Who should a bondholder talk to?

[Reposted after a version control issue in the original post. Apologies].

“Judgement does not come suddenly; the proceedings gradually merge into the judgement.”

Franz Kafka, The Trial

Right now the Bibby Offshore Holdings Ltd bonds are trading in the mid .30 range implying the company will default on its obligations and that owners of the bonds are interested in what they will get paid out at in the event of credit event. On June 27 Standard and Poors lowered their credit rating to CCC- (negative outlook). For those unsure of what this means here is the definition:

An obligation rated ‘CCC’ is currently vulnerable to nonpayment, and is dependent upon favorable business, financial, and economic conditions for the obligor to meet its financial commitment on the obligation. In the event of adverse business, financial, or economic conditions, the obligor is not likely to have the capacity to meet its financial commitment on the obligation.

That ranking is “Poor (high default risk)” below “speculative” which is a B grade. The last Moody’s report I can find (Nov 2016) is even lower “Caa (Highly Speculative)” and one above an actual default. So this is well telegraphed and understood and followed by professional investors.

So the market understands completely that there will be an event of default here. For the avoidance of doubt default covers any of the following events:

  • A missed or delayed disbursement of interest and/or principal, including delayed payments made within a grace period;
  • Bankruptcy, administration, legal receivership, or other legal blocks (perhaps by regulators) to the timely payment of interest and/or principal; or
  • A distressed exchange occurs where: (i) the issuer offers debt holders a new security or package of securities that amount to a diminished financial obligation (such as preferred or common stock, or debt with a lower coupon or par amount, lower seniority, or longer maturity); or (ii) the exchange had the apparent purpose of helping the borrower avoid default.

Just to be clear: even voluntarily agreeing a debt restructuring is an event of default. The original bond investors were professional investors who have a process and warning system for investments that go into default and know what they are doing. Much of the trading in the bonds over the last couple of months is likely to have been from the original investors selling out, as they are “long only” funds that want the interest payments, and in are moving more aggressive funds who specialise in complex workouts and default situations. For those who want a flavour of the aggression of some of these funds they can be seen by Elliot Capital Management, who has partnered with Siem in offshore, have a unit NML who sued Argentina in a complex default case:

NML Capital, a unit of Elliott Management Corp. — sued under a different and cleverer theory. Argentina’s defaulted bonds had a pari passu clause that said that the bonds would “at all times rank at least equally with all its other present and future unsecured and unsubordinated External Indebtedness.” After the default, Argentina had done a restructuring in which it exchanged many of those bonds for new bonds, which it then serviced normally, while continuing to stiff holdout creditors who refused the restructuring and kept the old bonds. NML sued in U.S. courts, claiming that the pari passu clause banned Argentina from paying interest on the new exchange bonds without also paying off the old holdout bonds in full: By paying the exchange bonds and not paying the holdout bonds, Argentina was violating its promise that the old bonds would “rank at least equally” with the new ones…

But the U.S. courts, to everyone’s surprise, sided with NML Capital, and Argentina couldn’t make payments on its new bonds, and it was forced to default again, and everyone was very sad, and ultimately Argentina solved the problem by settling with NML and its fellow holdouts for quite a ton of money.

Getting companies like this on the bond register marks the beginning of the end because they force a solution and .02 or .03 movement is a big deal for these investors and they are very aggressive to get their ends. Some of the original investors will ‘coat tail’ on the skills of the restructuring funds knowing their tactics can generate higher payouts.

I should also note here that in keeping with all bonds like this the BOHL bondholders have a “share pledge” as part of the security package that essentially means should a payment be missed the shares are delivered to the bondholders or the administrator. There is no dispute about this and one of the reasons the interest payment was made in June, when  the company should arguably have preserved the £7m cash, was to stop this security package being invoked.

The only questions about the BOHL default are how it plays out rather than if one will occur. There are three scenarios:

  1. Complete liquidation. Management and investors take no action and eventually the company simply runs out of money and administrators are called in when payments start failing. This is pretty unlikely.
  2. Recapitalisation led by the Bibby LIne Group: in this scenario BLG seek to remain in control of the company, they reach an agreement with the bondholders on the size of the writedown they will take, and new funds are injected (in this case from a new capital provider not BLG) . Should a new investor not be found bond investors would be required to contribute new funds to working capital. I think this is more unlikely than option 1 but it is being tried at the moment.
  3. An event of default where the bondholders enforce their rights and seek to maximise value and seek to sell the operations of the company while leaving the debts with “Oldco” (BOHL). Clearly to my mind the most likely scenario.

There are few other viable outcomes because BOHL did borrow £175m and cannot realistically pay it back ever, and certainly cannot pay it back as it is contractually obliged to.

Option 2 is clearly management and BLG’s preferred option. There are however a number of problems with it: the core one being that BLG don’t have enough money to compete with other proposals and as soon as the bondholders were approached about a writedown and a potential “funding gap” they had zero incentive not to invoke the share pledge and wipe the equity holders (BLG) out unless there was serious money on offer. The only offer that has been presented publicy is a neglible contribution to the revolver from BLG and I suspect this enraged the bondholders as should a default event occur this would see BLG recover funds before the bondholders, and indeed there was a question on the first conference call this year as to why this money wasn’t going in as equity? BLG/BOHL has been trying to interest some large US/London funds in a conditional deal whereby the bondholders take a writedown and they inject liquidity into the business and receive these funds first and at a higher rate but I don’t believe a Heads of Terms has been signed nor even a writedown percentage agreed in principal.

