For the tier 2 contractors summer isn’t coming… a long hard grind beckons…

Back in the dark ages of November 2016 a consensus was forming amongst the more optimistic of the subsea and investment community: things had got so bad there must be an upturn in 2017? M2 raised money from Alchemy, the Nor DSV bondholders did a liquidity issue, SolstadFarstad started their merger discussions, York began acquiring a position  in the Bibby bonds, Standard Drilling went back to the market to buy more PSVs (could they be worth less?), and early in 2017 on the same wave Reach also raised money… what could possibly go wrong? A quick rise in the price of oil and the purchase orders would flow robustly again… risk capital would have covered essentially a short-term timing issue and as the summer of 2017 came things would revert, if not back to 2014, at least some degree of normalcy and cash profitability. Everyone would be positioned for the next big upturn… This wasn’t a solvency issue for the companies involved figured the investors, this was merely a liquidity issue that they could profit from by supplying the needed funds…

Things haven’t quite worked out the way they planned. Summer, in terms of high day rates and utilisation didn’t come last year, and it hasn’t come this year with sufficient force to change much this year, but next year the true believers tell you it will be massive. Bigger than ever. You just need enough money to cover another loss-making winter to get there…

No one can know the future, although I think many of the signs were there, and a lack of any due diligence was a common theme of many of the above transactions; but the real question now is when the industry accepts the scale of the change required and the necessary exit of some capital to reflect new demand levels? Or not maybe? There is so much excess liquidity (that’s the technical term for dumb money) floating around, and the capital value of the assets in  subsea is perceived as so high, maybe another cycle of working capital to burn beckons… but certainly not for everyone. And there will be some mean reversion here but it is looking on the downside not the up.

Alchemy Partners appear to have realised this and seem committed to a quick exit from M2, the sale process appears to be highly geared to an asset only deal. Such a transaction would save them from the timing and cost of issuing a full IM, due diligence, and the time spent negotiating an SPA for a loss-making business that a self professed special situations investor cannot bring itself to commit more to. The first question anyone would ask them would be “why is one of the once great names in UK retsructuring unable to make this work?”.  Reputational risk alone for them argues for a quick process here… With XLXs going for $1.5m used Alchemy may feel they get just as much from a clean asset sale as from any possible going concern basis, when matched with the profits made from being in the Volstad Topaz bond they may not come out too badly here.

Reach Subsea have decided the numbers are so bad that their Q1 2018 results won’t appear on the website. (Reach aren’t the only people playing this strategy; for all their entrenched bureaucracy Maersk Supply can’t seem to find their numbers to put up after Q3 last year either). As a general rule in this market if you aren’t putting up numbers it’s because they are even worse than people feared.

For Reach Subsea one is treated to  the newshub with a few bullet points of “financial highlights”. It is hard to comment without seeing the full financial statements but Subsea World News appear to have seen the full numbers and say that turnover was NOK 114m and operating costs were NOK 101m ROV days sold were up 89% and EBITDA was up to NOK 13.2m. However, losses before tax were up 50% on the same period last year. This could just be an accounting convention as part of the change to a new accounting standard for leases, but with M2 unprofitable, along with a host of other ROV companies, the chances of Reach making money with exactly the same business model and service offering have to be regarded as remote.

The spot market nature of the Reach business is highlighted by the fact that their order book is at NOK 147m (mostly for 2018) which is 10%< of the amount of work they are bidding for in the pipeline. Everyone goes on about tendering but it’s a real cash cost and if you aren’t winning 30% of the work you are tendering for then you are tendering too much and just wasting time and resources. Tendering NOK 1.7bn in work implies Reach Subsea should turnover about NOK 600m this year, with their firm pipeline at NOK 147m in Q1 that has seem a long way off.

All these companies are doing is providing capacity at below economic rates of return and burning OpEx in a way thay ensures the industry as a whole cannot make a profit. Eventually investors, not usually management because these are lifestyle businesses, tire of this. ROV rates are such at the moment that even though most are purchased with only a 20% deposit operators are not making enough to cover the deposit on a new one when they wear out. Eventually the small players get ground out because even if they can survive in operational terms hopes of replacing equipment becomes a fantasy. This is how the industry appears to be reducing capital intensity.

I have expressed my scepticism consistently on the ROV industry on many occassions based on one simply premise: Oceaneering. Oceaneering is the market leader, widely regarded as a well run company and has signficant economies of scale and scope, and even they can’t make money off ROVs. Neither could Subsea 7 in  the i-Tech division… so how on earth are all these small companies going to make money? All they can sell on is price, and there is sufficient overcapacity to ensure the E&P companies play all the tier 2 contractors off against each other. To my mind this is one of the drivers of increased tendering that all the tier 2 contractors claim while their numbers become even worse.

