The Economics of Constraints and (Really) Deepsea Diving…

It’s a poor sort of memory that only works backwards.

Lewis Carroll, Alice in Wonderland

In historical events what is most obvious is the prohibition against eating the fruit from the tree of knowledge.

Leo Tolstoy, War and Peace

One of my frustrations with offshore/SURF is that despite the mathematics of engineering and economics being the same, both are really optimisation problems, there is precious little of the latter influencing the former in offshore. A classic case of this came in Frontrunner today where there was an attempt at a serious discussion about diving below 300m. Now I accept that this is technically possible, lots of things are technically possible, for a billion dollars you can probably get NASA to take you on holiday to the moon, but because not that many people want/are able to spend a billion dollars on such a holiday there are very few companies offering this as an economic choice. If money is not a constraint then you have few constraints, but in economics and business money is always a constraint.

Diving at up to 600m is definitely technically possible, but it would be economic lunacy. Don’t get me wrong if I was an equipment supplier I would want to believe it was possible as well, but that doesn’t make it viable. There are so many realistic economic and organisational constraints on this I can’t be bothered going into them all, but here are a few, all of which are complete showstoppers:

  1. There is no market: the list of marginal field developments that could be made viable between 300-600m of water if a DSV could be used is minimal, even on a global basis. Most shelves drop off completely below 300m and there simply no proof that there are suitable reserves that could be tapped by this technology
  2. In order to service this (non) market you would have to build a 600m capable DSV completely at risk (which is admittedly what UDS claims to be doing), budget $160-185m, then prove the technology and procedures, which will be months of testing and practice dives etc, and only then be ready to sell it, all the while burning vast amounts of risk capital. Then you would need to get a bunch of global oil companies to change their entire HSE approval process, which will take years, and get this to coincide with a project approval process. This strikes me as an enormous barrier because even if you could prove this worked there is no demonstrable evidence of the long-term health effects on the divers and you risk creating an abestos like residual legal claim on the oil companies (as the diving contractor may be bankrupt) for approving this. And then, and only then, years after building a 25 year asset and burning through working capital you might, just might, win a project competitively tendered against an ROV solution. That is without going into IMCA, class, various regulatory agencies etc. All this for a project whose financial upside must by definition be capped at what a comparable ROV service could deliver the project for. So a venture capital investor has no possible way of making a returns in the 100s of % to cover the risk. Literally nuts.
  3. ROVs are currently oversupplied and operating below their capital cost, and are likely to for an extended period, so not only would this harebrained plan have to compete for work against the above constraints it would have to with competitors who will be selling at below economic cost

If you speak to divers who go below 250m they will tell you the joints hurt and they really notice the pressure. It is not a popular depth to dive at. Subsea 7 and Technip now have special dive procedures in place for anything over 200m and there is enormous resistance to diving over this depth level even if you could prove what it costs. Changing this organisational inertia for marginal benefits only just don’t represent a viable economic time/cost trade-off.

This is just a classic case of someone trying or thinking of doing something because it is technically possible not because there is any economic rationale to it. The idea is so DOA from an economic perspective it doesn’t bear serious analysis.

SOR also make the following highly questionable claim:

Sources close to the scene, suggest BP’s huge west of Shetland Quad -204 redevelopment might have cost a third of the total bill if the project could have used divers. [Emphasis added].

Now the best estimate of the costs I have is £4.4bn ($5.7bn), but that includes drilling, fabrication, control modules, a FPSO etc. Traditionally the SURF installtion scope is 10-15% of the total project budget, so at best what I think SOR mean is they could have saved 1/3 of this… so maybe 5% of the total budget. But that is a pretty minimal saving in the scheme of things and exposes the installation to a lot more weather and other operational and contractual risks. For a 5% saving on the overall cost you would have exposed yourself to having a minimal choice of assets to complete the task and run the risk that all future OpEx operations would have to be done by divers (i.e. no ROV handles) and that needs to be factored in to the total economic cost.

[But if I am wrong I am happy for SOR to publish some more detailed information to correct my erroneous logic and I will happily publish a correction having been suitably educated].

But again the Quad 204 cost statement avoids the economics of this situation: if Quad 204 was going offshore in 2014, when every North Sea class DSV was operating at capacity the job would probably have cost more because DSV rates were at a premium. Re-bid the job now and you might get a different answer. Markets are dynamic not static. So there “might” have been a saving, but there is a much smaller North Sea class DSV fleet than ROV fleet that “might” have been busy, or it might not, and the saving would have been dependent on that. And surely the losing contractor would have gone back and offered to make such a substantial saving? But whatever the situation it would not have transformed the economics of a project the size of Quad 204 as suggested.

Interestingly the whole Frontrunner is relatively bullish on diving. Although, frankly any previous investors in vessels backing MEDS would be amazed if their ability to get hold of a vessel should be seen as a sign of confidence in  the market given the losses they have suffered on the Altus Invictus and Altus Extertus (disclosure of interest: I was a Director of one such company). I don’t think SAT diving is going to go away, that isn’t what I am arguing at all, but until significant CapEx projects involving DSVs return to the North Sea then the market on any reasonable basis remains over-supplied and day rates and utilisation levels will remain under huge pressure.

SOR has been at the forefront of reporting the creditors involved in the rescue of Bibby Offshore and I’d be interested to know if they have a consulting relationship with any of the bondholders who they have named? Either someone very close to the deal is speaking to them or they are working on this deal… And you would really have to believe in a degree of bullishness about diving that isn’t grounded in current market reality to buy into the Bibby deal at current value levels…. And frankly any financially rational actor would be more than a little nervous now Boskalis have the Nor vessels… contracts for small DSVs in Brazil won’t save the North Sea market…

I am wondering if a lack of clear economic thinking has permeated the deal for the investors, maybe they have been blinded by perceived benefits such as 600m diving, because when you have to get management to warrant that:

  • Within the next 7 days, Bibby Offshore will appoint an independent consultant on behalf of the noteholders to support management on the ongoing cash flow management and transition of the business to the new shareholders.

you clearly don’t have a great handle on the business or what you plan to do with it. This could well be a classic situation of the “Winners Curse” in M&A.

