels. An industry which needs to cover 365 costs on a 270 day utilisation year is again a very different economic model from the past for offshore supply and it only reinforces the size of the adjustment the industry still requires. This is an industry that will significantly delverage going forward and that will mean far more (expensive) equity levels and lower asset values.

An interesting conundrum is whether Standard Drilling and Solstad can really co-exist? I mean either you can buy vessels for a few million and bring them to the most sophisticated market in the world and make money against historic tonnage, or you can’t? At the moment both companies are a financial disaster but surely a recovery story really only works for one company as a logical proposition? There is no indication that the Solstad vessels are trading at a premium in the PSV market to the Standard Drilling/ Fletcher vessels which gives you an idea of what the Solstad fleet would be worth in an open market sale. The same is true for the high-end AHTS fleet where rates remain locked at marginal costs (or below on a 365/economic basis) and competition shows no sign of abating.

Solstad has also provided a natural experiment into the limits of synergy realisation versus the depth of this industry depression: quite simply consolidation alone will not be sufficient. All year Solstdad has highlighted the cost synergies it has achieved by combining with DeepSea Supply (in default before the first quarterly results) and Farstad (in default before the second quarterly results). But these are insignificant in relation to overall running costs and the level of day rate reductions E&P companies have extracted from OSV (and rig) operators. Pretending that consolidation alone is an answer now lacks credibility. New business models need to emerge and a fundamental factor of these will be collectively less supply and capacity.

The Solstad announcement presages a horror season of Q3 reporting coming up across the OSV sector. As I said some time back the summer simply hasn’t come in terms of the volume or value of work for either the supply firms or the subsea contractors. The cash crunch is coming. New money will be come on extortionate terms and prices to reflect the risks involved and not everyone will get it. Rebalancing is beginning to start in earnest and the fact is this market is the “recovery”: a slightly busier summer to build up a cash reserve to cover the costs of an expensive an under-utilised winter. The new normal – lower for longer is the reality of offshore supply and subsea.

The slow fade to obscurity and Gell-Mann amnesia…

Dum loquimur, fugerit invida ætas: carpe diem, quam minimum credula postero.

(While we speak, envious time will have fled; seize today, trust as little as possible in tomorrow.)

Horace

For this will to deceive that is in things luminous may manifest itself likewise in retrospect and so by sleight of some fixed part of a journey already accomplished may also post men to fraudulent destinies.

Cormac McCarthy, Blood Meridian 

Amid the seeming confusion of our mysterious world, individuals are so nicely adjusted to a system, and systems to one another, and to a whole, that by stepping aside for a moment man exposes himself to a fearful risk of losing his place forever.

Nathaniel Hawthorne

Media carries with it a credibility that is totally undeserved. You have all experienced this, in what I call the Murray Gell-Mann Amnesia effect. (I call it by this name because I once discussed it with Murray Gell-Mann, and by dropping a famous name I imply greater importance to myself, and to the effect, than it would otherwise have.)

Briefly stated, the Gell-Mann Amnesia effect works as follows. You open the newspaper to an article on some subject you know well. In Murray’s case, physics. In mine, show business. You read the article and see the journalist has absolutely no understanding of either the facts or the issues. Often, the article is so wrong it actually presents the story backward-reversing cause and effect. I call these the “wet streets cause rain” stories. Paper’s full of them.

In any case, you read with exasperation or amusement the multiple errors in a story-and then turn the page to national or international affairs, and read with renewed interest as if the rest of the newspaper was somehow more accurate about far-off Palestine than it was about the story you just read. You turn the page, and forget what you know.

That is the Gell-Mann Amnesia effect. I’d point out it does not operate in other arenas of life. In ordinary life, if somebody consistently exaggerates or lies to you, you soon discount everything they say. In court, there is the legal doctrine of falsus in uno, falsus in omnibus, which means untruthful in one part, untruthful in all.

But when it comes to the media, we believe against evidence that it is probably worth our time to read other parts of the paper. When, in fact, it almost certainly isn’t. The only possible explanation for our behavior is amnesia.

Michael Crichton

Fearnley Securities resumes OSV coverage as slow pickup starts to take shape…Analyst Gustaf Amle places buy ratings on Tidewater and Standard Drilling at a time market is experiencing a slow recovery…

Tradewinds

Energy companies and investors are focused on profits and reluctant to boost spending even after crude prices surged to four-year highs, a senior Goldman Sachs banker said on Thursday…

But this time round, the barriers for investments are high, with investors seeking returns of as much as 15 to 20 percent from multi-billion dollar oil and gas projects, Fry said.