Oceaneering is by an order of magnitude the largest ROV company in the world:

Oceaneering market position.png

And yet with all that scale cash flow is getting worse:

Oceaneering FCF.png

That’s not a reflection of Oceaneering management that is a reflection of market conditions. And if the largest company in the industry can’t get any uplift then the small companies, with no pricing power, are also operating at a significant loss without the resources of the larger companies. Talk of other companies doing a buy-and-build strategy in the ROV market is just laughable given the sheer scale of the top 5 companies controlling more than 50% of the market. Someone got there first 10 years ago, and executed well, this isn’t the market for an imitator it is  the market for large industrial players to grind out market share.

What is happening, and will continue to happen, is that those companies with scale and resources will continue to grind out market share and volume by pricing at whatever they can get (in economics terms below marginal cost) and they can keep this game up longer as they have more resources. It is just that simple.

DOF Subsea, DeepOcean, and Reach Subsea, have within days of each other announced they have framework commitments from Equinor. Such “contracts” (in the loosest sense of the word only) guarantee no work just a pricing and standards level from the contractors. The only obvious economic implication from this contracting method is that Equinor believes it doesn’t need to cap it’s costs going forward as overcapacity will keep rates down. Equinor is keeping it’s options open and help keep some small Norwegian contractors alive to prevent SS7 from Technip from strangling them, but it’s generosity appears limited. (It should also be noted Saipem/Aker appear to be making real moves now to bid the Constellation and Maximus in Norway so even tier 1 rates there look set to suffer.)

DeepOcean is the one company that appears to really be on the point of being regarded as a tier 1 contractor in terms of IRM and renewables scale. Acquisitions at the bottom of the market in Africa and the US, a smart charter of the Rieber vessel, and a large European business with a strong renewables business have probably given it enough scale to be regarded as in a different league now from the smaller companies. But it shows the size of commitment a buy-and-build strategy would require and the industry simply doesn’t have enough inherent profitability to make it worthwhile. A point Alchemy have now implicitly acknowledged and their commitment to the socialist idealogy of helping E&P companies lower maintenance costs by supporting them with investors funds seems to have ended. DeepOcean should probably be regarded as the minimum efficient scale a company in this market needs to be to survive, a vast mountain to climb for any investor coming in this late no matter how cheaply they buy some kit.

For all the tier 2 contractors there is no respite. Pricing pressure will remain extreme, they have identical business models and assets, there is no scope for differentiation, and capacity far outstrips any reasonable expectations of demand inceases. Make no mistake Alchemy won’t be the first to throw in the towel and other investors need to think what they know that Alchemy Partners doesn’t? For as long as the industry can find investors willing to believe the downturn is a normal cyclical part of the oil industry, rather than a secular change where the relationship between the oil price and offshore expenditure has fundamentally changed (a regime shift in econometrics) then this seems to be the only likely outcome.

The New North Sea…

[Pictured above a sneak preview of the new (TBC) York Capital/Bibby/ Cecon OSV]

Subsea 7 came out with weak results last week and specific comments were made regarding the weakness of the North Sea market. I have been saying here for well over a year that this UKCS in particular will produce structurally lower profits for offshore contracting companies going forward: you simply cannot fight a contraction in market demand this big.

In Norway spending has remained more consistent, largely due to Statoil. But it is worth noting how committed they are to keeping costs down:

Statoil Cost reduction Q1 2018.png

A 10% increase in production is balanced with a 50% reduction in CapEx and a 25% reduction in per unit costs. Part of that is paid for by the supply chain… actually all of it. What I mean is only part of it is paid for by productivity improvements and lower operational costs… the rest is a direct hit to equity for service companies.

But as a major offshore player this presentation from Statoil highlights how efficient they have become in the new environment (and how offshore will compete going forward):

Statoil drilling efficiency.png

Cutting the number of days per well by 45% not only vastly reduces the costs for rigs it clearly reduces the number of PSV runs required to support the rig for example. The net result is that offshore is more than competitive with shale/tight oil:

Statoil break even.png

In fact Statoil is claiming its breakeven for offshore is USD 21 ppb on a volume weighted basis. It’s just a timing and economic commitment issue on a project basis to get there, but the future of offshore in demand terms is secure: it is an efficient end economically viable form of production. Especially when your supply chain has invested billions in assets that they are unable to recover the full economic value from. Demand is clearly not going any lower, and is in fact rising, just nowhere near the level required to make the entire offshore even cash breakeven.