At the time I had worked with two seperate hedge funds who were also looking at the deal. We valued the business at ~.08 – .15 of the outstanding bonds (£14.0 – 26.5m) reflecting the new working capital required. Different people have different perceptions of value and therein will lie the answer to who makes money on this deal. A 2 x North Sea DSV operation, focused only on being a low cost operator, was the plan. In order to get to a bigger number you need to back a platform business to expand. No one outside of the large contractors has made diving work on a global basis as there are no economies of scale and procurement is all regional and follows different standards. So in order to recover £115m Enterprise Value York & Co., are backing a subscale, loss-making business, in an industry that is consolidating with large competitors, in a market with huge cost pressures. Traditionally that has been a poor route to value creation… but it is also true that counter cyclical investments generate huge returns. The hard part here is that because of the lead times for projects (which are well documentted), and Bibby’s own investment documents show, this is a market forecast to grow at CAGR c. 7%… roll the dice…

Private equity and offshore: Bibby/York Offshore, DOF Subsea, and Ocean Installer and “stuck in the middle”..

Realism provides only amoral observation, while Absurdism rejects even the possibility of debate.



The firm stuck in the middle is almost guaranteed low profitability. It either loses the high-volume customers who demand low prices or must bid away its profits to get this business away from low-cost firms. Yet it also loses high-margin businesses — the cream — to the firms who are focused on high-margin targets or have achieved differentiation overall. The firm stuck in the middle also probably suffers from a blurred corporate culture and a conflicting set of organizational arrangements and motivation system.”

Porter, Competitive Strategy, p. 41-42


“Alice laughed: “There’s no use trying,” she said; “one can’t believe impossible things.” “I daresay you haven’t had much practice,” said the Queen. “When I was younger, I always did it for half an hour a day. Why, sometimes I’ve believed as many as six impossible things before breakfast.”

Bibby/York Offshore, DOF Subsea, and Ocean Installer are all tied into the same economic dynamic in the offshore market: the improvement in the market is coming in IRM spend (marginally), large-deepwater projects, and  step-outs associated with existing deepwater infrastructure, not the markets that made these firms viable economic entities (although the DOF Subsea question is just as much about leverage and overcommitting to assets). These companies highlight that although offshore spending may increase in 2018 over 2017, though DNB notes risk to the downside, a recovery will not benefit everyone equally: asset choice and strategy that recognise different market segments are important to identify.

I have read the Bibby Offshore “Cleansing Document” that was sent out as part of the takeover/recapitalisation notice. A cleansing document is required when investors, who are classed as “outsiders”, gain confidential information as part of deal and therefore become “insiders”, who learn confidential information, and must make all the investors aware of what they know. It’s an extraordinary presentation, a business plan so outrageous that it can’t be taken seriously. The document obviously has its origins in the EY attempted distress M&A transaction, that couldn’t be funded, and when you read this you can see why. Worringly the new investors must accept something similar or they are involved in a gigantic scheme to knowingly lose money.

The most obvious affront to intelligence is the 2017 growth rate for revenue pegged at 52%!!! Seriously, in this market someone is telling you they are going to grow at 52% and they actually have enough chutzpah to put it to paper… words don’t often fail me. Not only that they then double down and state it will rise 50% again the year after. I can tell you there is a 0 (zero)% chance of that happening. There is more chance of drydocking the Sapphire on the moon to save money. It’s not just the fact that IMR spend, the core Bibby/York offering, is set to grow at 3.3%, or the fact that total market spend is due to grow at 6.7%, that is just a common sense point: if the market grows at 6.7% and you are growing at 53% then 46% of your growth is coming from winning market share. Does anyone really think Bibby’s competitors are just going to wake up one day and allow them to be the only company in the entire industry that can grow that fast and let them take all that market share? Really?

Fictional Revenue and EBITDA Forecast

Lewis Carrol

Source: Lewis Carroll

To be clear the previous best year of growth was 2013-2014 when Bibby chartered in tonnage, in the greatest North Sea DSV boom ever, and it grew a measly 46%… seriously you can’t make this up.

North Sea Outlook

The fact is this forecast shows the core Bibby/York IRM market declining after 2019 and all the growth is coming in windfarm work. A portion of the windfarm work is likely to be bundled with installation workscopes, and that leaves Subsea 7 and Boskalis well positioned with their topflight installation capacity. And I have said many times the lack of oil and gas construction work (the light grey bar EPCI) will leave a surplus of DSVs as there are no multi-month construction projects to soak up capacity. There is an even more absurd graph later on designed to show a market shortfall in a few years that ignores latent capacity in meeting supply challenges.

Bibby/York will turnover £85m if they are lucky for 2017. In this market, if they have an amazing year next year they will turnover £95-100m, and if they have a bad year they will come in at £70-75m. And the risk is on the downside here because the first six months of 2017 included ROVs in Asia that were sold, most of which were working. But in offshore contracting in general some jobs will go your way and some won’t, so everyone in the industry budgets a modest increase and some get lucky. But what definitely won’t happen is putting 15 Red on at the casino and winning 30 times in a row, and talk of £130m in revenue is more unrealistic mathematically than that.

Even more the Sapphire now looks to be going into layup! So not only is turnover going up 53% but DSV capacity is going back 33%. It’s a miracle I tell you! That’s not profitability that is top-line!

The US office is of course a giant millstone and is put in the presentation as a “Diversification” play rather than as a cost centre – and certainly no spefic financiakl data on the office is offered. The US must be costing Bibby/York c.USD 250k per month in cash terms and now has no boat to bid. That puts them Bibby against DOF Subsea and OI for any significant project except they don’t have a boat? Zero chance. Literally less than zero. Only someone who really didn’t understand, or didn’t want to, the reality of the current market would sanction such move. Operating margins of similar competitors, following exactly that strategy are less than 10%, which means you will be losing cash forever. Nuts. Not needed and not wanted in an oversupplied market, it is simply a matter of time before that office is closed.

But I don’t want to get into it in a micro level because it degrades the wider point: in this market businesses don’t grow organically at 53%. It is a preposterous statement and needs to be treated as such on that basis only.

Not only that, Bibby claim they will make an EBITDA of ~£12m on the 2 x DSVs in the North Sea, and a staggering c.£11m using vessels of opportunity. So not only are they betting they will take enormous amounts of market share off their competitors they are also planning to do it at margins way above anyone else in the industry. And this from a management team, with exactly the same asset base, who presided over a revenue decline of 56% in 2016 and is on target for a 45% decline in 2017. The first few people who got this presentation must have phoned up and asked if the printer had had a typesetting error, not believing that intelligent people would send them this.

