Heart of darkness…

Colonel Kurtz: Did they say why, Willard, why they want to terminate my command?
Capt. Benjamin Willard: I was sent on a classified mission, sir.
Colonel Kurtz: It’s no longer classified, is it? Did they tell you?
Capt. Benjamin Willard: They told me that you had gone totally insane, and that your methods were unsound.
Colonel Kurtz: Are my methods unsound?
Capt. Benjamin Willard: I don’t see any method at all, sir.
Colonel Kurtz: I expected someone like you. What did you expect? Are you an assassin?
Capt. Benjamin Willard: I’m a soldier.
Colonel Kurtz: You’re neither. You’re an errand boy, sent by grocery clerks, to collect a bill.
Someone needs to collect the bill here. It isn’t the only one that needs to be paid.

EZRA fate depends on more than debt write off… it would need significant capital

“Don’t cry because it’s over, smile because it happened.” 

– Dr Suess

An update on the EZRA situation in the Straits Times this morning deals with one part of the EZRA problem:

Much of the company’s fate now hinges on the willingness of its creditors, including bondholders, to write off – whether partially or in full – its massive debt.

Which is true as I have said many times before here, but this would be nowhere near enough. What EZRA would need in addition to a massive debt writedown is a gargantuan injection of equity to fund the company through until profitability. I don’t what the exact number would be, but it is in the tens of millions, and I suspect that number is scaring the banks now. It would also need a completely new leadership team, but I will treat that as a given.

As the article rightly points out the banks exposure is to the high-end vessels like the Lewek Constellation. An engineering marvel it may be, a liquid asset that could be sold at anything like book value, it is not. I often talk here about asset specificity, which the offshore industry and their financial providers spectacularly mispriced in the last boom, but the Lewek Constellation is also an example of a complementary asset: the return on the asset increases the marginal return to another (or its owner). In the hands of a contractor wanting to do deepwater pipelay it’s a very valuable asset, but the reverse is also true, without the right owner such a specific asset is actually close to valueless. Intuitively we know this to be right about the Lewek Constellation, there is nothing else that can be done with that vessel without enormously expensive modifications. Banks should have had a much lower loan-to-value ratio on the vessel, in effect it was a project that was entirely equity risk should it go wrong, because even to hold it at port costs ~USD 15k per day, and it will take months to sell at a fraction of its build cost (unless Subsea 7 are silly enough to buy it) as the Ceona Amazon did.

There was a straight asymmetric payoff for EZRA shareholders here where they put up a fraction of the value of such a complex asset and received all the benefits if it worked and the banks were left holding an unsellable asset with high running costs if it didn’t. It is also clear, and this should be a warning to anyone thinking of funding this, that EZRA massively underestimated how long it would take the vessel to get decent utilisation, and therefore how much capital would be required to fund the roll-out of the Lewek Constellation. A new contractor could realistically only hope to win one or two jobs a year with such a new specialised asset, the EZRA equity holders would have had to accept dramatically lower utilisation than anyone else, and therefore lower immediate payouts (dividends), for the prospect of a higher value firm in the future (if you were following MM theory). But that is equity risk and it is clearly a big number when funding a deepwater pipelay asset to challenge the world’s industry leaders.

But the banks behind EZRA have a choice: accept the loss now, or risk putting millions more in working capital into the venture in the hope that the asset values will increase enough, and the company can repay even more money in the future. Both are really bad options in the current market. Any new equity investor not already exposed to this company would demand market prices for the assets, which doesn’t help the banks at all, but to take an equity position (whatever for the semantic legal definition the capital injection took) to dig themselves out of a very deep hole is a real problem for banks. Equity risk has to be reserved at almost a 1:1 ratio under capital adequacy provisions at the moment, and for good reason: no one can tell when this market is coming back, and indeed if it will ever come back like before.

And even if the market turns a reconstituted EZRA would be competing against Technip, Subsea 7, McDermott, and maybe, longer-term, Saipem (for another blog day). This new company would require sufficient capital to convince the Board of any potential customers that they were the right partner for a large, strategically important, complex offshore field development that would cost in the tens-to-hundreds of millions of dollars. I don’t see anyone taking them up on such a remarkably unattractive offer, in this market, with a surplus of good assets and contractor capacity, you would be mad to willingly choose EZRA as your offshore development partner. All engineering and procurement work for long-term projects is effectively contractor specific and exposes potential E&P customers to becoming unsecured creditors should the new EZRA fail, so it would need a fortress-like balance sheet to convince people they will be here next year, or the year after, but would you hand over a key strategic project to a contractor who has just come out of Chap 11 and defaulted on a large number of people throughout the supply chain? I just don’t see it.