Statoil has also changed its contracting mode which is probably part of the reason Subsea 7 is suffering from margin erosion in the North Sea. Statoil has clearly made a conscious decision to break workscopes into smaller pieces and keep Reach and Ocean Installer viable by doing this (and helping DeepOcean but it is clearly less vital economically for them). Part of this maybe long term planning to keep a decent base of contractor infrastructure for projects, but part of it maybe rational because previously for organising relatively minor workscopes larger contractors were simply making too much margin. A good way to reduce costs is to manage more internally in some circumstances, and especially in a declining market. I doubt you can be a viable tier 2 size contractor in the North Sea now without a relationship with Statoil to be honest, it just too big and too consistent in spend terms relative to the overall market size (Boskalis is clearly a tier 1 if you include its renewables business).

I still struggle to see Ocean Installer as a viable standalone concept. At the town hall recently the CEO stated that Hitecvision were in for another two years as they needed three of years of positive cash flow to get a decent price in a sale. But what is a buyer getting? They have no fixed charters on vessels (not that you need them) and no proprietary equipment or IP? All they have is track record and a Statoil relationship. In a volatile market even investors with as much money as Hitecvision must want to invest in businesses with a realistic chance of outperforming in the market?

The UKCS is a different story. Putting the Seven Navica into lay-up is an operational reflection of a point I have made here before: there is a dearth of UKCS CapEx projects. Demand is coming back in the IRM market overall but the diving market remains chronically oversupplied and this is likely to lead to much lower profits in a structural sense regardless of a cyclical upswing.

As I have said before Bibby, surely to be renamed soon if York cannot sell the business, remains by far in the weakest position now. Bibby appear to have won more than 70 days work for the Sapphire but that is just the wrong number. Bibby are caught in a Faustian pact where they need to keep the vessel operating to stop Boskalis getting market share, but they have no pricing power, and are not selling enough days to cover the cost of economic ownership on an annual basis. The embedded cost structure of the business overrides the excellent work on the ground the operational and sales staff do.

Boskalis with a large balance sheet are clearly using this year to get out and build some presence and market share. The operating losses from the Boka DSVs won’t please anyone, but would have been expected by all but the most optimistic, and all that is happening is they are building a pipeline for next year. Coming from Germany and the Netherlands, areas more cost-focused, gives them an advantage, as does their deep experience and asset base in renewables. Boskalis know full well the fragile financial structure of Bibby and this is merely a waiting game for them.

The problem for Bibby owner’s York Capital (or their principals if the music journalist from Aberdeen is to be believed)  is the lack of potential buyers beyond DeepOcean or Oceaneering. I spoke to someone last week who worked on the restructuring and told me it was a mad rush in the end as EY were £50m cash out in their forecast models of the business (which makes the June 17 interest payment comprehensible). This makes sense in terms of how York got into this it doesn’t help them get out, and frankly raises more (uninmportant) questions, because it was obvious to all in the offshore community Bibby was going to be out of cash by Nov/ Dec 17 but not to the major owner of the bonds? Bizzare.

Internally staff don’t believe the business is in anything other than “available for sale mode” because the cost cutting hasn’t come, the fate of the Business Excellence Dept is seen as a talisman for the wider firm, and there is no question of money being spent on the needed rebranding by year end unless required. A temporary CFO from a turnaround firm continues without any hint of a permanent solution being found for a business that continues to have major structural financial issues.

Managers at Bibby now report complete a complete lack of strategic direction and stasis, it would appear that winning projects at merely cash flow break even, with the potential for downside, is making the business both hard to get rid of and the current shareholders nervous of where their commitments will end. Any rational financial buyer would wait for the Fairfield decom job to finish and the Polaris and Sapphire to be dry-docked before handing over actual cash, but there is a strong possibility the business will need another cash infusion to get it to this stage. And even then, with the market in the doldrums, all you are buying is a weak DSV day rate recovery story with no possibility to adding capacity in a world over-supplied with DSVs and diving companies. An EBITDA multiple based on 2 x DSVs would see a valuation that was a rounding error relative to the capital York have put into the business. All that beckons is a long drawn out fight with Boskalis who will only increase in strength every year…

On that note Boskalis look set to announce an alliance with Ocean Installer. In a practical sense I don’t get what this brings? Combining construction projects with DSVs from different companies is difficult: who pays if a pipe needs relaying and the DSV has to come back into the field for example? But the customers may like it and having a capped diving cost may appeal to Ocean Installer… it’s more control than most of their asset base at the moment.