Another problem with this deal is the scale of the writedown needing to be taken. When the bond was issued there were four Bibby North Sea class DSVs working and now not even two are sufficiently, and the Sapphire is going into layup. A normalised earnings might be as low as £6-10m EBITDA for a standalone business which would imply maximum debt capacity of £24-60m (at a 4-6x range), probably the lesser as there is little contractual backlog, so the bondholders are likely to rank even a small cash offer significantly above the promise of a higher payout later. In reality a business with such cyclical cash flows really needs to be mainly equity financed, a position the bondholders will be acutely aware of should they be prepared to cut a deal.

By approaching the bondholders BLG/BOHL ensured the bondholders needed to make sure this was the best offer they could get. So when someone tells you that “bondholders categorically haven’t had” a discussion with the largest and most liquid industrial company in the offshore and dredging sector in Europe the question is more, why wouldn’t they have had this discussion? If all BLG/BOHL are offering is a writedown of debt and dilution of returns to their own securities, while making any further BLG cash guaranteed, why wouldn’t they sound out in the market who would give them a higher price?

And I can assure you, that even though some discussions have been tentative, that is exactly what has been going on. This is a deal, in its many guises and possible forms, that is doing the rounds of the financial advisory firms all hoping for an angle on it. This will be a significant default in the London market (as opposed to Norway) and a large number of advisory firms and distressed debt investors are seeking to profit from it.

All the bond investors want now is to maximise their returns. A cash offer is better than anything but some of the new investors will happily put money in if this increases the likely future return. But fundraising becomes complex, expensive, and time consuming because the original bond investors who brought in still have rights and it is very hard to convince customers to sign up while the financing conditions are so uncertain.

So the bondholders are talking to anyone who will give them a higher payout potential. Indeed it would be a breach of their fiduciary obligations if they did not. They are not sitting there saying “we really like this management team who have had some bad luck” they are saying “how do we minimise our losses/ maximise value, all options are on the table and what is our exit route?”.

Anyone with the potential to help them gets a meeting and a serious hearing. A company with nearly €1bn in cash, current subsea investments in the North Sea, who took risk on a foray into Fugro, and has a strong UK business in dredging, get a big hearing. It is true McDermott is also likely to be part of the discussion along with DeepOcean and others (I have been told Hitec are putting no new money into OI so they are unlikely to do so).

For what its worth I think McDermott, without the windfarm work, and having seen how unprofitable the 2 x DSV UK Bibby Offshore business is, won’t want to risk GBP 20-30m in OpEx until they can sell some project work. But they have a lot of diving days in the Middle East/ Africa the vessels could cover to de-risk it. From a corporate perspective they would not want a loss making North Sea acquisition distracting investors from their very good Africa region story (into whom it would look likely to report). McDermott are a credible bidder, but their order book is less than they would like and should they win some big projects there is sufficient North Sea DSV tonnage for them to charter and commission relatively quickly should they not find a time charter availble (Nor, Toisa, Vard, Volstad) so I think they can achieve the same goal at a lower risk profile. But there is no doubt they are extremely credible as a bidder and the bondholders would be delighted to see a bidding war erupt between McDermott and Boskalis.

There could be others… my point is that the financial advisers to the bondholders serve their client the best when they generate the most options and ultimately get the best price, and to say they are not discussing this with credible transaction counterparties is absurd. Certainly every OSV company with some funds will have been called by investment bankers wondering if they are interested in the deal, waving a mandate letter in front of them, and claiming to have excellent contacts with the bondholders and their advisers. That is how financial markets work.

I know for a fact two big US private equity houses are running the slide rule over the deal. One I believe is working completely independently and is again in preliminary discussions with the bondholders. I just don’t see this going to private equity as BOHL has cash losses in all trading regions and has no backlog. PE don’t normally take 100% market risk with their money which is all this would be. I am least sure of this point because PE just have so much money at the moment that anything is possible, but this is at the very risky end of the spectrum. It would also be a 100% cash equity deal which is very rare when asset values are so uncertain.

The value of the business to an industrial player like Boskalis is the DSVs, systems, Master Service Agreements, project history etc. So there is value if contracts can be novated and the vessels can replace chartered in tonnage. As a general rule private equity houses struggle to compete when industrial companies can find synergies in an acquisition. My own view is that given their strategic position and stated plans, asset base, corporate development skills, track record, and a host of other factors, Boskalis are in the best position. But I am not close to this and it is an educated guess rather than having seen anything proprietary.

The one thing I am 100% certain of is that there is a seismic change coming to BOHL. Any new money simply isn’t funding a corporate centre to preside over three loss making regions. Loss making US office exposed to Borderlon claim and no competitive position? Gone. Loss making Norwegian office? Gone. Ex-pat jobs for the boys in Houston? Gone. Jobs for wives? Gone. Three separate Boards? Gone. The scale of these changes mean a change in legal form is also likely. These were part of a lifestyle business where the people benefitting weren’t supplying the capital and it is inconcievable that anyone supplying new money to fund the business, in whatever form it takes, would accept the current cost structure (as it would reply 100% on an improvement in day rates to make money). An industrial player will simply roll the business into their existing operations and take on really the UK projects teams and maybe not that much else. A PE player would send in a hit team of management consultants who would fundamentally transform the organisational structure.