“In the near term the focus is on returns as opposed to growth for the sake of growth,”

Big Oil still reluctant to open spending taps: Goldman

I haven’t written much lately a) because I have been busy with an LNG project I am working on, and b) because it’s a bit like Groundhog Day at the moment: a bunch of offshore companies come out with bad results and tell you it’s grim out there and then a bunch of Norwegian investment banks and consultants write reports about what a good time it is to invest. In the same way the relentless expansion of shale continues apace so to does the inevitable decline in value of the offshore fleet and the capital intensity required to maintain it.

Offshore supply is so grim, with such vast oversupply, it is not even worth the effort to rebut some of the more outlandish claims being made. But if you buy Standard Drilling shares expecting the World Wide Supply Vessels to reocver anything like 60% of their historical value I wish you luck, the money would probably be better spent on lottery tickets, but good luck. If you have relied on one of these above-mentioned reports it is likely you are suffering from Gell-Mann amnesia, forgetting the false positives these self-same analysts saw before (this time it’s different…)

On the contracting/subsea side in the North Sea a denouement slowly approaches regarding capacity and the number of firms. I am interested in the North Sea not only because I worked in that market but also as a quite specialised market, with a small number of players and potential assets, it is as close to a natural experiment in economics as you are likely to get. So when you see a load of small firms losing cash, charging rates below what it would cost them to replace capital equipment, and competing against diversified and well capitalised multi-national corporations, the most likely scenario is that sooner or later their private equity owners decide they are not worth putting money into and they are shut down.

It isn’t the only scenario: the investment industry is awash with liquidity, every PE house wants to be the hero that called the bottom of the market right before it boomed. This idea found its ultimate expression in Borr Drilling, but York Capital buying Bibby Offshore was based on a similar sentiment. The problem is that the price of oil has doubled and the amount of offshore work has remained relatively fixed. Next year (apparently?) the oasis in the desert will appear…

Despite the music journalist from Aberdeen claiming that the management reshuffle at Ocean Installer a few months back was just a small thing and all about focus, this week the ex-CEO left to join DOF Subsea. No one would have had more share options in OI than Steinar, and I bet DOF Subsea wasn’t buying any out: when insiders know the shares are worthless you can bet they are. Even a PE house as big as Hitec Vision has to admit sometimes they cannot keeping pumping money into such a marginal venture as OI with such clearly limited upside for an exit? McDermott and OI couldn’t agree on price and unless another bidder can be conjured up to pay more for a business than you could build it from scratch then it’s days are surely numbered?

OI is a subscale business with a few chartered vessels and is exposed to their charter rates rising if the market booms. The downside is limited to zero for equity and but the upside effectively capped. It is no one’s fault it is just a subscale firm in a remarkably unattractive industry from a structural perspective. Eventually, just as with M2, the grown-ups take charge and face reality. As my shore-based offshore engineering guru reminded me: only a well-timed exit from the Normand Vision kept the business open as long as it has been in all likelihood.

But in the long-run OI has no competitive advantage and will be lucky to earn a cost of capital beyond Reach or other such comparable firms, certainly not one to move the needle on a PE portfolio for Hitec. Is there a market in Norway big enough to keep OI as a Reach competitor? I doubt that despite it being a favoured Equinor outcome.

DOF Subsea revealed in it’s most recent numbers that it only makes a ~9% EBITDA margin on projects (excluding the long-term pre-crash Brazil boats).

DOF pre-post.png

That one graphic shows you the scale of the change in the industry: contracts signed pre-2014: profitable, business post that? Uneconomic. No firm in the market will be making much more than DOF Subsea in IMR  and that is loss making in an economic sense: a signal to the market that there is severe excess capacity in contracting.

The Chief Strategy Officer of Maersk Supply recently went public and admitted even an oil boom won’t save them (a relatively frank admission for a company seeking a buyer whose only interest must be seeing MSS as a leveraged play on an oil boom!). For Maersk Supply the future is charity projects (waste collection), decom (E&P forced waste collection), deepsea mining, and a crane so clever it will make windfarms more than a zero sum game for the vessel provider. The chances of that being as profitable as helping an oil company get to “first oil” are zero. But still with a big corporate parent Maersk remain there supplying capacity at below economic cost and ensuring “the great recovery” remains an elusive Loch Ness styled creature.