Subea 7 and Technip just need to keep their new DSVs working. They are building schedule at c. £120k per day and peak bookings at c.£150k per day and are winning the little project work there is. Although even the large companies are having to take substantially more operational and balance sheet risk to do this. The Hurricane Energy project, where Technip are effectively building on credit and getting paid on oil delivery, highlights that what little marginal construction work there is in the North Sea will go to companies with real balance sheet and field development integration skills. I have real doubts about this business model I will discuss another day: the solution to a debt crisis is rarely more leverage to a different part of the value chain.

But services are clearly holding up better than owning vessels. The contrast between the supply companies and the contracting companies continues the longer the downturn for vessels continues. The  old economic adage that organisation has a value is true. Technip and Subsea 7, along with McDermott and Saipem, have not needed to restructure as many vessel companies have. The worst years of the downturn were met with project margins booked in the best year of the upturn giving them time to restructure, hand back chartered ships, and reduce costs to cope with a new environment. There has been a natural portfolio diversification benefit the smaller companies and supply operators simply haven’t had.

Subsea 7 for example is a very different business to 2014 (investor presentation):

Subsea 7 cost reductions.png

Staff costs down 60% and a very decent effort at reducing vessel costs despite declining utilisation (and despite reducing vessel commitments by 12 vessels):

Subsea 7 vessel utilisation.png

In the past people in susbea used to say they were in the “asset business”. Without assets you couldn’t get projects. And that was true then. Now the returns in subsesa will come from adding intellectual value rather than being long on boats, and that is a very different business. In the North Sea it will lead to a clean out of those businesses who effectively existed only as entities that were willing to risk going very long on specific assets. I count Reach, OI, and Bibby in that group. Historically the returns to their asset base, or access to it, vastly exceeded all other economic value-added for these companies. The Norwegians went long on chartered vessels, Bibby chartered and purchased them, but it doesn’t matter in the end because service returns for such generic assets as OI and Reach run are minimal and easily repliacted, and the returns on DSVs are economically negative due to oversupply in Bibby’s case. Rigid reel pipe, full field development, long term embedded flexlay contracts in Brazil, all these provide sufficient economic return to ensure long term survival (very high organisational and commitment value), and a return that will exceed the cost of capital in an upturn. But for the smaller companies there isn’t a realistic prospect of replicating this now their returns from commoditised tonnage have been so dramatically lowered.

Outside of diving Bibby, OI, and Reach all do exactly the same thing: they charter ships only when they win work, after having dumped a ton of money tendering, and bid the same(ish) solution against each other. Bibby are even using an (ex) core OI asset for a break-even decommissioning job. In the end, regardless of the rhetoric, the compete on price doing this and it is a business model with low margins because it has low barriers to entry (i.e. a lot of people can do it). Eventually in a declining or very slowly growing market that leads to zero economic margin. And as subsea has shown in Asia what eventually happens is someone takes too much contractual risk with a vessel and gets wiped out in a bad contract. This is how the North Sea will rebalance for the marginal providers of  offshore contracting supply without a major increase in demand. That is as close to a microeconomic law as you can get. They simply do not have the scale in a less munificent market to compete.

Goiung forward balance sheets, intellectual capital, visible market commitment and financial resources will all be as important as the asset base of a company. Services will be important in economic terms, they will provide a positive economic return going forward, but not all services, and not in a volume likely to outweigh historic investments in offshore assets. There is a far more credible consolidation story for offshore contracting than for offshore supply with a smaller relative asset base spread over a global service provision set to tilt to regional purchasing by E&P companies.

For the North Sea as whole, a market that provided disproportionate structural profits due to the environmental requirements of the asset base and regulatory requirements, there is also the slow but gradual realisation that the supply chain will have to exist in a vastly less munificent environment than before. Scale will clearly be important here. A market that has contracted in size terms like the North Sea just doesn’t need as many marginal service companies, or assets, and that is the sad fact of life.

Bibby Offshore restructuring: Latham and Watkins, York Capital, and DeepOcean/Triton…

Latham and Watkins, legal advisers to Bibby Offshore Holdings Limited in their restructuring, recently published a ‘thought leadership’ article on the transaction. It is a short read, and as an exercise in varying perceptions, well worthwhile if you followed the relatively shambolic proceeds that allowed the company to reach it’s current state.

I liked this line:

In early 2017, Bibby Offshore’s directors determined that the company’s capital structure had to be right-sized and that additional liquidity was required to meet the challenging market conditions facing the business.