All options, apart from the status quo, are currently very real.

(For the avoidance of doubt I have no financial interests at all in this position as someone asked me to clarify last week).

Boskalis holds all the cards, the importance of windfarms, and restructuring transactions…

I don’t need a watch, the time is now or never.

Lil Wayne

A couple of people have sent me emails asking some questions relating to my Bibby/ Boskalis post and it is easier to answer them once. Obviously this isn’t investment advice (and no one reading this is likely to own the minimum of GB 100k anyway) and is a general indication of events not specific advice. Deals never go the way anyone plans.

Firstly, under UK law a company is insolvent if the assets do not cover the debts or if it cannot pay its debts as they fall due. Should either of these circumstances occur the shareholders have lost control of the company and it is in effect run for the benefit of the creditors and at that point the debtholders can decide whether to call in administrators. Trading while insolvent is a very serious offence for the Directors as it increases creditor losses knowingly.

In Bibby Offshore’s case the only assets of note are the cash, DSVs, and ROVs which combined would come nowhere close to the value of the debts, and in fact Bibby is one of the few companies in the entire offshore industry not to have taken an impairment charge recently on vessel values, so everyone knows the GBP 100m book value is simply not real and the delta is a number like £50m not £2m. The next trading results will make it clear that without an immediate liquidity injection the company is unlikely to make the December interest payment and therefore the Directors now have a very limited window in which to gain funding (this is where is gets complex because a “highly confident” letter from a reputable financial institution may be enough to cover them for a bit but within a strict legal corridor). Given Bibby Offshore is operating at a loss in every geographic region, and has minimal backlog, and seems unable to meaningfully reduce its cost base, it is very unlikely to get this as any investor has to deal with the bondholders who realise they are going to take a substantial write-off here and have to work out how to minimise this loss. To all intents-and-purposes Bibby Offshore Holdings Ltd is controlled by the bondholders not the shareholders now, and it is their interests that are paramount. This can be seen from the BOHL balance sheet in March and the cash balance will be down at least around another £7-10m at best since then (excluding interest costs that have been paid).

BOHL Balance Sheet

BOHL Balance Sheet 20 June 2017

The only refinancing deal Bibby (BLG and BOHL) had been working on was a complex capital injection which required the bondholders to take a loss and work with new capital providers (such as M2 backer Alchemy) who would inject the funds for working capital and agree to pay the bondholders back less than the £175m but more than they would receive in a liquidation scenario. There is simply no realistic way the company could trade out of present situation even if the market recovered. The only conditonal funding from BLG was to back-up the revolver facility that essentially meant they got their money back before bondholders. I imagine this move went down badly with the bondholders.

The other things that seems to have been forgotten here is that the cash being burned is the creditors cash. If the bondholders can turn this spigot off then that money is available for distribution to them, so an option where they stop the cash burn at £15m in the bank is potentially an 8% increase in their recovery, which is meaningful when the only other option is watching it being burned on by a company with poor cost control who are seeking a free option on timing for their shareholder. The bondholders and their bankers will be remarkably unemotional when the first chance comes protect value. It is clear that the BOHL Directors  (and frankly at least one banker involved in the bond issue) failed to understand the seriousness of the 2016 financial result and the Non-Exec Directors at BOHL have performed particularly poorly. Making an interest payment in June, and then running into a liquidity issue now is not a market driven event. The backstop offered by BLG is insignificant in relation to the cash burn rate and reflects the lack of realism about the precarious nature of their situation.

Boskalis have therefore now made a price and pitched it to the “owners” of the company: the bondholders. The offer which I understand is for the bondholders to sell them certain assets of the company,  in-effect the North Sea Bibby Offshore, and leave the legal structure and debts with bondholders. These will be liquidated and generate a minimal recovery but that company will recieve the consideration for the assets it has sold and therefore the bondholders would be paid out of these funds. The price is c. £52m I have been led to believe which equates to the bondholders getting around 30% of the face value (par) of the bond. That means that any competing offer to control the company needs to give the bondholders the certainty of £52m (or whatever the final price agreed on is). Boskalis has wisely laid a marker in the ground, and with nearly €1bn cash on their balance sheet on the last reported financials, there is no doubt they can complete the transaction so the bondholders can bank this number.

It’s pony up with your money time if you are in the race to own these assets (the company will not be sold as the company has a legal obligation to pay the bondholders £175m which only liquidation or a restructuring agreement can extinguish). That sum of money, and the required OpEx for the company to trade through its losses for the next 12 months (say £20m), is so far beyond the capacity of Bibby Line Group to come up with up it might as well be a trillion, barring Sir Michael winning Euromillions twice in one week (and it needs to be next week).

So the only other question the bondholder advisers will be trying to answer now is can they can get a better offer… and who that might come from? I think the only credible bidder would be DeepOcean, as like Boskalis they have North Sea windfarm backlog and a customer base and chartered vessels they could hand back, to de-risk the asset OpEx. But DeepOcean are not as attractive for the bondholders as they are owned by a consortium of PE investors, and raising that sort of capital adds an execution risk to the deal,  one the bankers advising the bondholders will be acutely aware of. The worst case scenario for the bondholders is to lose a deal for accepting a higher price only to find the other side cannot deliver.