The only certainty of this plan is that it will fail. Statements around its release confirm the company ~50 days of work for 2018 yet they are planning 78% utilisation (up from 53% in 2017), yet if the first quarter work isn’t booked in now it won’t happen in a meaningful sense.  And once you are chasing you tail to that extent a dreadful dynamic sets it because you have committed to the cost and the revenue miss means you know early in the year you are facing a massive cash flow deficit. The fixed cost base is so high in the operation that a miss on the revenue side produces catastrophic financial results; just like a budget airline, the inventory is effectively disposable (i.e. after a possible days sale has passed) yet the cost base is committed. This of course explains how the model was created I suspect: a revenue number that magically covered the costs was devised, how real management believed that number to be at the time will be crucial by March (only 12 weeks away) when the plan is revealed as a fantasy. I’m not saying it’s deliberate, humans are strange, it took Hiroo Onoda until 1974 to surrender, so if you want to you can believe a lot of things, and unless you believe the revenue number then the whole economic model falls apart.

York clearly got into this late in 2016 and early 2017 not believing the scale of the decrease going on in the business in revenue terms, and without clearly understanding how the competitive space was directly supported by the construction market. Instead of pulling out they have doubled down and appear set to pump more in working capital into the business than the assets are worth (one of which is going into lay-up for goodness sake). York appear to have confused a liquidity problem with a solvency one.

The funds this come from are large but this is till going to be a painful episode for York while doing nothing to solve the long-term solvency issues at Bibby who now only have a 6 month liquidity runway based on current expenditure. At an Enterprise Value of £115m it values a business with one DSV on lay-up and a cost centre with no work, and an operation with a 1999 DSV and one chartered asset, losing substantial amounts of money and with historic liabilities, way above a the operation Boskalis are building with 2 x 2011 DSVs at a blended capital cost of ~USD 80m. Good luck with that.

I still wouldn’t rule out a Swiber scenario here where as York get close to the drawdown/ scheme of arrangement date they get lawyers to examine MAC clauses (e.g. Boskalis buying the Nor vessels), or simply not pay and worry about getting sued by the administrator. They must know now this is a terrible financial idea.

DOF Subsea on the other hand have the opposite issue: First Reserve looked to reduce their position earlier in the year via an IPO and couldn’t. Now DOF are slowly diluting First Reserve out in  the latest capital raise… there is no more money coming from First Reserve for DOF Subsea. I get the fact that some technical reasons are in  play here: it is difficult for late-life private equity funds to buy inter-related holdings, but they always seem to manage it on the up but never on the down.

DOF Subsea might be big but the problem is clear:

DOF Subsea Debt repayent profile Q3 2017


DOF Subsea EBITA Q3 2017

DOF Subsea isn’t generating enough cash to pay the scheduled debt repayments. And in these circumstances it is no surprise that the private equity fund is reluctant to put more equity in. DOF Subsea could sell its crown-jewels, the flexlay assets, to Technip but that would involve a price at nothing like book value; or maybe DOF/Mogsters’ bail them out but that will further dilute First Reserve. Either way First Reserve, some of the smartest energy PE money in history on a performance basis, have decided if you can’t get someone else to buy your equity then dilution is a better option.

Ocean Installer is a riddle wrapped in a mystery. OI has some chartered tonnage and some smart people. But it is subscale in nearly everything and I doubt it was even cash flow positive in the boom years as they were “investing” so much in growing capacity. The company had takeover talks with McDermott, that failed on price, and seems to exist solely because Statoil is worried about having an installation duopoly in Norway. It can’t continue like this forever. Rumours abound that Hi Tec have now installed staff in the Aberdeen office and are seriously looking at how to cut the burn rate.

There is nothing in OI that you couldn’t recreate for less in todays market, and that unfortunately means the equity is worth zero. Hi Tec, whose standard business model of taking Norwegian companies and opening a foriegn office, expanding both the quantum and size of the acquisition multiple (admittedly a fantastic idea in the boom), will not work here. Now it’s hunker down and build a substantial business of scale or exit. All the larger players have to do is sit this out, no one needs to pay an acquisition premium, buying work at a marginal loss, which will eventually reduce industry capacity, is a far more rational option.

Not all of these companies can survive as they are simply too similar and chasing the same projects that are also now being chased by the larger SURF contractors. Clearly DOF Subsea is in the best position as OI and Bibby/York have a very high cost of capital and owners with unrealistic value assumptions.

All these firms suffer from two problems:

  1. In strategic terms they are “stuck in the middle”. In 1980 Michael Porter wrote his famous text (“Competitive Strategy“) positing that a company chooses to be either low cost or value added; firms that didn’t  were “stuck in the middle” and destined to low profitability forever. In subsea the deepwater contractors are the value-add and the contractors without a vessel, or the regional companies with local tonnage,  are the low cost. Bibby/York, DOF Subsea, OI are stuck in the middle – not deepwater/rigid reel to add value and with too high a cost base to compete with the regional low cost operators – given their funding requirements this will not carry on indefinitelyPorter stuck in the middle
  2. The projects that made these companies profitable (if OI ever was) have suffered the largest fall in demand of all the market segments. Small scale field development, with flexibles as the core component, just aren’t big enough to move the needle for the the larger companies and the smaller E&P companies can’t raise the cash. All the FID stats show these developments to be almost non-existent. These were projects commissioned at the margin to satisfy high oil prices and therefore are the first to fall off as the price drops. That is why these companies have suffered disproportionately in the downturn: they have lost market size and market share (Bibby Offshore revenue has dropped by 77% since 2014 where as Subsea has (only!) dropped 45%

The subsea/SURF market is an industry that private equity/ alternative asset managers struggle with: a market with genuine advantages to industrial players with economies of scale, scope and knowledge. In an age of seemingly endless debt and leverage these equity providers are not used to coming across industries where their organisational advantages of capital and speed cannot work. But for the next few years, as the industry requires less capital not more, the smart money here will be on the industrial companies. It wasn’t the distressed debt investors in Nor Offshore who made money on the liquidity bond (issued this time last year), it was Boskalis when the reckoning came for more liquidity. That is a parable of this market.


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.