This is a business that lost £1m a week in 2016 of actual cash. How early in 2017 did the directors determine the need for a change in the capital structure? As I noted in June 2017 paying the interest payment was irresponsible when the business needed new funding within the next few months. The fact is this transaction only started seriously in August, as testified by York claiming £200k per month for their efforts from that point (and public announcements by Bibby at that time), but by which time the business was insolvent in an accounting sense, only a going concern because they were in discussions about a transaction, and the restruucturing plan itself presented when the business was literally days away from administration as they were down to ~£2m cash.

The fact that Moodys downgraded Bibby Offshore Holdings Ltd in Nov 2016 could also have been a hint?

In fact in March 2017 the Chairman of BOHL (who later lost his job in part because of this fiasco) made this statement :

Mike Brown 23 March 2017

I guess it wasn’t that early in 2017 the Directors came to that realisation then? Like, “well positioned” apart from the fact they were running out of money? Or did they just decide to print something blatantly untrue in their statutory accounts?

Maybe this line from the CEO (25 March 2017):

CEO Bibby 25 March

This disclaimer “apart from losing £1m per week at operating cash flow level and we will therefore need to right-size the capital structure” should really have been added to make the Latham and Watkins story credible. Or maybe this one:

Bibby CEO March 2017

In case orders should increase rapidly?!!! Turnover in 2017 dropped 50% over the previous year and they obviously had to drawdown on the revolver! Surely this was obvious by the end of March (which most people calculate as nearly 25% of the way through the year)? The Bibby directors don’t sound like a group of proactively looking at a restructuring “early” in the year here. Reference to the Bibby shareholders putting money in is comedically short given the known financial position of the Group and how far underwater the equity was.

You literally cannot make this up (unless you are a lawyer I guess?).

Look, I get this is essentially a small marketing piece for Latham and Watkins (the vessel on pictured on their website isn’t even an offshore vessel, yet alone a Bibby Offshore one), and they are being diplomatic. But the truth is the Bibby restructuring was a highly uncontrolled event by a management team out of their depth and a shareholder unwilling to accept the reality of his financial situation. All the documents (since taken down) relating to the transaction were clearly drafted late in the process and reflected the power, and weakness, of York at that stage who was committed to a deal. The restructuring agreement contained wide ranging clauses designed in lieu of actual execution documents that would be drafted when more time was available. This is not a criticism of Latham and Watkins, to get a deal over the line at that stage, when it appears that Barclays had refused to extend the revolving credit facility and the much vaunted “supportive shareholder” was unwilling to put anything in, was creating a situation that would have led to an immediate administration, it is therefore a considerable achievement. But it was that close.

The reason I am going on about the past is that it is impossible to understand the dire current position of Bibby Offshore without understanding the context. I guess if you buy companies with zero due diligence you have to expect the occassional dud, and it is clear this is a bomb that has blown up in the investors face.

The crucial point is this say Latham and Watkins:

As echoed by Bloomberg’s comment on the transaction: “(….) this is about as fair of a deal for all creditors as I have seen. Parties may differ on what the future holds, but the terms of the restructuring are clear and equitable. This is a text-book restructuring (…)”.

The reason for this is clear: York and their co-investors dramatically overpaid. The rest of the creditors were happy because they couldn’t believe the terms that someone was putting money in at! The old saying that “if you don’t know who is getting screwed on a deal it’s you” is apt here. The only question now is how much money the Bibby investors lose and how quickly?

One of the great mysteries of this deal is why York, charging £200k per month for their competence and skill, allowed the business not to go through an administration process (which they would have controlled as the largest creditor), and emerge via a pre-pack debt free. The business had virtually no backlog, and as has happened in the Norwegian restructurings, trade creditors can be protected. By not doing this the business has been saddled with many of the historic obligations that now call into question the viability of the business. In particular the office space in Aberdeen and the US (both entered into at the peak of the market), residual liabilities to Olympic (the Ares redelivery costs are owing and the Olympic Bibby charter), and ROV leases and hangers, redundancy costs, Trinidad tax etc, all these costs must be paid for from current market revenues and rates which are significantly below levels when the contracts were entered into, by a business that is dramatically smaller in scale.