In addition, it would appear that the Norwegian arm is to be liquidated and contracting on this scale only works as a global operation. There is simply no industrial logic for a recapitalised EZRA.

If the banks want a lesson in how expensive a strategy of providing working capital in a depressed offshore market can be they need look no further than Nor Offshore and their two DSVs parked at Blyth. Having raised USD 15m last November, and making a big deal about how much financial flexibility this gave them, they now look certain to have to raise funds again at the end of this year as the entire amount will have been spent on working capital without any work being generated in 2017 (remarkably like 2016 for them).

Nor are desperately hoping that their combined bid with Oceaneering for the BP Trinidad work will come to them. I don’t see it. Bibby have the Bibby Sapphire in the Gulf, know the worksite etc. DOF have the DOF Achiever in the region as well. Would BP really bring a new DSV, with a new crew, that hasn’t dived in a year, and put it into a complex and tidal worksite? I rate their chances at less than 5% (and on a rational basis 0%). Unless Oceaneering has a remarkable relationship with someone at BP I don’t see it happening: at the end of the day a DSV puts people on the seabed and someone at BP would be accepting that if anything went wrong from a safety perspective they had taken a very risky option. And given the market BP would not save any money in doing something so risky. BP need the work done and they need it done safely.  Sure BP, try and get the price down, but who would risk their job to take such a decision? Safety first in everything we do right?

And even if Nor/Oceaneering won the work it’s a 20-25 day transit, 400k on fuel (which BP won’t pay for), and then sea trials, bell run trials etc. Madness. The Nor bondholders will be going backwards in cash flow terms given current day rates at OpEx only, just to get the boat moved. So they will be raising money at the end of the year, or selling the vessels for a lot less than they had hoped, when they raised the USD 15m last year. It is literally locked in because they have no other work and no hope of recovering their liquidity position given the market and their position in it.

Such a situation is magnified a hundred times for the banks involved in EZRA. Someone senior would have to agree to in effect provide enough working capital for at least 24 months to prove they were going to make it through, potentially offer refund guarantees against procurement and engineering etc. As Nor has shown there is no guarantee that conditions will improve in time if you simply sit back and watch. And Nor is bidding on short-cycle projects, most of the construction projects EZRA would have to tender take years to come to fruition and the tendering costs, which require vast engineering resources, are extremely expensive (particularly when you are starting with a pipeline of nothing). As I have said before as well there is no proof that EZRA was actually any good at contracting: the BHP project in Trinidad I believe was a significant loss maker, I have had many people tell me the engineering coming out of Singapore was substandard, and I spoke to someone about the work performed in the Med and they couldn’t have been more critical of the work standard. EZRA is a busted flush.

Investors, or potential investors, should remember my favourite maxim of The Great One: markets can remain irrational longer than you can remain solvent (and I am not even sure they are being irrational at the moment). People keep coming up with really complex theories about EZRA and yet I see it really simply: find me a rational investor who would pump hundreds of millions of dollars into a new subsea contracting company at the moment, in an oversupplied and fiercely competitive market, with an uncertain future, and the industry as whole operating at negative economic value? Until you can find this mythical institution there will be no EZRA. The working capital costs of offshore contracting are so high that only a fool backs a business model with no clear path to decent utilisation.

The solution here is clearly for the banks to approach another contractor with a deal that would preserve asset value while taking capacity out the market. Maybe the banks swap the assets for a stake in Ocean Installer? Let Subsea 7 take the specialist vessels for nothing and some warrants? Save face somehow through financial engineering. Because the truth is the assets really are worth collectively hundreds of millions less than book value in the new environment and no one wants to be exposed to the OpEx of them. Pumping a company with a poor industrial strategy and futile market position full of working capital is the last thing the industry needs, and frankly won’t help the organisations that do it in the long-run.

 

The market isn’t coming back anytime soon… Asset values will suffer.

“It’s not the despair, Laura. I can take the despair. It’s the hope I can’t stand. ~ Brian Stimpson, Clockwise ”

I have been struck over the last couple of weeks by the contrast between the rig market and the subsea market. OceanRig, Seadrill, Vantage, all seem to be realistic that the equity is nearly gone and the previous business model was unsustainable. Borr Drilling has shown that with a clean balance sheet, and access to assets at potentially “low point” pricing, and a clear cash runway to 2020, you have something investible. It’s a punt, but at least one with a plan. Subsea and offshore seems some way away from this reality, Rigs lead the market in terms of creating demand and it seems the sheer scale of their financial needs has made them face economic reality to a greater degree as well. At least the rig guys have a plan, which is not something you can say of subsea yet (apart from sitting around until the market recovers).