I don’t see McDermott (or someone like them) entering the race. Although they are the largest diving contractor in the world now, the North Sea is expensive, and as Bibby have shown perhaps not even profitable for a third player. McDermott want to get the 105 working in the North Sea, but having Boskalis or DeepOcean owning the Bibby DSVs gets them covered on that front without being exposed to the OpEx risk which they have no work in the region to cover so would be starting from scratch. DOF won’t want assets that old and would only be buying backlog of which there isn’t much.

Without any material backlog I don’t see any private equity bidder coming in period. It leaves them 100% exposed to execution risk and market recovery and the very real possibility of losing everything, and to be clear they would have to offer the bondholders something at least as good as £50m cash. Also for the bondholders advisers’ PE companies require due diligence and conditonal closing clauses that they simply don’t want to take execution risk on.

Such competing theories may also be irrelevant: last week (as I noted here) a large buyer of the Bibby bonds sent the price up. If that buyer was Boskalis, and I suspect it is, they may now own enough bonds to dominate (or at least block) the restructuring talks anyway and any competing proposals would be a waste of time. In that case all that is going on here is the protocols required to close this as a deal. In such a scenario Boskalis have probably also reached out to Barclays, who as owner of the revolver just want their money back quickly and will work on any constructive financed proposal to get out rather than risk having to recover their funds from a liquidator. The inability of BLG/BOHL and Barclays to agree a deal that was outlined in the 2016 YE results shows you exactly where Barclays are with this and they are an important stakeholder. It would also highlight this was essentially a hostile offer because the Bibby Town Hall recently, where Sir Michael reassured the staff about their solution, would not have taken place (or would have had a different tone).

So this could happen very quickly because the bondholders now have the certainty of a number and a credible counterparty, and the only internal/competing proposal is not “fully financed” in investment venacular i.e. the BLG shareholders don’t have an investor or an agreement in principal with the bondholders to renounce a proportion of their debts. My broad understanding, and only lawyers can answer these questions definitively, is that the bondholders and Barclays are within their rights now to call in the administrators, or will definitively be able to when results are due in the next few days. The vessels must have been revalued now so there is no place to hide and brokers giving valuations will be aware of their position so will be extremely realistic. The bondholder advisers then will simply seek irrevocable undertakings from the majority of bondholders to back the Boskalis deal, this would save the execution risk of a bondholder vote and this may have already been done, then agree a final deal with Boskalis. The they will call in the administrators with the deal being done at the same time. In legal terms it would all happen in a couple of hours as the major agreements will have been prengotiated and documented and the firm may have a small period in administration while the execution period vests (e.g. formal bondholder vote and Boskalis will seek to novate contracts for work).

This isn’t meant to be a definitive guide as to what will happen but it is a likely scenario and the final version will not be too different. There are numerous specific legal hurdles that must be covered and all insolvencies are different (I am also not a restructuring expert but I have been involved in some so this is broad rather than specific guidance), but I don’t believe the path will be materially different from the one I have outlined unless Boskalis pull out (and they have no reason to here because they are in control of this process).

Boskalis and DeepOcean show how much the market has changed since the oil and gas work dropped and how building up from a low cost windfarm environment has allowed them to take advantage of these opportunities. Both firms have the backlog and work that will allow them to trade the DSVs as peak SAT assets in the North Sea summer, doing diving work and minor project work only and the core maintenance work that Bibby used to do almost exclusively.

Windfarm work in the UK is getting deeper, some of the newer installations are at a depth of 60m which is pure SAT diving work, and work that was is on the margin of SAT or air diving can be carried out by  the Sapphire and Polaris economically given the purchase price. Without that base of windfarm work to spread the OpEx over it is very hard to see how a third major 2 vessel SAT diving player could survive in the UK North Sea because it is clear the Technip and Subsea 7 will protect market share aggressively in a quiet period for oil and gas. DOF Subsea could be expected to bid more aggressively but there is no certainty here as a few staff moves lately make it clear they are backing away a bit.

That will leave Technip and Subsea 7 to the major construction projects and who will hopefully be able to introduce some pricing sanity. Boskalis will do the lower end IRM work that Bibby used to specialise in, keep the cost base at an appropriate level, and yet still support companies like McDermott who need DSV support for SURF work but don’t have commit to running a DSV fleet.. This is a microcosm for how the whole offshore contractting industry will adapt to lower for maybe forever.

As I have said before in The New Offshore all that matters is: liquidity (a derivative of backog), strategy, and execution.

Bibby to Boskalis looks likely…

I have been told by mutliple credible people now that Boskalis are negotiating directly with the Bibby Offshore bondholders to purchase certain assets of the company that would in effect be the refinancing of the company. Booskalis are pitching at around .30 which values Bibby Offshore at c.£52m if true. For that they would get the Sapphire, Polaris, and all intellectual property etc and simply collapse the North Sea business into their current operations. The rest will be left for the creditors who will make a minimal recovery.

Despite the fact the bonds have recently traded at .39 if I was a bondholder I would jump at this offer and be running to find a pen to sign. The only other option is likely to involve them putting money in or a hugely dilutive liquidity issue (like the Nor Offshore one). Instead this is clean and well above any possible recovery they would get in a liquidation event.

The London high-yield market will get a timely reminder that covenant light issues have real risks. The Bibby shareholders took a £39m dividend when the bond was issued and another £20m at the start of 2016, at that stage they must have known the order book was empty,  in the end the company lost £52m at the operating profit level that year. As I have said before at that stage this event, or if it doesn’t happen one similar, became only a matter of time. Bibby Offshore may not have created as much value as Bibby Line Group would have dreamed only a few years ago but they have still done okay out it, whereas bondholders who in effect lent a non-ammortising loan on depreciating assets at the peak of the market, have suffered severe losses. They should be thankful however because a Nor scenario that saw them taking delivery of the Polaris and Sapphire in this market would have seen losses I believe as high as 90-100%.