A quick look at the uses of the £50m rights issue shows Bibby Offshore to have solved its immediate financial problems but it has not solved the issues with its economic model. Without a substantial change in market conditions the business will require a further capital injection, potentially as early as later this year. This is a rough guide to how much cash Bibby Offshore currently has available:

Bibby 50m.png

I have made aload of assumptions here, I have, for example, no idea what the Latham and Watkins fee or EY fee is, but have made an esitmation based on London Big 4 rates. If anything I could have underplayed these, but the overall number will be correct within a few million, especially as trading losses are likely to have been higher. I haven’t included rebranding costs as York are hoping to flip this prior to dropping a 6 figure number on these. The point is this though: it is not exactly an impregnable balance sheet and unless market rates for DSVs rise substantially, and there is no indication they are doing so, it will not be enough to get to this time next year as a credible going concern. Bibby/ York realistically require victory in the (highly speculative) EMAS case for the business to have a viable financing strategy that can absorb trading losses for longer than the ~£20m they realistically have available.

I believe York confused a liquidity crisis for a solvency crisis and therefore acted as if all the business needed was a short-term cash facility. York appear desperate now to offload the business quickly to Triton/ DeepOcean. There are few other logical buyers and yet there are huge challenges if Triton/DeepOcean take on this risk. DeepOcean appear to be keeping the diving personnel on to give them some options in this area.

One challenge is contractual risk: Bibby Offshore recently won a large decomissioning job for Fairfield. I haven’t seen the exact specs, but it is probably ~30 days DSV work and ~120 days ROV work. Which is good… but … to win they have taken all weather risk, which is just gambling. They may have needed to in order to win the work, but that is taking an active decision to take risk that you cannot mitigate. It may all work out well and they could make a profit, but a bad summer and the boats will be bobbing around unpaid while they finish the work, and all to Bibby’s account. For a small loss-making, undercapitalised, contractor that is a disaster scenario. Anyone buying the company would be mad to take on this, literally, incalculable risk. Why not just wait and see what happens?

The problem for the seller is the longer the cash burn continues the weaker their position becomes and the harder raising, or justifying raising, capital will be. Bibby’s competitive position is significantly weaker than a year ago with Boskalis buying the Nor vessels. Bibby faces three very well capitalised companies who are clearly committed to the market. Any further fundraising for the company would recognise this, and the fact is that the Bibby fleet is older than comparative fleets.

There are very few investors who will continually inject new money into a micro-scale, loss making, niche business, competing against three global players with strong balance sheets, in an industry that requires vast quantities of CapEx , has over capacity issues on the supply side, with weak demand growth forecast, and a realistic chance of dropping from the #3 player to number #4. And that is exactly the scenario facing Triton/DeepOcean as well (they can capture some cost savings but how much do you pay for those when the order book is less than a year and your newest competitor has €1bn cash?).

The whole economic and market environment has changed. DSV rates look to be settling at £100-130k for the Boskalis/Bibby fleets (slightly higher for the Technip/SS7 new builds) and at that level I don’t think the business model, especially with historic obligations, works. Is there really room for four DSV companies in the North Sea market? in 2014 the Harkand boats worked in Africa to get utilisation. If not, do Bibby, currently operating at a trading loss, have a real plan to battle it out against 3 publicly listed giants, with no other plan than a market turnaround in day rates? Without CapEx work picking up the IRM space will be competitive for years.

The big surprise is how slow the inevitable restructuring has been. The US and Norwegian offices were closed within weeks (despite L&W claiming ” that it has a strong consolidated position from which to expand in the markets in which it operates”) but there are well over 200 people in Aberdeen! 3 vessels working have to cover not only the crew onboard but nearly 70 people onshore per vessel as well (and some very expensive consultants to boot at the moment). That is totally unsustainable and it is causing the company to burn through its much vaunted cash pile. The DOF Subsea ratio is 1 boat to 42 people.

Scale and legacy cost issues pervade the business: the Bibby office in Aberdeen, for example, must be at least £3.5m per annum, that means even with three vessels working 270 days each one needs c.to earn £4.4k per day just to pay for a proportionate share of it. And these three vessels still have to pay for the US office until they can get out of the ten year lease. The same for the ROV hanger. The same for the upcoming restructuring and redundancy costs. There are simply too few boats working to cover proportionately the expenses being incurred.

In addition Bibby Offshore has the least competitive asset base of any North Sea DSV contractor. The Bibby Polaris needs a fourth special survey next year. At 20 years old she is two generations behind the newer vessels (the Bibby ST and Tecnhip/SS7 newbuilds), the forward bell arrangement is awkward, and the carousel is not efficient. So even if someone paid the equivalent of £20m for the vessel, and assuming you got ten years of life out of it that means c.£7500 per day in depreciation if the vessel works 270 days a year, over and above running and financing cash costs. If the drydocks come in over budget you would be lucky to achieve even cash breakeven at current market rates. PE investors, like York, mainly talk cash, which is fine until you run into an asset with a finite life. Sell the vessel out of the North Sea and you would be lucky to get £10m, and it would cost you six months running costs to get that.