Bibby Offshore restructuring… End of an era…

Bibby Offshore Holdings Limited announced today it reached a comprehensive agreement on the recapitalisation of its balance sheet with noteholders who hold 80% of the £175 million 7.5% senior secured notes due 15 June 2021 issued by its subsidiary Bibby Offshore Services Plc .
The terms of the recapitalisation will result in the group having a substantially debt-free balance sheet with an equity injection of £50 million to enable it to consolidate and expand its position within the offshore inspection, repairs and maintenance and construction markets. At completion of the transaction, Bibby Line Group Limited (BLG) will transfer its entire ownership in Bibby Offshore to the group’s noteholders.

It is mildly ironic that after the Nor and Bibby bondholders spent so long seeking a resolution to their problems that both solutions were announced within hours of each other. On a first pass I would rather be a Boskalis shareholder than a Bibby bondholder.

Let’s be really clear this was no ordinary refinancing: this was in effect a relatively hostile takeover by the bondholders after the financial situation became untenable. Bibby Line Group exit with 0% having clearly been unable and unwilling to put any money in. After taking out £60m since 2014 they may consider this a good deal, but it will be painful for the Group accounts next year.

Bibby Offshore can keep using the name for another 12 months and the Directors have warranted not to frustrate the handover or pay the December interest payment (amongst other things). As at the close of the last quarter Bibby Offshore had a mere £3.1m cash in the bank, so the last point was academic in a way, but it avoids the need for a disruptive administration process. It seems pretty obvious to outside observers that it took the bondholders to make BLG aware of the gravity of the situation. Smaller companies in Aberdeen supplying goods on credit were taking an enormous risk here.

The restructuring values Bibby Offshore at £115m: basically the outstanding £175m bond (valued at .37) + 50m in new cash. Transaction and other expenses need to be taken from the £50m going in. Therefore for £115m bondholders are now the proud owners of the Bibby Polaris, Bibby Sapphire, a risk share charter on the Bibby Topaz, and all the associated IP, master service agreements, etc of the company that make it a business. This is a company that will now undergo a fundamental operating restructure as the announcement makes clear:

Within the next 7 days, Bibby Offshore will appoint an independent consultant on behalf of the noteholders to support management on the ongoing cash flow management and transition of the business to the new shareholders.

That means a group of restructuring consultants (in all likelihood from Alix Partners or Alvarez and Marsal) who will come in and do a restructuring plan that will be loosely based on zero-based budgeting. This is a brutal process and will aim to significantly reduce the costs so the business is at least cash flow breakeven by June (or they will be through a significant portion of the £50m on current trading levels). Given this hasn’t been the case for well over 2 years now you can imagine the scale of what is about to go on here (even accepting that vessel charters have been part of the issue). I’d imagine Small Pools, Business Excellence, and ex-pat managers in Houston look to be first on the list of costs to be reduced but there is a real question about what the business model is and what position the company will hold in the market that needs to be addressed.

For staff this is still the best outcome even if it provides huge uncertainty in the short-term: with only £3.1m in the bank without this agreement there would have been an administration process begun in the next few days. The revolver expired in the next couple of days and that would have brought the nuclear scenario. This was not a deal made in strength but in effect a shareholder being faced with insolvency having a gun held to their head and told to handover the keys.

The consultants’ budgeting process will highlight the fundamental issue the new owners of the business have: What is the competitive and market position of the business? A high end North Sea contractor trying to compete in the US market which is the most price sensitive in the world? Cut the costs back to a “Bibby lite-2007”, with 80 people in Waterloo Quay, shut all other offices, and trade with 2 x DSVs and Sapphire in lay-up or sold, and you will never recover your £115m. But keep trading as you are with an uncompetitive US and Norwegian office and you have to burn vast amounts of cash to make it through until the market changes. There are no economies of scale or scope through these regions and therefore no need for an expensive corporate staff and administrative overhead.

The fleet strategy will also need to be sorted out. Sapphire is in warm stack and Polaris (1999 build) cannot keep going forever. Both vessels are to old for mortgages and will be equity funded for the rest of their lives and there is a valuation implication in that (i.e. lower).  The Topaz is only on a risk sharing charter and frankly without that vessel it is arguable if there is a “Bibby Offshore” at all.

The Boskalis shareholders got a much newer DSV for $60m (£45m at todays exchange rate) and have chartered another one for a rate I believe that is c. $7.5k per day bareboat. The new Bibby will have to compete with a company with a much lower implied asset cost and breakeven level. Boskalis now has sister ships that they can interchange on projects and tenders and appear to have done this for an implied CapEx of c. $40-45m per vessel. Balance sheet strength prevails during consolidation and this will be no exception.

Bibby Offshore now looks exactly like Harkand before it folded. Harkand had 2 x the Nor vessels in the UK and the Swordfish in Houston for their ex-Veolia acquisition. Oaktree funded Harkand 3 times, and it only broke even a couple of quarters, before finally giving up. In the scheme of operating North Sea class DSVs £50m is not a  lot of money given the direct operating costs and associated infrastructure (tendering, marine, overhead etc). The new shareholders will require a firm constiution and plan to carry through this through for any length of time given that the order book is nearly empty and vessel commitments remain until Q2 2018.

One option maybe to seek higher value services such as well intervention with some talented ex- Helix staff floating around though the barriers to entry are high though and it will require further capex. The Bibby investments in renewables capacity (i.e. the carousel) look prehistoric compared to the DeepOcean and Boskalis fleet. Simply bashing up against three substantially bigger companies offering DSV days doesn’t strike me a great strategy and certainly not a sustainable one.

There is no other reasonable expectation now than for Boskalis and the “new Bibby” to fight it out for utilization by dropping the day rates they bid at (and Technip and Subsea 7 have shown they play this game as well). There is no guarantee the market is big enough for four companies at current activity levels. The “new” Bibby Offshore is a hugely leveraged play (both operationally and financially) on an oil price recovery that will force a declining basin back to higher production levels with small scale developments and higher maintenance requirements. It looks like a big ask at this point, but the team leading this investment have the financial firepower and competence to see this through if they choose; but it will not look even remotely close to the current Bibby Offshore.

Something rare happened today: the entire picture of how this market will look for the next 5 to 7 years was made public with just two announcements. It is going to be a much better market to be an E&P or renewables company in than a contractor for a good while yet.


Boskalis takes the Nor vessels…

In a widely telegraphed move Boskalis has now taken both of the Nor DSVs and this would appear to be the start of the end game for the restructuring of the North Sea DSV market. I remain convinced Boskalis had preliminary discussions about buying Bibby but gave up on price and complexity. This transaction is clean for them and allows them to organically grow a business in line with their culture and values and will clearly be a significant IRM/ light construction player over the years.