A slow descent into obscurity would seem the best case scenario for OI while the worst case is clearly a suddent stop in funding when the investors realise 2019 will just be another drain on cash. Something the ex CEO and CFO have acknowledged in their career choices…

I fear the same thing for Bibby. Clearly York are delaying spending on the re-branding (required by their acquisition) because they were hoping to sell the business before the year was out. The financial results released make it clear how hard that will be. Not only did they overpay to get into the business they then, despite Bibby having spent £6m on advisers, had to pump in £15m more in working capital. When you have to put 30% more investment into working capital don’t believe the line about customers paying slowly: it was a simple, yet dramatic, complete misundertsanding about how much cash the business could generate and would therefore need. If you really believed Polaris, Sapphire, and the ROV fleet were worth 80m you would take the money and run…

Like OI the most likely, but not the only scenario, is that Bibby is simply ground down by Technip, Subsea 7, and Boskalis. At the moment North Sea DSV day rates are such that they do not come close to covering the funded purchase of a new DSV (likely to be USD 170m), and yet Bibby have a relatively old fleet. The 1999 built Polaris for example only has 10 years life left in her: on a DCF valuation model that means she has a finite life and not a capitalised value. In all probability Polaris simply cannot earn enough money in the next ten years to pay for the deposit on a new-build to replace herself (particularly given the dearth of bank financing). When I talk of capital leaving the industry this is a classic case of how this will happen. Boats can be chartered now but then the value accrues to the owner, a situation Volstad are only too aware of and will take advantage of when the Topaz charter comes up for renewal.

A quiet winter and a couple of dry-docks later in June 2019 and it is going to be hard to convince an investor to put another £15m because the customers just keep paying slowly (sic). A bidding competition to renew the Topaz charter would in effect render the business worthless.

There are other scenarios for these firms. I sometimes think optimism is a mineral in Lofoten. A veritable army of Norwegian investment bankers are no doubt trudging around with pitchbooks and research reports showing that if you just pay them a transaction fee in cash these contracting companies will bring you untold wealth (next year). But the most likely scenario is that a dramatic reduction in demand is followed by a large reduction in supply and at the moment only the first of these outcomes has occured as the previous cyclical nature of the industry has encouraged hope for a demand led revival. “It’s not the despair, Laura. I can take the despair. It’s the hope I can’t stand” as John Cleese famously remarked.

But it is starting to feel like the end of the road… Solstad has become a national embarrasment, OI a vanity project, and Bibby simply a mistake (to name just three examples). Eventually, when all the other possibilities have been exhausted mean reversion and cash needs will begin dictate economic reality.

One of the most bullish offshore data firms recently published this forecast:

IMG_0992

Just remember as a general rule: the larger the orange bar at the bottom (particularly in a relative sense) the less your offshore asset is worth.

[Graph in the header from this Seadrill presentation. Not a graph I suspect that will appear in one from Borr Drilling soon].

Chinese subsea vessels…

Last month COOEC successfully delivered a high spec DSV and IMR further adding capacity to an already depressed market. The only effect is that companies like who used to charter DSVs and IMR vessels in the region have now lost completely the chance for this work and these vessels will be offered at rock bottom rates when they are quiet domestically.

Given that it is cheaper, and will be for some time to charter vessels rather than own them, one wonders why construction on these vessels was started long after this became clear?

A good article here highlights the scale of the subsidies for Chinese shipbuilders and the effect this has had on the industry:

Chinese shipyards.png

Given the conclusion:

[t]his calculation implies that a frequent assertion that China developed shipbuilding to benefit from low freight rates for its trade seems to be unsubstantiated. Indeed, the benefits of subsidies to shipping are minimal. Perhaps instead, the Chinese government is aspiring to externalities for sectors such as steel and defense, or even national pride …

[t]he results of my study suggest that Chinese subsidies dramatically altered the geography of production and countries’ market shares. Although price (and thus consumer) gains are small in the short run, they may grow in the long run as the operating fleet becomes larger.

It is hard not to see this as a move to ensure China moves up the value chain in the production chain for high spec vessels. Not good news for residual values long term I would suggest.