The Bibby Sapphire looks to have temporarily avoided the fate of layup and is currently at anchor in Aberdeen. Sapphire will dive some days this summer, but having an asset that is needed only 90-100 days a year, at £100-120k per day (less 50k for project crew), is not economic at more than a de minimus price when the full 365 costs are taken into account and dry-docks/surveys are needed. Yes, she can work as an ROV vessel as well, but in-case no one noticed the reason that companies like Reach, M2, and ROVOP are making money at the moment is that they get the boat for free (in an economic sense).

I get how the spreadsheet added up to £115m Bibby valuation that York led the investment at… it’s just the assumptions required to get there that I think are erroneous.

York don’t have a good track record in offshore. Cecon, which York gained control of via distressed bonds, was a disaster, and for many of the same reasons the Bibby Offshore: a fundamental misunderstanding of the asset base and business model of the acquisition. The rump of Cecon is Rever Offshore, which mainly consists of a rusting hulk in Romania (ironically named the Cecon Excellence originally), rapidly going nowhere. York may have made some money off the one  Cecon vessel sold to Fortress at the peak of the market… But transactions such as this saw York Capital Management lose a significant portion of assets under management in 2017:

…funds to see withdrawals included York Capital Management, which lost $6.10 billion [from $22.3bn to 16.2bn]. The fund posted negative 2015 performance of 14% and was flat in 2016, a year in which The Wall Street Journalreported fund CEO Jamie Dinan said he experienced “his most intense client interactions in years.” That can happen when dramatically underperforming benchmarks.

York must be hoping there is a hoping there is another financial buyer who knows even less about subsea than they do.  Triton/DeepOcean want to make sure that York’s one good investment in offshore, their minority position in DeepOcean, doesn’t go the way of their other investments in the sector by trying to take advantage of York’s … er … skills…

Generational change coming in North Sea DSV market…

I was told DeepOcean has hired Jerry Starling to set up a diving department: this marks the start of the new competitive landscape that looks set to shape up the North Sea saturation diving market. DeepOcean have the perfect competitive position to break into diving with a large backlog of work from windfarms (increasingly at depths that make SAT diving profitable), excellent relations with an IRM customer base, and a very good operations department skilled at running complex vessels like the Maersk Connector. Clients know and like them and diving is just a fill-in service.

But the real significance in economic terms of this is that it signals how the structure of the market no longer provides the profitability it used to. Quite simply a shortage of North Sea class DSVs, and the high fixed cost commitment to either a charter or ownership of one of these vessels, combined with the investment in location specific infrastructure that is expensive, provided a classic “barrier to entry” for North Sea diving that simply didn’t exist anywhere else. Over time these very high margins were noticed by vessel owners, who built new tonnage, and investors (like LDC and Oaktree) who added capacity, meaning even by 2014 margins were declining. Pretenders tried to imitate but either didn’t have the capital (Bluestream with the Toisa Paladin) or infratsructure (Mermaid/ KD Diving/ Mermaid Endurer).

While these very high margins made it sensible for these companies to invest in this business DeepOcean and to a lesser extent Boskalis were working away at the less sexy end of the market in trenching, ROVs, widfarm work under civils contracts. This work looked low margin in comparison but was completely countercyclical.

And then demand crashed and everyone got left with some very expensive vessels and not enough work as the IRM market declined more than people thought and the construction DSVs came down to take maintenance market share. First Harkand folded and now it appears almost certain Bibby Offshore will as well. Both have suffered for the same reason: if you pay c. $100-150m for a North Sea class dive vessel (or take on financial asset exposure to the same amount) you need 250-270 days utilisation to break even at around USD 150-180k per day. Since 2015 there has been nothing like that sort of utilisation, especially for the smaller players.

The market was bid down in 2016/ 2017  by reducing the day rates to effectively cash OpEx only with no return for the vessel. When you have the balance sheet of Subsea 7 and TechnipFMC this is sustainable for a while as effectively the equity portion of your balance sheet adjusts to reflect this. When you are highly leveraged with an undiversified business model, as both Harkand and Bibby Offshore were, that isn’t an option.

The loss is being taken on asset values, eventually DSVs will be mean reverting assets i.e. their value will be derived from the cash flow they generate and this implies a substantial reduction from the book value of some vessels. It is for this reason that I don’t think much has changed for the Nor bondholders: the two DSVs will only generate a minimal number of days work for the foreseeable future, with a high operating cost (including SAT maintenance), and as recent work has shown potentially long transit times. The capital value of such assets isn’t USD 60m and the really interesting thing will be how the next liquidity issue for the bonds is priced?