A number of implications flow from this:

  1. Rates in the North Sea for DSV will remain under pressure. These vessels did not work in the North Sea last year and if you accept my broad categorization of the North Sea fleet, then these vessels c. 20-25% more capacity to the market for high-end SAT work (depending on how you calculate the lay-up tonnage SS7 reactivated etc and if you include the Skandi Achiever). While the amount of IRM work will increase in 2018 it will not go up in proportion to overall potential capacity
  2. Boskalis will win work with these assets and they will do it initially on price and schedule (a derivative of price in the summer months to some extent)
  3. A refinancing of Bibby Offshore from anyone outside the current Bondholder group is DOA at current price levels. Only the mad or committed back themselves to compete indefinitely against companies with the balance sheet strength of Boskalis, SS7, and Technip in a market where rates are only marginally above cash break even and low growth is forecast
  4. Bibby Offshore looks suspiciously like the Harkand of old with two North Sea class DSVs and an overspecified US unit struggling for utilisation while being owned by a distressed debt investor. The upgraded Swordfish was probably a better proportionate asset than the Sapphire. The ~£70m that Bibby is holding firm on the asset values of the Sapphire and Polaris would appear to be a fantasy
  5. If you are building a North Sea spec DSV in Asia the vessel is worth USD 60m at best. It doesn’t matter how much it cost to build the most you could claim it is worth is what Boskalis just paid. In reality it is probably worth less as the number of companies willing and able to pay USD 60m is an ever decreasing pool and that price reflects an operator who can get North Sea rates
  6. It is a reminder that such complex assets take months to sell and the running costs of such assets must be subtracted from any realistic asset value calculation. Nor put the cost of running the vessels in their public documents at c. USD 500k per month per vessel. There is a very small pool of buyers and that diminishes with each round of distressed purchase
  7. Trying to seperate out the asset value from the infrastructure required to run a North Sea class DSV is a mistake. Without a credible contractor to run the asset in the region they will trade only at Rest of the World prices (i.e. much lower)
  8. The Sapphire looks almost certain never to return to the North Sea now
  9. The  business model of purchasing DSVs for USD150-200m and then operating in the spot market for periods of a few days to a few weeks looks broken. Banks will insist on signficant forward cover to finance assets or only those players with strong balance sheets can compete. The days of small upstart offshore companies with a few good ideas and small contracts have vanished (and that is not just in the DSV space). Such a market looked reasonable when everyone was making a 60% gross margin off DSVs but the both the reduction and the volatility of the associated cash flows have changed the market forever
  10. The North Sea diving market for IRM is now dominated by firms for whom it is not a core activity and they will therefore price accordingly (lower). Boskalis, SS7, and Technip are all construction/renewables/dredging focused firms. They have a business model that doesn’t rely on diving being profitable in its own right which means they can sustain low margins for long periods of time. The same is simply not true for Bibby Offshore. Any new entrants into the SAT dive market will view it as an “add-on” service and will bargain a lower utilisation and day rates that were historically the norm. This will affect vessel values that will not recover to anything like 2014 levels and in reality will be lower than implied depreciated values from that period forever
  11. The Nor bondholders got lucky here that Boskalis decided not to muck around on a 20 year investment and pay a decent premium for convience and transaction success. There were no other bidders at anything like these levels and Nor was out of money in February. This was a binary pay-off model where without this transaction they would have been required to inject new money that would have devastated the value of the investors in these boats
  12. I think USD 60m isn’t a fire-sale but a reasonable price at which you could expect to earn a reasonable economic return on the asset over an economic cycle. Boskalis has to commit to a certain amount of infrastructure and fixed cost to achieve this but it can spread this over its existing overhead better than anyone else and therefore do this at a lower per unit cost than others

Boskalis have played a good hand well here.

DOF Subsea, Bibby Offshore, and The Pecking Order Theory…

We always plan too much and think too little.

Joesph Schumpeter

We were succeeding. When you looked at specifics, this became a war of attrition. We were winning.

General William Westmoreland on US involvement in Vietnam

DOF AS/ Subsea reported numbers yesterday that were frankly terrible. All those who keep telling you the market is getting better seem blithely ignorant of the constantly decreasing financial performance of nearly all the companies in the sector. It’s like Comical Ali or General Westmoreland constantly assuring everyone that victory is just around the corner, if not in fact delivered. Tendering, like the Viet Cong, never ceases to stop appearing in increasing numbers, and it will bring victory…

I have another theory why tendering is increasing: there are a lot of engineers who are worried about their jobs. In a completely rational strategy they are increasing the number of parties who receive tendering documents, spending more time assessing them, and making the tenders ever more complex. Turkeys don’t vote for Christmas. More people appear to be spending increasing amounts of time and money on the same tenders and it is making industry margins even thinner, and allowing management to claim that completely unproductive work is actually a sign of an industry returning to health.

But back to the numbers… this is the same DOF Subsea that as recently as Q1 and Q2 this year was hoping to get an IPO away. It’s a good reminder, as if anyone needed one, that when insiders are selling out you should be wary of what you are buying. I call it the Feltex Carpets or Dick Smith theory. Economists have however developed a far more robust theory about how firms decide on their capital structure: The Pecking Order Theory. It’s based on the information asymmetry that exists between the insiders of the firm (shareholders and management) and the outsiders (investors and funders). Basically it’s a deeply cynical view (which probably means it is right) that managers and owners use internally generated funds first, then use debt and only issue equity as a last resort.

In a classic paper Myers and Majluf (1984) argue managers and owners issue equity only when they believe it is overpriced. It is very hard not believe that early in 2017 the insiders at DOF Subsea (i.e. the private equity owners) looked at the vessel schedules and the likely win/loss ratio of the tender pipeline (not the amount of tendering), and decided that if they could dump some stock they would. Luckily investors are aware of the asymmetric information problem and “they discount the firm’s new and existing risky securities when new issues are announced“. Or in other words they just refuse to buy at the asking price which is what happened in the DOF Subsea case.

You should always be wary of financial presentations that start with highlights that don’t include any financials (like the latest DOF Subsea one). Just to be clear the DOF Subsea revenue was down 11% on the same period as last year and EBITDA was down 6%. Luckily, they are doing more tendering.