Debt is the problem…

Pacific Radiance announced it was restructuring last week and Harvey Gulf this week. I have talked about the Pacific Radiance situation before and this latest deal just reveals how desperate the banks are to keep some option value alive here. They basically write off $100m and get $120m of new money as working capital… I guess in their situation it’s logical… but it just locks in another cycle of burning newly raised money in Opex and ensures that day rates in Asia will remain depressed.

Eventually, as it is starting to happen in the ROV game, this will end. A good slide here from Tidewater this week highlights the efficiency of US capital markets and the state of denial that exists in Europe and Asia at the lending banks:

OSV net debt.png

The US firms all firmly on the left (well when Hornbeck Chap 11’s anyway) and the Europeans stuck firmly to the right. There is a very limited number of ways this will play out. SolstadFarstad is coming back in early June with it’s DeepSea solution (the photo above was at Karmoy this week, Solstad’s home port) when another excruciating round of write-downs and negotiations will be presented. But nothing sums up the sheer impossibility of SolstadFarstad being a world leading OSV company that than the slide above, and the Herculean financial challenges all the leading European companies face. It is simply not sustainable.

What is an offshore construction vessel worth?

There is an article from Subsea World News here that is sure to have bank risk officers and CFOs choking over their coffee… VesselValues new OCV is launching a new analytics tool for the sector. The ten most valuable vessels in the OCV sector are apparently:

  • Normand Maximus $189m;
  • Fortitude $99 million;
  • Deep Explorer $97 million;
  • Siem Helix 2 $96 million;
  • Seven Kestrel $95 million;
  • Siem Helix 1 $95 million;
  • Island Venture $94 million;
  • Viking Neptun $92 million;
  • Far Sentinel $90 million;
  • Far Sleipner $89 million;

Firstly, look at the depreciation this would imply? As an example the Maximus was delivered in 2016 at a contract price of USD $367m. So in less than 2 years the vessel has dropped about 48% in value. Similarly the two new DSVs the Seven Kestrel and Deep Explorer appear to be worth about 67% of value for a little over two years depreciation.

Secondly, the methodology. I broadly agree with using an economic fundamentals approach to valuation. And I definitely agree that in a future of lower SURF project margins that these assets have a lower price than would have been implied when the vessels were ordered. I have doubts that you can seperate out completely the value of a reel-lay ship like Maximus from the value of the projects it works on but you need to start somewhere. It is clear that SURF projects will have a lower structural margin going forward and logically this must be reflected in a vessel’s value so I agree with the overall idea of what is being said.

There is a spot market for DSVs on the other hand so their value must reflect this as well as the SURF projects market where larger contractors traditionally cross-subsidised their investment in these assets. A 33% reduction in value in two years might well reflect an ongoing structural change in the North Sea DSV market and is consistent with the Nor/Boskalis transactions on an ongoing basis. This adds weight to the fact York have overpaid significantly for Bibby, who would be unable to add any future capacity to the DSV market in the pricing model this would imply and not even be earning enough to justify a replacement asset. Given the Polaris will need a fourth special survey next year, and is operating at below economic value at current market rates, even justifying the cost of the drydock in cash terms on a rational basis is difficult.

Depreciation levels like this imply clearly that the industry needs less capital in it and a supply side reduction to adjust to normal levels. Technip and Subsea 7 are big enough to trade through this and will realise the reality of similar figures internally even if they don’t take a writedown to reflect this. Boskalis looks to have purchased at fair value not bargain value to enter the North Sea DSV market. SolstadFarstad on the hand have major financial issues and Saipem locked into a charter rate for the next 8 years at way above market rates, but with earnings dependent on the current market, will have to admit that while the Maximus might be a project enabler it will also be a significant drag on operational earnings. The VesselsValue number seems to be a fair reflection of what that overall number might look like.

The longer the “offshore recovery” remains illusory the harder it will be for banks, CFOs, and auditors to ignore the reality of some sort of rational, economic value criteria, for offshore assets based on the cash flows the assets can actually generate.

HugeStadSea goes wrong…

If completed, the Combination is expected to provide Solstad Offshore, Farstad and Deep Sea with an industrial platform to sustain the current downturn in the offshore supply vessel (“OSV”) market and be well positioned to exploit a market recovery. The Board of Directors of the three companies consider this to be a necessary structural measure that will enable the Merged Group to achieve significant synergies through more efficient operations and a lower cost base. The Combination will influence the SOFF Group’s financial position as total assets and liabilities as well as earning will increase substantially.