It will be very interesting to see what happens to the Topaz. I suspect Boskalis don’t need it and will seek a charter that is 100% risk based if at all. I could be wrong on this as they have substantial North Sea operations and windfarm backlog that could use the vessel in a support role. Either way Bibby will revert to a small UK 2 or 3 x North Sea DSV operation supporting the Boskalis operations in Europe with management 100% dominated by Boskalis.

Whether this is in effect a hostile offer or is supported by Bibby Line Group I don’t know. I would struggle to see it being friendly given it would wipe out BLGs equity entirely but it would be the best thing for the company and provide a degree of security or at least certainty for those involved. The bond requires, according to my broad reading, only that interest payments are current and that BOHL has £10m, so a struggle whereby the necessary administration is delayed for a situation that cannot be changed would help no one. Waiting until December for an interest payment that cannot be made (interest accruing at c. £35k per day), or for the cash covenant to be broken allowing the bondholders to act, would be disastrous for their postion. The only thing I am sure of here is that some very expensive lawyers from both sides will be reviewing the bond indenture very carefully.

A competing offer from private equity looks unlikely as they simply do not have the contract coverage Boskalis does to risk some overhead on the vessels. Boskalis can probably release some chartered tonnage and have the DSVs work as ROV vessels on some of their windfarm projects if needed. For Boskalis this is a very sensible acquisition that offers upside only for them really with very minimal risk on running costs.

This will not take long to play out. When the BOHL financials are released it will all become obvious because if the assets have been revalued at anything like market levels it won’t just be a liquidity issue but a solvency one forcing the Directors to protect the creditors, and highlighting how close they company is to running out of actual cash. Resolution by the end of August is my prediction here.

Tidewater, European banks, and zombie companies…

You walk outside, you risk your life. You take a drink of water, you risk your life. Nowadays you breath and you risk your life. You don’t have a choice. The only thing you can choose is what you’re risking it for.

Hershel (The Walking Dead)

Tidewater announed their restructuring today… as is widely reported they have written off USD 1.6bn of debt and reduced operating lease expenses by USD 73m. US Chap 11 isn’t perfect, and having nearly been on the receiving end once I find it amazing that US courts will claim jurisdiction essentially on the basis of a US domestic dollar bank account and Delaware address (which clearly isn’t the case here), but it is remarkably efficient from a macroeconomic perspective.

Last week The Economist published an article on Zombie companies noting:

there is a growing belief that the persistence of zombie firms—companies that keep operating despite a poor financial performance—may explain the weak productivity performance of developed economies in recent years.

An inability to kill off failing companies seems to have two main effects. First, the existence of the zombies drives down the average productivity level of businesses. Second, capital and labour are wrongly allocated to such firms. That stops money and workers shifting to more efficient businesses, making it harder for the latter to compete. In a sense, therefore, the corporate zombies are eating healthy firms.

… [the] analysis builds on the work of an OECD paper* published earlier this year which found that, within industries, a higher share of capital invested in zombie firms was associated with lower investment and employment growth at healthier businesses.

A fair summation of European shipping and offshore at the moment if ever I read one.

The contrast with the European shipping and offshore firms, where the banks have constantly tried to pretend that insolvent companies are viable by allowing them to pay interest only and deferring the principal payments, and the willingness of US firms to restructure and move on is clear. Part of it is structural as US banks have a smaller percentage exposure to these troubled assets but that doesn’t change the outcome. Quite how long auditors are going to allow this to continue when there are clear market based transactions with demonstrable asset values is anyone’s guess but eventually these loans will default. I agree with short-term measures, the equivalent of a liquidity rather than a solvency crisis for firms, when it really is that but with depreciating assets eventually the bullet payment is due and years into these situations the arguements for writedowns on a scale not yet seen is becoming more apparent.

The Nordic banks have been through this before during the Nordic Banking Crisis (1988-1993) having overextended themselves in real estate loans, in this case the credit bubble was driven by deregulation, like offshore shipping with a high oil price, the boom was procyclical.

Nordic Banking and Real Estate 1988-1993

Nordic Banking Crisis Data.png

As can be seen a reduction in asset values leads to a dramatic reduction in the amount of bank credit. The same thing will happen in shipping in offshore, despite it being a much smaller part of the overall bank loan books, and this reduction in credit is likely to permanently impair asset values. Economists have called this process the financial accelerator and it is clearly interacting between the banks and zombie offshore and shipping companies.

The sceptic in me thinks only a combination of liquidations, writedowns, and scrapping is going to return these sectors to an economically viable level. But the actions of the various stakeholders, individually rational but collectively irrational, the collective action problem I have mentioned here before, makes this unlikely. A future of low profitability and structural overcapacity in Europe beckons while restructured American companies with clean balance sheets look to be able to move ahead with a cost base that matches the operational environment.

North Sea refinancings continue… Volstad and Bibby edition

On Monday the Bibby Offshore bonds jumped from £0.32 (implying Bibby Offshore was worth £56.0m) to £0.39 (implying a value of £68.3m), the only tangible cause would appear to be the refinancing of Volstad Maritime which would give Bibby continued access to the Topaz as the Volstad Subsea bond was redeemed in full. The two companies make an interesting contrast as to how a likely refinancing will happen at Bibby.