DOF also helpfully provided this chart of the business:

DOF Business Model.png

Basically without the long term chartering business, which is really just a risk diversification move by Technip, there is no business: the 10% EBITDA on the projects side wouldn’t cover the economic costs and frankly potentially the cash costs either. This is a business where unrealised gains from derivatives (probably interest rate and/or currency swaps) were 6 x the operating loss for the period of NOK (41m).  Year to date DOF Subsea has had to turnover NOK 2.8bn to get a mere NOK 45m in profit. It is pretty clear from the above that actually the projects business, with 17 very expensive fixed costs assets, is not an economic entity; and as I have said before you need a very good return on the vessels on long-term charter in Brazil because as the above graphic makes clear if their contracts aren’t renewed (and no one believes they will be on anything like the current terms) then the value of the vessels will drop like a stone if you believe at some point a vessel is only worth what it can earn in cash terms. The number of other activities you can perform with a 650t vertical lay system is actually pretty small which lowers resale value regardless of how much it cost to build. In which case the value of the business is probably much smaller than the current shareholders would be willing to admit to themselves. Time is not a friend to the investors in this deal because everyday they hold this company future investors get one day closer to finding out what happens in Brazil.

DOF Subsea is a pretty good projects house and the EBITDA margin is just a reflection of market overcapacity. If you were going to invest new money in a subsea projects business you would need therefore to look at that as a realistc EBITDA margin you could earn for the foreseeable future until further supply capacity leaves the market or there is a significant increase in demand. Bear that in mind if you were, for example, looking at injecting funds into a company about to default on its bonds…

The Pecking Order Theory is also helpful in explaining (some of) the shennanigans involved in the Bibby Offshore attempted refinancing at the moment. The insider shareholders in this case also saw the writing the on the wall and in January 2016 took a cheeky £20m off the table in the form of a dividend (after a c.£40m dividend recap that was flagged in the prospectus). In the next 12 months Bibby Offshore lost £52m at the operating profit level, and it must have been known to the Directors by June 16 that without some sort of miracle the business would require a restructuring (which to be clear is an event of default as defined by the ratings agencies even if consensual). It was certainly apparent to any responsible Director by Oct 16.

Bibby Offshore cannot realistically make an interest payment in December, and management have qualified the accounts such that it is not a going concern without a refinancing. And now  the insiders (Bibby Line Group and management) have decided they want outsiders to put money in. They don’t think the equity is overvalued (they know it is valueless);  the insiders think the debt overvalued is and there is too much of it. All the talk of a supportive shareholder reveals it for the sophistry it is: the insiders don’t believe enough to contribute financially. BLG aren’t putting in any of the £60m they have taken out not just because they don’t have it but also because they know the business better than anyone and The Pecking Order Theory makes clear they want someone elses money here.

One deal that is on the table is some “Super Senior” financing (i.e. paid before anyone else) provided by the distressed debt desk at Deutsche Bank. Now Deutsche are arguably the best desk at this in the City, but if you need this sort of financing it is pretty much the end of the road. If EY have resorted to the distress desk at Deutsche as an alternative it shows that no long term investor is interested. This form of financing is more suited for a company in bankruptcy (where it is called debtor-in-possession financing) than for one imminently approaching it. The Deutsche plan would be to lend fully secured against the Polaris and the Sapphire and give Bibby enough money to make until next summer when DSV day rates miraculously improve and the business can service this new debt and bonds. But don’t the bond holders own those boats I hear you ask? Yes. And I am not close enough to this to know exactly the specifics but the security agent is only likely to hand over the ownership papers to the vessels if the bond holders agree to this (I guess); and (I guess) Deutsche would only advance the funds in conjunction with a writedown of their claim. Unbelievably management will argue they are they best people to trade the business out of this mess.

The real tension here appears to be how much equity the bondholders take, and how consensual the handover is, as the business undertakes a debt-for-equity swap. The bondholders can hold out for 100% of the equity as their only other asset apart from the DSVs (and a couple of ROVs) is the shares of Bibby Offshore, but in  order to follow through on this they have to push the company into administration and a liquidation scenario is completely possible at that point as customers and suppliers refuse to trade. The Bibby/Management/EY plan envisages a far more generous structure whereby any money Bibby Line Group put in is also fully secured and they retain majority control so they can consolidate Bibby Offshore in their Group accounts (20% of net assets). The problem with this is of course that BLG don’t have anywhere near enough money to put in proportionately.

A nightmare scenario for the bondholders is taking over a company in such circumstances where agency conflicts abound and in a practical sense now it is a hostile takeover with management having acted until the last possible moment to realise the rights of the debt holders. It is arguable for all of this year Bibby Offshore should have been run with the creditors interests at the forefront of all decisions and it is clear that this has not happened.

In case you’re wondering what is in it for Deutsche: it’s the fees. They are looking at advancing c. £20-30m on the vessels and it would have to be cleared before the bondholders get paid. They would get a 7 figure upfront fee and an interest rate of c. 15%, and if a default occurred they would sell the assets in a fire sale to get their money as quickly as possible. Which is why you can’t get much money from such deals because the bank needs to be conservative here (and I think this deal will die on broker valuations given the likely fire sale prices of Polaris and Sapphire). The problem is of course that debt got Bibby into this mess and it is very unlikely to be the cure to get them out of it. I don’t think the Deutsche proposal has passed credit committee and even though they would make an eye-watering fee on the this the risk is clear: becoming the proud owner of 2 x North Sea class DSVs (and as their offices are some way from the Thames they wouldn’t even add to the famed Deutsche art collection).

With no significant work booked for next year the Bibby plan relies 100% on day rates increasing significantly above current levels. And therein lies the real problem for the bondholders and any potential distress desk coming in on this: at some point the only solution to a market in oversupply is for some capacity to go. How can Bibby credibly claim to make a better margin than DOF Subsea? At the moment Boskalis look almost certain to enter the market in a big way and other companies are also looking to enter the market. Not only does Bibby need tens of millions of pounds under its current cost structure just to make it until next summer there is actually no certainty that this magical scenario of higher rates will allow them to come close to settling the outstanding debt obligations they are generating to get there.

