Corporate finance Borr Drilling style…

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

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

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

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

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

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

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

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

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

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

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

Built to last .png

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

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

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

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

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

 

Hindsight Offshore: McDermott Amazon

Way back in February 2017 I asked how good a deal McDermott buying the Amazon really was?

Here is the answer in their latest results… and it is that it was not that good a deal:

On July 27, 2018, we entered into agreements (the “Amazon Modification Agreements”) providing for certain modifications to the Amazon vessel and related financing and amended bareboat charter arrangements. The total cost of the modifications, including project management and other fees and expenses, is expected to be in the range of approximately $260 million to $290 million.

So they got a deepwater lay vessel finally for $310-345m including the initial purchase price. I would say Saipem got a much better deal on the Constellation (€250m) if they can ever get any work for it (and given their strained relations with Aker on North Sea work the real winner in that deal were the banks).

McDermott face trying to break into the UDW installation market with that asset in order to have any hope of recouping that level of investment, and although they have vast technical expertise the fact is most of it is in shallower water, and the only way someone is going to hire them for UDW work is for them to be cheap. SS7, Technip FMC, and Saipem all have substantial excess capacity in this regard. Entering this market will also require vast amounts of working capital, something McDermott clearly lacks at the moment. They are going to have to take delivery of the new vessel and associated kit in an oversupplied market with no backlog of note with the only certainty being the lease payments on a ~300m worth of kit (and use this to fund a loss making onshore construction business).

The Winners Curse.

A f&*^up of immense proportions….

You know it takes a lot of gumption to put this statement out…:

We are ahead of our plan to become a premier, fully integrated, global EPCI provider, with product solutions spanning on-shore and off-shore from concept to commissioning

When you have just written off ~$750m, burned through operating cash of $221m in the quarter,  have had to undertake a capital raise (~$300m in private redeemable share placement and increase working capital facilities), and sell businesses with $1.5bn in revenue… McDermott shares at the time of pixel are down around 45% to $7.

Which part of the plan was that?

The MDR and CBI merger was always about stopping someone buying them. Instead, as was obvious at the time, they have ended up with a bunch of on-shore, low- margin, construction contracts, which management didn’t know enough about to due diligence properly. There is no return from here. McDermott will never have enough capital now to compete as a new entrant to transition into deepwater as a tier 1 player, and never have sufficient skill to bid the CBI business properly. You can start to write their obituary now. In time the offshore business could well be sold to Subsea 7 for a fraction what they gave it  away to the CB&I shareholders for.

Shale and structural change…

The graph above is from the IEA’s most recent energy report. No huge surprises for anyone reading this blog but the historical comparison is interesting. When someone tells you that offshore isn’t facing structural issues this graph would be a good data point to discuss. The IEA is also sounding more confident of shale becoming cash flow positive although as I have said I don’t think that is a big issue. My scepticism of plans that involve buying a load of ‘cheap’ offshore assets and waiting for ‘the inevitable’ recovery continues to grow…

Satire is dead…

I just want to remind myself in the future that Dennis Rodman, sponsored by a crypto-currency company seeking to transact in legal marijuana transactions, went to assist Donald Trump negotiate with North Korea. I didn’t see that coming. Love the photo as well,

Shale productivity, oil prices, and marginal demand…

The quote above comes from the CFO of NOV Global, Clay Williams, in 2011. Clearly he understood the transformative nature of shale before many (as well as putting it as eloquently as anything I have ever read). The question for a long time for many was when will shale stop getting funded? But actually the shale revolution is beyond quetion now and the real question for offshore in a era of rising prices again is what proportion of new investment is directed to offshore versus onshore? Particularly for asset owners with high fixed running costs, and rates at below cash break-even on an annualised basis, what is likely in the short-term?

One of the reasons shale continued to be funded wasn’t just rising oil prices it is because capital markets in the US are efficient enough to support business models with high rates of productivity improvement even if the payoff is not immediate. This recent presentation from Helmerich & Payne, the largest US land based driller, shows why:

HP Well efficiency.png

H&P are targeting a 40% increase (as a stretch goal) in efficiency/productivity, an outcome that would further rapidly enhance the economics of shale. Not only that they are doing it with an assumption of pricing power for the drilling contractor where a 20% improvement in efficiency in operations for the customer leads to a 33% increase in their prices (15k-20k), and the next 20% increase brings them another 25% (20k-25k). With these sort of possible productivity improvements, and a much shorter payback time, it is hard to see a freeze in capital funding anytime soon, and in fact at current prices the investment boom is self sustaining anyway. This incremental learning-by-doing and constant improvement is a core part of manufacturing efficiency and has become part of the standard DNA of manufacturing companies (for a fascinating look at how this came to be in the car industry read The Machine that Changed the World). Deming would be proud.

Those sort of productivity improvements, on a per barrel delivered equivalent basis, are the competition for offshore production at the margin for project investment decisions. I continue to believe this will favour much larger, high volume, offshore fields over shallow water developments. Offshore faces the hurdle of clong lead times that were previously just assumed as an unavoidable part of the oil basis. A blog post for another day is the insights behavioural economics offers to this.

Pioneer Natural Resources also came out this week talking up their productivity:

Pioneer Improvement.JPG

This data point is interesting and is the crux of future demand across the offshore supply chain:

Shale rigs vs offshore.JPG

That index ratio is really what will drive the strength of any offshore recovery. Since May 16 up until January 18 rising oil prices (much slower than currently) were met with a massive increase in the shale rig count and continued decreasing demand of the offshore rig count. In May 16 the price of WTI was ~$44.00 and Jan 18 the price of WTI ~66.60 so a ~51% increase in the price of oil was followed by a 160% in US land rigs and a 22% reduction in offshore rigs. Any statistical model of industry demand that not have this relationship in the regression is to my mind invalid. Any statistical model without a period break from c. 2014-2016 should similarly be treated with exceptional caution. The future, statistically speaking, will not be like the past.

There are a host of reasons (many covered here previously) but the argument that increasing oil prices will be met at the margin first with an increase in demand for short cycle shale seems irrefutable. Any “offshore recovery” post the shale revolution is clearly going to be very different to recovery cycles prior to this enormous investment and capital deepening process that has taken place in the last 5-7 years.

NZ bans offshore oil and gas exploration…

Hardly a move that will cause tremors among the offshore companies of the world, and I don’t think a harbinger of things to come for other places, but I was surprised to see NZ ban offshore oil and gas exploration from today.  But if if you want to understand the NZ pysche behind this seemingly Luddite stance you need to understand this comment:

James Shaw, the New Zealand Green Party’s co-leader and climate change minister, praised the move as “the nuclear-free moment of our generation” – a reference to a 1984 ban on nuclear-armed ships entering New Zealand’s waters.

And if you want to understand that comment there is no finer place to start than David Lange at the Oxford Union in 1985. One of the finest pieces of debating you will ever see, I get goosebumps watching it, and it’s hard to overstate the effect this had on NZers at the time.

Watch the whole video “I can smell the uranium as you lean towards me…”

 

One of the finest pieces of debating ever. Only 6 minutes so watch it.