SolstadFarstad merger prospectus, 2017

This was always going to happen… nice timing though… just a few days before Easter, with everyone looking the other way, and only a short time before the Annual Report was due (with its extensive disclosures required), SolstadFarstad has come clean and admitted that Solship Invest 3 AS, more familiarly known as Deep Sea Supply, is in effect insolvent, being unable to discharge its debts as they fall due and remain a credible going concern:

As previously announced, Solstad Farstad ASA’s independent subsidiary, Solship Invest 3 AS and its subsidiaries are in discussions with its financial creditors aiming to achieve an agreement regarding the Solship Invest 3 AS capital structure.

As part of such discussions, Solship Invest 3 AS and its subsidiaries have today entered into an agreement with its major financial creditors to postpone instalment and interest payments until 4 May 2018.

I am not a lawyer but normally getting into agreements and discussions like this triggers the cross-default provisions of debts, including the bonds which look set for a default… and this would make all of the c. NOK 28bn debt become classed as short-term (i.e. payable immediately). Maybe they saw this coming and omitted those clauses when the loans were reorganised, but its a key provision, and I struggle to see it getting through compliance and lawyers without this? But it strikes me as a crucial question. The significance of this for those wondering where I am going with this is that it would be hard to argue SolstadFarstad is actually a going concern at that point. Maybe for a short while, but getting the 2017 accounts signed off like that I think would be tricky (ask EMAS/EZRA).

Investors, having been told  how well the merger is going, may want to have a think if they have been kept as informed as they would like here? There is nothing in this statement on 19 Dec 2017 for example to reflect clearly how serious things were at Deep Sea Supply. Indeed this statement appears to be destined for future historians to recall a management team blithly unaware of their precarious position:

With the reduced cost base we will be more competitive and with our high quality vessels and operations, we will be in a very good position when the market recovers.

The PR team may have liked that statement but surely more cautious lawyers would have wanted to add the rider “apart from Deep Sea Supply which is rapidly going bankrupt and the vessels are worth considerably less than their outstanding mortgages. We anticipate in the next 12 weeks defaulting on our obligations here until a permanent solution is found.” To make the above statement, when 1/3 of merger didn’t have a realistic financial path to get to this mythical recovery is extraordinary.

But the real and immediate problem the December 19 press release highlights is that in an operational sense Deep Sea Supply has been integrated into the operations of HugeStadSea:

The merger was formally in place in June 2017 and based on the experiences from the first six months in operation as one company, Solstad Farstad ASA is now increasing the targeted annualized savings to NOK 700 – 800 mill.

By the end of 2017 the cost reductions relating to measures already implemented represents annualized savings of approximately NOK 400 mill…

new organization structure implemented and the administration expenses have been reduced by combining offices globally and centralization of functions.

The synergies laid out here can only be achieved by getting rid of each individual company’s systems and processes and integrating them as one, indeed that is the point of the merger? So how do you hand Deep SeaSupply back to the banks now? For months management consultants from Arkwright have been working with management and Aker to turn three disparate companies into one, now apparently, as an afterthought, the capital structure needs sorting as well along with disposing of “non core” fleet. Quite why you would get into a merger to create the largest world class OSV fleet while simulataneously combining it with a “non core” fleet at the same time (that wasn’t mentioned in the prospectus) is a question that seems to be studiously avoided?

Just as importantly going forward here management credibility is gone. Either you were creating a “world class OSV company” with the scale to compete, or you weren’t, in which case taking on the Asian built, and pure commodity tonnage of Deep Sea Supply was simply nuts.

Around 12 months after the merger announcement, and six momths after the legal consumation, when managers have had sufficient day rate and utilisation knowledge to build a semi-accurate financial forecast, they are back to the drawing board. If SolstadFarstad hand the Deep Sea fleet back to the banks they will have to either fire-sale the fleet or build up a new operational infrastructure to run the vessels independently of SolstadFarstad… does anyone really believe the banks will allow that to happen? The problem is the tension between the different banking syndicates: a strong European presence behind SolstadFarstad and Asian/Brazilian lenders to Deep Sea. This is likely to get messy.