DOF Subsea made clear that while tendering activity is robust project work is dismal (and indeed they made a specific comment that amounted to a profit warning about it). At 7.0 x debt to last-twelve-months EBITDA DOF Subsea (and everyone else in the market) will be throwing everything into trying to win work… all the non-DSV work will compete with Bibby (no one really expects them to reactivate the SAT system on the Achiever) and they will keep margins at ~EBITDA breakeven in order ot get utilisation. As a committed industrial player that is a rational economic strategy. Subsea 7 and Technip are booking DSV days at less than £120k for 2018 to get utilisation in early and they can clearly keep this up virutally indefinitely. The dumb non-industrial money won’t last as long as those with an operational logic and an industrial strategy + balance sheet in this market.

The problem for the Bibby bondholders is that not only at current prices (.36) have they capitalised the firm at c. £63m, way above what it could hope to earn in an economic sense, it also needs £20-40m just to keep trading until next summer.  The major competitors have no cash flow issues (Boskalis has €1bn in the bank) and every reason to chase market share over profit. There is therefore no rational economic reason why under this scenario North Sea class day rates will rise, particularly if Boskalis enters, and every reason to believe they will stay at current levels. Any rational investor in Bibby Offshore would shut down everything apart from the UK business, but 2 x DSVs in the UK doesn’t justify anything like £60m in value…

The Nor bondholders tried super senior financing on their DSVs in Nov 2016 and it is clear, as they slowly run out of money and cannot raise anymore at anything like the 15% fully super senior they did last time, that when someone says you can’t lose on a North Sea class DSV, you can on some. It’s all down to asset specificity as I have said before. Deutsche and other distress desks will be well aware of the mistake the Nor bondholders made, and frankly if I was going to make a mistake on two DSVs I’d rather do it with the Nor vessels than the Bibby ones.

This will all be resolved soon. A bondholder meeting is scheduled for next week and everyone will lay out their plan. The problem is of course there isn’t one really and it should never been allowed to have get this close to Dec 14 when the interest payment is due. The Bibby plan is for it to continue as a lifestyle business where external investors allow the family and management to stay in control and fund it until the market returns. A few (27) redundancies are underway but in a microcosm of the cost and conflict issues that define the company the CEO’s wife, who runs the Business Excellence department, is staying , as is the Director of Small Pools and Innovation, while the Engineering Manager is made redundant (seriously).

The Bibby plan relies on a small number of bondholders, enough to block the majority, being so afraid of the great unknown they back them to carry on as before. This will just delay things until next summer because the cash burn is just so high that even £20-30m would be gone by this time next year without a wholesale change in market conditions. Handing back the Olympic Bibby cuts the cash burn, and may allow the business to come close to cash break even, although the US will make another substantial trading loss in 2018 as will Norway (and without the Ares why bother?); but doesn’t solve the core problem that the business itself is unprofitable at an operating profit level. Call it the slow-burn and pretend strategy. It was disastrous for Nor as eventually reality comes and the cash is gone. As plans go it is pretty terrible.

But the bondholders don’t have a good one either. The bondholders appears to have spectacularly misread the willingness and ability of Bibby Line Group to support Bibby Offshore as well as how badly the business would perform in 2017 versus 2016 (revenue -50%). Some of the funds involved in the bonds don’t need money from an institution like Deutsche, but unless they control the company they have to hold a bondholder vote every time they want to make any significant moves, and letting the company go into administration risks a total wipe-out of value. Stripping the company back to a smaller business locks-in a loss, continue funding it until the market returns is simply throwing good money after bad and it’s real cash. If they do take the business over they will have an awkward period where almost the entire senior management are changed out and they will be cash funding a business, with an unknown financial commitment, while their consultants re-do the numbers and tell them how much capital they will need to inject. I have done that as a management consultant and it is hugely destabilising while it goes on and makes normal operations almost impossible. If if takes consultants 6 weeks to produce an initial report (30 working days), and Bibby Offshore is losing c. 100k a day in the interim even an emergency facility of £3m + £1m for the consultants is real money given the limited upside sale potential. And then they are only in February with a real funding commitment until the mythical summer season that will save everyone… until it doesn’t…

There is a more complicated scenario here where the Bibby Offshore is restructured through a pre-pack insolvency that the current bondholders control. This will remove the historic liabilities incurred (i.e. property leases, Trinidad tax) and see a new company emerge free of its past shareholders and with a new capital structure. I think this the most likely but it will be a dramatically smaller business and will be run solely for sale ASAP. I also see no guarantee it will realise more value than a liquidation despite it being enormously risky given changing market conditions.

The Bibby Offshore refinancing is a mess and liquidation is clearly a very real possibility here. Getting to less than 28 days of an interest repayment before trying to finalise a refinancing is irresponsible in the extreme when it has been telegraphed for months and your plan is simply not to hand the company to the bondholders. The only thing I can definitely tell you is that if you brought Bibby bonds at .36 you are going to lose some real money here.

Bibby bond restructuring…

Photo: The Bibby Topaz idle in Aberdeen Harbour yesterday.

The Bibby restructuring is a big deal. In 2003 Bibby purchased the Aquamarine and on the back of an offshore oil boom attempted to build an international EPIC contractor. One of the major themes of this blog is excessive leverage and as I have consistently argued, since around this time last year, the debt load Bibby Offshore was always going to require a financial restructuring. It was obvious at this point last year when they were clearly on course for their £52m operating loss, and it has just got progressively worse this year and frankly they have left it far too long before taking any action.

The proposed Bibby bondholder led restructuring  as I understand it is:

  • Bibby Offshore gets a capital injection of GBP 40m
  • Bondholders take a 50% haircut on the debt and take 50% of the business (presumably this means they subscribe to 50% of the new equity i.e. £20m)

I don’t think this is a starter for a number of reasons but I also think it shows how little, if the rumours are true of a small US/London fund buying in, they actually know what they have brought. But this is surely the opening gambit here that promises to be quite a public conglagration for an organisation that values secrecy for all but the most optimistic news. However, with the next interest payment scheduled for Dec 14 it also promises to move quickly from here.

The key to this is cash. Here is the BOHL cash flow statement from the most recent results (Q2 2017):

BOHL Q2 CF 2017.pngBOHL had sales of £37m over the first six months of the year (a 30% drop on 2016) and it cost them in cash terms £60m to get those sales. That is a totally unsustainable business model. BOHL is on target for less than £80m in sales in 2017, down from £155m in 2016, while at the same time its administration expenses rose by nearly £2m! (I actually had to double check that before I wrote it). They are actually on target to spend a full 20% more in admin this year than last year when their sales were nearly 50% higher (excluding one-offs). Let that sink in. This for a business that lost £52m at operating profit last year, something management and the directors must have been well aware of from at least June 16.