I note that far from being a fringe opinion when I raised it early this year Bibby Offshore management have now accepted they need to change the capital structure to make the business sustainable. That means a restructuring event. However, the business still looks unprepared for the scale of change required in order to attract sensible amounts of new equity:  for example until recently there were 21 people in the US office which has had less than 30 days work in 2017. As early as Nov 16 that office should have been shut down and an agent appointed to sub-lease out the building, instead they have blown at least USD 3m in OpEx, with nothing to show for it and flown a new senior manager over just weeks before the cash crunch bites.

A refinanced Bibby Offshore, if it happens and I think it is a real if, will revert back to being a two, maybe three, North Sea DSV operation. Maximum 80 people and an Aberdeen office only. Quite how the musical chairs in management play out in the new structure is beyond me, but the days of effectively one Board per DSV are gone. Not even the UK operation is making money so any re-financing relies on new money accepting a “market recovery” will come in 2018, because without it you need GBP 20-30m in OpEx just to keep the doors open. As I have said before there is no backlog and that is the problem. The US, Singapore, and Norwegian offices are just vanity projects and if there is no structural way to close them through a pre-pack then the re-financing will fail.

Investors who believe the share pledge, Sapphire, and Polaris, the only security behind the bonds would be worth GBP 68m are either delusional or have not been following vessel values closely. The maximum in a fire sale for those 2 vessels is likely to be USD 30m excluding the running costs for the six months it would take. The business has fixed assets of £35-40m on a non distressed sale basis, but requires £20m OpEx for 1 year to access their full value, putting a value on that is very difficult because in a poor year (like this year or the year before) you have just blown £20m on Opex and clearly the business has negative value.

The Bibby bondholders face a realistic recovery of 5-10% of their initial investment under a bankrupcy scenario and this fact alone may convince them to put some money in for OpEx to try and see if time will buy them a higher recovery rate. But they will not invest anything like the current running costs of the company and therefore they will need a legal change in the structure and something significant to the cost base going forward.

I note that the funding Bibby Line Group made available (subject to Board approval and definitely not unconditional) was roughly equivalent to the Dec interest payment and ROV interest. It may be a coincidence but I think likely this was done only to help strengthen the BLG position in any negotiations, because if they miss a single interest payment the company is not theirs but the bondholders. Another poor year of trading results have made this a relatively pointless gesture. Remember BLG is only agreeing to guarantee Barclays a secured portion of the revolver facility, they are not actually injecting money into Bibby Offshore. In the Tidewater and CGG restructurings shareholders not putting in new equity have ended up with less than 5% of the equity and given the scale of the writedown bondholders will take here similar formulas will be used, I find it hard to see a meaningful role for Bibby Line Group in the restructured entity because they simply don’t have cash required for a significant recapitalisation.

Volsdtad on the other hand was another classic Norwegian restructuring. It doesn’t solve anything permanently but buys some headroom and financial flexibility. The real surprise was redeeming the bond in full which valued the Topaz at USD 60m if viewed as a standalone transaction. Clearly it wasn’t that but was blended in the overall cost of the equity injection from the Saevik family. The bondholders appear to have done well out of this as the bonds have traded as low as the mid-30s and large chunks I understand traded in the 40s recently, being redeemed at par was infinitely preferable to taking the Topaz in the current environment.

But Volstad has five other highend CSVs, three with a blue chip charterer with multi-year 365 contracts. If there is a recovery these assets will be a part of it. The risk of course is that Helix renew at dramatically lower charter rates or choose alternative tonnage, very easy now, which is all but a certainty even if they love the vessels. Some press reports tended to indicate a parachiol Norwegian element to the transaction but effectively the Saevik family paid USD 36m for a 49% share that gives them exposure to USD 540m of assets. If Bibby don’t make it, and the Topaz isn’t sold quickly, I guess the vessel can go into lay-up and the other five vessels keep ticking over. But the big contrast is that with the amount of backog the new investor is taking some risk on the asset price over time but no short term risk on OpEx as the is in the majority covered. As with DeepOcean you need backlog to successfully refinance in this market I would argue.

Long term however I am not sure Volstad shareholders are in a materially better place than the Bibby bondholders:  There are a large number of large CSVs either idle or entering lay-up, Bibby get rid of the Ares next week and the Boa vessels are available for example. Unless there is a fundamental increase in demand there are simply too may vessels and their capital value will remain below their contracted debt levels, the windfarm work that many are gravitating to covers OpEx only without even a basic contribution to drydocking.

The Saevik family have already achieved a similar result with the financial restructuring of Havila. It may give a runway until 2020 but this is a business that for Q1 2017 still lost (exclusive of restructuring charges NOK 100m) for 26 vessels 9 of which are in lay-up. But the link to Bibby is that with a poor order book Havila raised more in equity capital than it had to write off in debt and while every case is different it shows the scale of the challenge Bibby have in restructuring. The contrast between the Saevik and Bibby families could also not be greater: the Saeviks who have diversified interests in ship contruction and property, are investing equity, pure risk capital, as a core part of deals they are involved in. Instead of Michael Bibby flying to Aberdeen and telling staff the capital situation will be sorted it would be good to see them issue a corporate guarantee to all staff and small trade creditors of Bibby Offshore that regardless of circumstances they will not see them suffer should the worst occur.