I haven’t had a lot to say on the EZRA/ EMAS situation since Chapter 11 mainly because I don’t have anything constructive to add apart from the fact I think it is good for the industry to have this supply side capacity reduced. US Chap 11 is a court run process, and not one I know much about, the only thing I am sure here is that there is a very complicated problem coming regarding the Lewek Express. In order to frame it properly I ask the question can you be a boatless contractor?

The banks now own this asset, although Bibby was in court a few days ago trying to spread the cost of arresting the vessel with the fellow court participant Waksey Bridges, but I expect eventually the banks to have this asset returned, and then, what do they do with it? Even if the US judge returns EMAS Chiyoda to the market free of onerous charters, like that of the Lewek Express (and everything else) then all that remain is a project management company with perhaps the ability to charter ships? But the new owners aren’t going to put enough capital into the Newco to charter the Lewek Express, and without this asset there is no real point to the company. The reason subsea construction companies own vessels is because they have an asset specificity issue: it is cheaper once all the integration and contractual costs are included to own one.

If you try and charter a deepsea pipelay asset who pays for the liquidated damages if it arrives on the site late? Who pays if you buckle the pipe? Who pays if the vessel doesn’t lay at the speed forecast? These issues go on ad infinitum. And yes you can solve them all contractually, but the whole point is it’s cheaper to own the vessel than do this contractually. In the boom days you also needed the vessel to actually have access to one, and for the sort of work EMAS Chiyoda was chasing that is still the case: Technip and Subsea 7 aren’t going to charter them high-end vessels to do deepwater lay. Saipem might as it starts to get desperate enough, but actually they will just bid lower and cross-subsidize the engineering with sub-economic vessel costs. Without access to a vessel EMAS Chiyoda is just a project management house without a boat, no sane investor in this market would create more capacity by injecting equity in a company that would have to charter a vessel off a bank that requires years of tendering before it could win any project work. Remember the cash cost of running the Lewek Express is at least USD 15k per day, so someone might buy it for 100m but they are not buying it at anything like a level that will keep the banks whole.

I see no future for EZRA, EMAS, or EMAS Chiyoda. The first two were too long on vessels and the third simply isn’t viable as a boatless contractor and the market doesn’t need one. A court can’t change an economic reality. The only real question of interest is what percentage recovery rate the bondholders get and what the assets go for?

But at least the drama for this is in its final stages. The North Sea DSV farce continues. I don’t know who should be more terrified of the Bibby results: Bibby or the Nor Bond holders?

The Bibby results were as bad as feared, they actually could not have been any worse, a GBP 10m write-off to EMAS Chiyoda being the real low point of the US expansion strategy. A £-52m Operating Profit indicates a business model entered into in much better times and limited ability to change it as the market declines. The profits from leverage are so great in the good times succumbing to the temptation to go too long on vessels is hard to resist. And so it proved at Bibby. With the Olympic charters (Bibby and Aries) having significantly more time to run (late September 17 and June 18) unless the market changes significantly its a question of when, not if, the restructuring process begins. Customers should sign up now because the contracts will be novated across. The real question is why the bonds are still trading in the mid-60’s which implies an Enterprise Value of £105m, which for a business consuming cash at that rate seems extraordinary. Even stripping out exceptionals the business seems to be going back at £100k per day in cash terms.

I have to be honest and say I don’t think the solution here is to borrow more… The solution proposed seems to be that Bibby Line Group put £10m into the revolver and Barclays open it up for £20m more. If Barclays really follow through and increase their borrowing limits to fund this then they are braver than most commercial bankers; by putting the money in at the revolver level Bibby Line Group would guarantee themselves a seat at the creditor restructuring table, something Barclays and the bondholders are unlikely to welcome. One bondholder has already asked why the BLG £10m (50% of the dividend they took in January 2016) contribution to the revolver wasn’t put it as equity? The answer is BLG has enough accountants not to be that stupid: it’s a risk-free loan (given the revolver has seniority over the bonds) or nothing at this point from Group for Bibby Offshore.