So on the current run rate the bondholder proposal requires that £40m of operating expenditure just to do £80m in sales. Sooner or later businesses like this run into a cash constraint. The cash flow statement above makes clear: the problem isn’t the interest payments (a mere £6.9m), although they don’t help, this is an operational problem not a financial problem. This is not a stable platform on which you can base a recovery story.

I also struggle to see why the bondholders would only want 50% of the business when in a few weeks, when Bibby Offshore defaults on the December interest payment, they will own 100% of the business? The bond is secured on the assets and a share pledge as security: If BOHL cannot make the interest payments the bondholders own the company. I can only think this is some clever ruse to flush out the fact that Bibby Line Group don’t have £20m for their 50%, and even if they did wouldn’t do it as an equity injection because the bondholders would have to paid £87.5m before the equity had any value?

To be clear here is the cash position of Bibby Line Group in their most recent accounts:

BLG Cash 2016

BLG isn’t spending 100% of its available cash to bailout the bondholders here even if they wanted to. And the only previous offering from BLG was an unapproved facility that would have diluted the bondholders security interest (and potentially led to a legal claim for doing so). There is therefore no reason to believe there is any willingness at BLG level to support Bibby Offshore and every financial reason to see they cannot. Bibby Offshore is simply too big for Bibby Line Group to save. I actually partly wonder if this offer isn’t a shot across the bow of management by the bondholders to make sure they don’t use the Barclays facility as outlined (not that I thought Barclays would ever agree to it) as it simply adds more debt to a business that so transparently needs less and delays the inevitable.

I was surprised the auditors signed off the asset values at the last accounts (2016) but there is a problem now for Group because the BOHL assets are 20% of the total Group asset base and DSVs values have fallen percipitously in the last year. I see these asset values as the core problem moving forward because they disconnection between the cash they can earn and the values owners wish them to present is just so large, but the cash required to trade to a time when the owners believe the values will have come back is beyond them to supply.

The proposal as outlined above would actually value Bibby Offshore at £127.5m – 40m equity + 87.5 debt- post restructuring for assets (DSVs and ROVs) that would be worth c. £50m on a very good day on the open market today. That debt load alone is more than 1 x Last Twelve Months Revenue! No one can seriously expect that money to be paid back, and it is backed by a 1999  build and 2003 build DSV that will never get debt against them again, so this is a business that will be effectively equity financed forever. If someone came to you today and said they wanted to raise £130m to buy Sapphire and Polaris and invest it in a business losing £2m per month (pre finance costs) you would think they were nuts, and in investment the rule is to ignore sunk costs.

In order to make those numbers work you would need some heroic assumptions about DSV day rates, currently between £95-130k, in the North Sea to fundamentally have a different view on the value of the asset base, and believe that a start-up US operation can suddenly change course in the face of continued market pressure (despite having the best DSV in the region last year and getting less than four weeks work). Somewhere, in an exceptionally nice office, someone must be starting to wonder at the enormity of what they have brought into. Because with the bonds trading as high as .37 of face value last week institutions have effectively been paying ~.7 for a claim of £87.5 in debt that they also have to fund with £20m for a 50% share of the equity (I am assuming). Or at an average cost of .35 Bibby Offshore was valued at £61.3m (i.e. total debt 35% of 175m) but then you need to put in another 65% /£40m just to keep trading? And that is simply to fund operating losses until the market returns? Its just not serious. There is no meaningful backlog here and it is 100% dependent on the market turning and customers continuing to use a contractor who would be known to be on life support financially.

To suggest that the Polaris and Sapphire could support secured debts more than 2 x their current asset value at the moment is again I think a heroic assumption.

All this points to the fact that someone started building a position in Bibby over the summer before the Q2 results came out, and when they did in September they have started to panic. Bibby Offshore is performing materially worse in financial terms than in 2016 with significantly lower DSV utilisation at significantly lower rates because they are doing more air diving work. The DSV utilisation was 29% in 2017 versus 77% in 2016: a number that must have made bond investors more than a little nervous.

The other big mistake people seem to have made is not to understand that the frothy days of 2013/14 were driven by CAPEX not OPEX and until small scale shallow water construction returns there will be excess capacity in DSVs. There are almost no plans for this work, much of which used to be driven by small-cap E&P companies and their sources of financing are almost completely closed.

This is an absolute mess. Bibby Offshore has waited far too long to start discussions, making the June interest payment was absurd, and it would appear the bondholders are now being asked to put in more money than the assets are worth to keep a company trading with more debt than revenue. Its totally unsustainable. Clearly the EY led accelerated M&A effort has failed, as the equity has no value, and the company is in the process of being handed over to the bondholders, it’s just not everyone realises that yet.

The only viable model for the business would be a debt writedown to c. £30-40m and ~£20m equity injection and all that would be left was a 2 x DSV North Sea operation. The problem with this is it wouldn’t leave you with the right assets, there is no exit strategy for the investors, there is no guarantee the payout would be higher than a liquidation scenario, and it entails significant market risk. It would also appear to be hostile to management who have been increasingly shrill lately about their range of opportunities and have simply ignored economic, market, and finanial reality.

I am not saying a deal won’t be done: London is awash with dumb liquidity at the moment. I suspect someone got into this because they looked at the asset values in BOHL accounts and saw the discrepancy between those and the bond price and simply brought in without realising how inflated the vessel values were. Should this be the case the scale of the mess here is likely causing them to follow a “double-down” scenario that is simply illogical in financial terms, but it seems unlikely the other bondholders won’t request updated valuations before putting new money in and that is when the wheels will start to come off this completely as no shipbroker will issue a certificate to (notoriously litigious) investor groups that isn’t realistic. Sooner or later the grown-ups at credit committee will begin to take charge…

It is worth comparing the USD 15m Nor raised in November last year to support their liquidity for a year. That USD 15m represented what they hoped was 10-15% of the final asset value. Assuming the £40m is correct (and at less than 2017 annualised cash burn it must be a good approximation) Bibby is looking for 100% of the DSV value (on a good day) and still have another £87.5m owing?! Really? This can’t be serious.

I repeat my call that if Bibby Line Group wanted to be consistent to the values it espouses that it should guarantee all non-Director staff their contractual notice period. Such a meaningful gesture would be well received by those approaching the Christmas period with such massive uncertainty.