Is Deep Sea Supply really ringfenced from SolStadFarstad? Will the lending banks be able to force SolStadFarstad to expose themselves more to the Deep SeaSupply vessels? As an independent company Deep Sea Supply would have been forced to undergo a rights issue, and if not supported by John Fredrikson/Hemen it would have in all likelihood have gone bankrupt, the few hundred million NOK Hemen putting into the merger barely touched the sides here. For the industry that would have been healthy, but for the banks a nuclear scenario. Now management face a highly embarrassing stand-off with the banks to force them to take the vessels back, or the equally highly embarrassing scenario of admitting that the shareholders were exposed to the Deep Sea Supply fleet all along, and that the assumptions underpinning this deal were wrong… Something easily foreseeable at the time to all but the wilfully blind.

The “project to spin off the non-core fleet”, which I have commented on before, is the Deep Sea Supply fleet that makes a mockery of the industrial logic of the merger. That was started in Q3 2017 according to their annoucements, only a few months later needs to be sold? What is the plan here? Or more accurately is there one?

There are no good options here. The only credible option for the management team and Board to survive unscathed would surely be the banks writing down their stake in Deep Sea Supply entirely and making a cash contribution to SolstadFarstad to recognise the time and costs involved in running it. You can mark that down as unlikely. But just as unlikely is a recovery in day rates where Deep Sea Supply can hope to cover its cash costs even in the short term

The Board of SolsatdFarstad and their bankers need to ask some searching questions here. The merger was a very bad idea that was then executed poorly.  It is therefore hard to argue SolstadFarstad have the right skills in place at a senior management and Board level? This wasn’t a function of a bad market, this was the result of bad decisions taken in a bad market. This constant mantra that scale will solve everything, when the company has no scale, needs to be challenged. The other issue is how disconnected management seem to be from basic market pricing signals, and moving the head office away from its current location should also be seriously considered along with a changing of the guard.

I said at the time this merger was the result of everyone wanting to believe something that couldn’t possibly be true and merely delaying for time, but eventually reality dawns as the cash constraint has become real. The banks need to write off billions of NOK here for this to work. Probably, like Gulfmark and Tidewater, the entire Deep Sea Supply/ Solstad/Farstad PSV and smaller AHTS fleet need to be equitised at a minimum, and some of the older vessels disposed of altogether. The stunning complexity of the original merger, where legal form trumped economic substance, needs to be reversed to a large degree, but this will not be easy as the shareholders in the rump SolstadFarstad will surely balk at being landed with trading their remaining economic interests for a clearly uneconomic business.

The inevitable large restructuring that will occur here arguably marks the start of the European fleets and banks catching up with their American counterparts, and to some degree matching the pace of the Asian supply fleets. The banks behind this need to start a series of writedowns that will be material and will affect asset values accross the sector. Reporting season will get interesting as everyone tries to pretend their vessels are worth more than Solstad’s and the accountants get worried about their exposure if they sign off on this.

A common fault of all the really bad investments in offshore since 2014 was people simply pretending the market is going to miraculously swing back into a state that was like 2013. It was clear late in 2016 this would not happen. The stronger that view has been has normally correlated with the (downside) financial impact on the companies in question, and there is no better case study than HugeStadSea.

The Constellation goes to Saipem…

So Saipem has paid a headline figure of USD 275m to take out the Constellation, but based on this statement I don’t think the Italians handed over that money in cash as this statement makes clear:

The Constellation will be acquired for USD 275 million through the partial utilization of available liquidity. The 2018 Capex and Net debt guidance, as provided on March 6th 2018, did not include this investment. [Emphasis added].

As in they have partially paid for it with cash and got DNB to lend them a ton of money to take it out. A low interest rate and generous payment terms dramatically de-risk this for Saipem and with a bit of inflation could make the purchase price substantially less in real terms.

Yes the price discount doesn’t make it as cheap as McDermott taking out the Amazon, but the financing for that was arranged through Offshore Merchant Partners as a sale-and-leaseback, which is a long way of saying MDR were cash buyers. Boskalis also got a big discount as cash buyers at the high end for one Nor vessel and a short term charter on the other.

But as my original post made clear the banks have still lost a lot of money here, with 2 mortgages of USD 470m originally, but I still think they will be pleased with this. The original Subsea7 deal for the vessel had a purchase option at USD 370m, so the banks have obviously lowered their expectations since then, running costs of USD 15-20k per day tend to have that effect. I had heard the Chinese were trying to buy it for USD ~180m which would have felt really painful. Saipem on the other hand get a tie-back vessel at below the economic cost, stop anyone else getting the asset, and in all likelihood the deal includes a financial package at well below “market” rates (if there is such a thing for an asset like this).