Longer term I still feel that the European owners are positioning themselves poorly compared to the US counterparts. All the US deals involve significant writedowns on the secured elements of the debt whereas Havila, SolstadFarstad etc just involve deferral of the largest parts. Volstad will face the same issue when the Helix charters come up for renewal without a dramatic, and very hard to see, change in market circumstances.

Backlog is essential for re-financing…

“Just because you don’t understand it doesn’t mean it isn’t so.”
― Lemony SnicketThe Blank Book

The directors of such [joint-stock] companies, however, being the managers rather of other people’s money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own. Like the stewards of a rich man, they are apt to consider attention to small matters as not for their master’s honour, and very easily give themselves a dispensation from having it. Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company.

— Adam Smith (1776)

Subsea 7 purchased the remnants of EMAS Chiyoda last week in a tale that highlights how not getting your timing right can be an expensive mistake in subsea. Chiyoda have probably decided to stick to stuff they know something about this time.

Contrary to my earlier remarks I think the Subsea 7 is an okay defensive deal. The Gulf of Mexico is a growth deepwater market (one of the few) and the weakest one for Subsea 7, and in addition they bolster their position in the Middle East. Backlog for Subsea 7 was virtually static in the last quarter which highlights why they need to take such aggressive steps to prop it up, the downside is they have added to their fixed cost base at a time of declining demand and project margins. There is an outside risk as I have said before that the backlog was poorly tendered and there are integration risks associated with the delivery, but Subsea 7 is one of the world’s best engineering companies and probably consider this manageable.

But it was backlog that drove this more than any other consideration I would argue…

Another deal, Project Astra, is kicking around the distressed debt houses at the moment and this is a deal that comes with pipeline more than backlog: the refinancing of Bibby Offshore.  I think Bibby have left it extremely late to raise capital like this in what is actually a pretty complicated transaction. If executed as planned it will involve a substantial writedown of debt by the bondholders in addition to a liquidity issue. The real question is surely why an interest payment was made on June 15 almost simultaneously along with an IM seeking capital? Surely a business in control of this wouldn’t be paying bondholders interest while trying to organise a liquidity issue?

The answer is that far from Bibby Line Group (“BLG”) being a supportive shareholder they are actually the major problem here as this process starts the recognition that their equity value in Bibby Offshore Holdings Limited is worthless. BLG had every reason to try and believe, against all the available evidence in the market, that this was going to be a quiet year. After losing £52m at operating profit in 2016, having no visible backlog, and clearly no firm commitments for work, they instead sanctioned the Bibby Offshore ploughing forward into what is effectively a financial catastrophe. The BLG Portfolio Director is a chartered accountant and frankly should have known better: management wrapped up in the situation cannot pretend to be objective but that is what a Board, and financially literate Chairman, is for.

Instead, and clearly given the asymmetric nature of the payoff to BLG as shareholders, they sanctioned what can only best be described as bizarre financial decisions, all driven to try and protect the BLG shareholders against the interest of the creditors, which frankly from Sep/Oct 16 should have been the primary concern of the Directors. However, they are only human and when their employer is the shareholder it has placed the majority of the Executive Board in an invidious and conflicted situation.

Unless you are a full EPIC contractor subsea contracting is essentially a regional business and to justify the head-office an integration costs you need to add significant scale and value in the regions you are in. Bibby Offshore HQ offers none of this and new investors participating are merely prolonging this charade, like the Nor Offshore liquidity investors they will be buying something the literally do not understand.

In addition to the obvious and valid questions as to the structural market characteristics Bibby Offshore is involved in Bondholders, now presented with what is in effect an emergency liquidity issue or administration, must be wondering inter alia:

  • Why the ex-COO has been sent on an ex-pat package to Houston to build-up the business when they are facing an imminent liquidity crisis? (Fully loaded this must be close to USD 500k per annum including house, airfares etc? Madness).
  • Why they should pump liquidity into a North American operation that has no competitive advantage, no backlog, and having had the best DSV in the GoM this year has managed to win less than 40 days work?
  • Why the BOHL is holding the value of the DSVs on the balance sheet at over GBP 100m when it is clear that their fair value is worth considerably less? It would be interesting to see the disclaimers brokers have provided for this valuation because should the capital raised be insufficient to carry BOHL though to profitability the delta between those values and realised values are likely to be very sore points of contention by those who put money in this. The Nor Offshore and Vard vessels provide ample proof that these assets are effectively unsellable in the current market and if the have to sold down in Asia/Africa/GOM those two DSVs would be lucky to get USD 25m and substantially less for a quick sale
  • Why there is a Director of Innovation and Small Pools Initiative when the core UK diving business is going backwards massively in cash flow terms? Why in fact are there 3 separate Boards for such a small company? Has legal structure been confused with operational structure?
  • Why the CEO’s wife is running a “Business Excellence” Department when the overhead is well over GBP 20m per annum? It might sound like a minor deal but as the lay-offs have increased it has clearly become a huge issue for staff working inside the business and it is like a cancer on morale

These extra costs are in the millions a year and add to the air of unreality of the whole proposal.

DeepOcean was another company with a lot of IRM type work but managed a successful refinancing. Management and staff all took a pay cut and built up a huge backlog in renewables and IRM work prior to seeking a refinancing. Potential investors there face execution risk on project delivery but can model with some certainty the top-line. The same just isn’t true at Bibby although the cost base can be shown with a  great deal of accuracy and there management have taken no pay cuts and the cost cutting doesn’t seem to have reflected the seriousness of the downturn.