JS is close to The Contracts Department, who run the Nor vessels, but there has never been a better choice of DSVs. It would be hard to see DeepOcean going for two DSVs in one season so while this is better than nothing for the Nor bondholders it is very hard to see this being the “get out of jail card” they have been looking for. DeepOcean know the market well enough not to overpay for a vessel and it is highly likely they could get a risk based charter from Nor that would be lucky to be even cash flow even in one year. Given that the Atlantis needs serious crane work and a major thruster repair (at least) to get it working there would appear to be no way to avoid another cash call.

But it will be a different story for DeepOcean. They will gain a vessel on an extremely attractive charter and ease themselves into the SAT diving market with an OpEx margin and the vessel risk guaranteed. They will choose from Nor, Vard, Toisa, China Merchants (unlikely I agree), Keppel, and potentially the Topaz in terms of tonnage. DO will then drop a chartered vessel and try for maybe 180 days SAT diving in years 1 and 2, more if they get lucky. But the charter rate to support that, and therefore the capital value of the asset, isn’t USD 110m per vessel, or more for the Vard/ Keppel etc. DeepOcean’s shareholders don’t need to, and aren’t in the business of, helping distressed vessel sellers.

I have made my comments on McDermott and Bosklis before and see no need to repeat myself again. My view is that Boslalis with windfarm work are better placed than MDR to either buy Bibby Offshore or expand organically, as I am not close to McDermott I have no idea how aggressively they will chase this. But there is no doubt with substantial UK dredging, cable lay, and now Gardline Boskalis appear to have the most synergies for any deal.

The Bibby Offshore results were made public this week and I don’t want to say much. This blog was never meant to be anything other than my thoughts on how I had become involved in a credit bubble and other random thoughts.

My own view, as I have said many times before, is that Bibby Offshore will not survive this. The problems involved in a recapitalization are intractable and restructuring is more likely, with a trade sale of certain assets being the most likely outcome, and certainly in the bondholders’ best economic interests should a competitve auction be established. It gives me no pleasure to write this because my time at BOHL was an enormous learning experience and for the most part enjoyable.

I could write a long post but the basic reason is very simple: the company borrowed too much money and the current shareholders simply do not have the financial resources to reverse this course or indeed (just as importantly) the economic rationale to do so. The bondholders lent them too much money, lending bullet repayment on depreciating assets is madness, maybe therein lies a solution, but I doubt it because the MSAs, systems etc have more value to a player growing organically than negotiating a massive writedown and capital injection for the bondholders.

No one in this market puts equity into a business behind £175m of debt and poor cash flow generation. No one will invest a super senior tranche because this isn’t simply a liquidity problem. The entity that has been created and the operating model is inherently uneconomic and the scale of change required too big and too risky for a private equity provider to follow it through in a way that would allow the company to remain independent (in my opinion).

Talk of BOHL lasting until 2018 is simply a fantasy to my mind and doesn’t reflect (again) the seriousness of the situation. Being down to £7.2m at June 30, after having gone through £62m cash in the last 12 months, and allowing a slower run rate loss now vessels have been redelivered/ entered lay-up, implies the cash would be down to about £5-6m now (allowing the 46% DSV utilisation BOHL stated). Someone really needs to explain why the June interest payment was made.

It is impossible to see the OpEx being funded by the RCF, and indeed without serious hope of a new investor, willing to be behind the revolver of £13.1m and agreeing a deal with the bondholders, and no backlog, the RCF offers no solution and only prolongs things.  As soon as those figures were published in SOR every CFO in ABZ told his project staff not to contract with BOHL as the credit risk is simply too great… its like a bank run that becomes self fulfilling.

It must be an extremely worrying time for the staff involved an my heart goes out to them (having been in that position once I can genuinely understand). One thing the Bibby Family/ BLG could do to minimise this is ensure all staff are paid their contractual notice period as under any reasonable financial/ legal assumptions the BOHL simply doesn’t have the money for these to be honoured and the legal structure would prevent them from being treated as preferred creditors.

A North Sea DSV market without Bibby Offshore turns the clock back 15 years. Two large integrated contractors will control the oil and gas construction market and two will dominate the IRM and windfarm market. They will meet in the middle on some jobs. But the overall industry will not return to the supernormal profits of earlier years due to persistent overcapacity of DSV tonnage and lower entry costs. Boskalis and DeepOcean are also likely to bring a degree of civils cost control to the industry that keeps margin depressed: it is a microcosm of the whole industry to my mind.

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.