No one should blame the management but rather a supine and ineffective Board that have allowed this situation to develop. None of the potential investors I have spoken to look like putting money in. It makes much more sense to try and “pre-pack” the business from administration than go through the complexity of a renegotiating with the bondholders and getting a byzantine capital structure in place in which they do not share all of the upside.

The reason all these issues collide of course is a classic agent-principal conflict: In a market where activity has declined so markedly to raise money to invest in developing new markets is verging on the absurd. Bibby Offshore is losing money in Norway and the US, has a minor ROV operation in Singapore which is unprofitable most of the time, and has seen a significant decline in the core UK diving business. The logical strategy is therefore to strip it back to basics, but that means the people negotiating the fundraising would be out of a job and therefore the strategy they have devised, not surprisingly, is more of the same and hope the market turns. This has suited the shareholder for the reasons outlined above.

Like so many companies grappling with The New Offshore Bibby is a very different company to the one that raised cash in 2014. Back then there were 4 North Sea class DSVs all working at very high rates in addition to the CSVs (and two DSVs were chartered adding extra leverage). Now not even 2 DSVs are close to break-even utilisation and the CSV time charter costs are well above any expected revenue. Returning the Olympic CSVs will cut the cash burn but merely reinforces the fact that the business no longer has an asset base that offers any realistic prospect of the bondholders being made whole (the drop in the bond price in the last few weeks confirming they now realise this).

It is in-short a mess, and one the BLG Portfolio Director and NED more than others should be placing their hand in the air to take responsibility for. It was obvious when the £52m operating loss was announced that a restructuring was needed, particularly in light of what was happening in Norway, and leaving it this late to raise funds. To pretend a fundamental structural change is not required, is simply irresponsible.

I had five years at Bibby Offshore, 4 of those were the most rewarding of my professional career to date. It gives me no pleasure to write this but I can’t help feeling the path that has been taken here risks seeing people not getting paid one month while on the BLG website will be a big article about how they sponsored a mountain walk to Kenya and highlighting their credentials as a good corporate citizen. But it is also true by the end I did have an issue with the strategy, which when you are notionally in charge of it becomes a big issue. The company shareholders insisted on a 50% of net profit dividend strategy, which in a capital-intensive industry when you were growing that quickly meant there was constant working capital pressure yet alone expansion capital. Yet every year at the strategy planning meetings we were expected to present ambitious growth plans where capital was no object, except it always was. Over the years the farce built up that when multiplied by easy credit has not worked out well. What this translated to at the Bibby Offshore level was a management team who wanted to build another Technip without anything like the resources needed to realistically accomplish this.

I used to constantly try and explain the benefits of “plain vanilla equity” but it was simply not what the shareholders wanted and it was clear at Group that they were already concerned about the size of Bibby Offshore in relation to the overall holding company. This culture of unrealistic planning has formed the basis of which constantly missing numbers hasn’t sent the right warning signal to the Board about the scale of the impending losses in the business despite it being blatantly obvious to ex-employees.

What the BLG shareholders wanted was to do everything on borrowed money, which is fine if it’s your business. But this attitude led to the Olympic charters and fatefully the bond, which in itself was a dividend recap taking GBP 37m out, and it of course left the business woefully undercapitalised in all but the best of conditions.

Bibby Offshore as a company would have had the best chance of surviving this downturn if it had approached the bondholders early about the scale of the problem, stopped making interest payments and saving the cash, had a meaningful contribution from the shareholders at a place in the capital structure that was risk capital, and approached Olympic about massively reducing the charter rates while extending the period of commitment (this would have been complex but the banks were realising 2 years ago they needed deals like this as Deepsea Supply showed). These are the hallmarks of all the successful restructurings that have been done. Instead for the benefit of the shareholders they took a massive gamble that the market would comeback and had a spreadsheet showing it was theoretically possible in the face of common sense. The consequences of this are now coming home.

Bondholders of course only have themselves to blame, The Bibby bond was a covenant light issue and was essentially bullet redemption on depreciating fixed assets, a risk all financial investors know deep down is just gambling. Confident in the mistaken view that BLG would step in the bonds have held up unnaturally in pricing for an eon while the company continued to burn through cash at a rate that should have worried any serious investor. They have now been presented with a nuclear scenario where they must put something in or face potentially nearly a total write-off of their investment, a quick look at the Nor bonds and asset situation only strengthening Bibby’s hand.

London is awash with distress credit investors at the moment who are long on funds. Many are traders and hopeful of entering a position with a quick exit to someone else, and they may get this deal away with people like this. But it is a very hard sell because unlike DeepOcean there is no backlog only pipeline, and one is bankable and the other is not.

 

The New Offshore…

Another great graph from Rystad on Friday highlighting increased productivity in shale:

Rystad Av IP30

Offshore isn’t going away as this graph makes clear:

IEA Energy Mix June 2017

But it is going to be different, and the “Demand Fairy” isn’t going to make it like 2014 quickly:

IEA Capex

Change at the margin of an extra 1 or 2% of shale as a share of the energy mix will have a major effect on offshore utilisation and day and day rates. Offshore needs to deal with overcapacity on the supply side and the increasing productivity of shale which will only continue.

Liquidity. Strategy. Execution. Nothing else matters. The New Offshore.