But Bibby got DSV utilisation up to 77% which is impressive. I have put a little comparison in with the Nor vessels:

Bibby DSV Utilisation:      77%

Nor Atlantis Utilisation:    0%

Nor Da Vinci Utilisation:   0%

The problem isn’t that there isn’t any work out there the problem is no one wants to buy what Nor are offering, and this despite the fact The Contracts Department (“TCD”) claimed that they had a plan for the vessels and they were the first point of call people would naturally go to for the vessels and associated work (or so I was told by AMA Ca[ital the bondholders financial adviser). It is hard to know if TCD actually believed this, in which case they aren’t close enough to the market to know what they are doing, or if it was a cynical ploy to extract some money from a dispersed group of clueless financial investors. Most rational people would think sitting at Blyth for well over a year, waiting for the mountain to come to you, was not the most cunning plan, and as sometimes happens the madness of the crowds was right in this instance. The Nor vessels have turned into a rort for contractors and service providers, the dive systems are being maintained by a company whose previous strength was in mobilising Ampleman systems, the Contracts Department are fighting with them now (no doubt to try and get their friends at Rocksalt on the vessels), and there is no economic incentive for any party to actually save the Nor bondholders money because they don’t know when this gravy train will end, so just front load the returns everyone figures. The only work, for one vessel only, appears to be in the Middle East where Nor are one of 18 bidders. Nor Offshore remains a salutary reminder that financial investors can continue to get taken to the cleaners by Ops personnel who realise how limited the general financial investors’ knowledge of the asset is. Any serious charterer or buyer for the Nor DSVs  just needs to sit around until November now, when the owners will be nearly through their USD 15.9m, without having worked a day, and get the firesale price they demand or force them into another complicated fundraising (given the last USD 15 was “super senior”). Given Subsea 7 fired up a DSV for 200 days for Apache the logic of this strategy has really been laid bare for all the risks it entailed.

But unfortunately for Bibby they have got utilisation up by getting real on price (and it’s a credit to the operational managers who have got utilisation this high). Day rates for DSVs have been as low as GBP 75-100k for SAT diving (and the divers/ project crew are £50k of that), there is precious little in the mob fees etc. All that is happening is that equity is being eroded (or is gone), and older DSV operators, who have depreciated the vessel, are at an advantage over newer owners, who must at some time try to recover their capital. Scale and scope count at this point which benefits Technip, Subsea 7 and DOF.

Everyone is chasing wind farm work, but as all those involved in the industry know it is hugely margin dilutive, even if it gets you utilisation, it comes with greater contract risk. Civil contracts are used (not LOGIC), variation orders are hard to get through, there is a greater reliance on free issue equipment etc, and because production doesn’t bring “first oil” there just isn’t the ability for a contractor to make as much money.

I stand by my previous statements that unless there is a substantial pick-up in construction activity this is the new normal in the North Sea DSV market. IRM has reached its lower limits and will not drop more. But Subsea 7 and Technip have introduced new tonnage, and USD 50 oil just isn’t enough to get new projects launched that are based on the “small step-out/ infield” model that drove previous construction booms. Both Bibby and Nor seem to be like rabbits stuck in headlights just pretending that if they wait in the middle of the road long enough, and with enough determination, the good old days will return. Unfortunately for the rabbit it takes a road a very long time before the road returns to it vegetative state, normally longer than the rabbit can last.

 

These cases are just microcosms of a bigger problem which not enough people in subsea have realised in my humble opinion: the fabled recovery, the great hope that everyone holds out for doesn’t seem to have a good economic foundation: supply has increased, demand dropped dramatically, and the “constant” of maintenance work proved to be illusory. At some point asset values are going to have to reflect the fact that OpEx has remained constant (these costs have “nominal rigidity” due to the high labour input), and therefore it is an identity that the asset values must be lower when overall expenditure is capped. Getting there strikes me as a painful journey that has just begun.

DSVs and pipelay vessels have in common that in the old days (c.2014) banks and bondholders would lend against them and that made asset values higher. This downturn has shown how illiquid these assets are, and in the worst case scenario even running them while waiting to recover the costs can entail significant cash expenditure. This means quantitatively the assets are worth less: they will be financed with less gearing (if any) and the payback period will need to be shorter. The biggest change in offshore finance going forward will I believe be the realisation of this factor creeping across the industry: smaller players will struggle to come close to matching the financing advantages of larger companies, a situation that has never before existed in offshore. On any rational basis, the industry will be financed with a significantly higher degree of equity than people were used to in the past and that pool of equity will be chasing more limited financial returns from projects. This will lead to significantly lower equity returns for an extended period that will dry the investment market for all but the best companies and business models, and the slow, inexorable, correction process will continue… just like the rig market, only slower by the look of it.

EMAS… I never saw that coming!

Of course I saw the Chap 11/ restructuring event coming… what I didn’t see coming was buried in the filing where Subsea7 and Chiyoda appear to have entered into a Debtor-in-Possession credit agreement. I can only assume they want the work booked already with Chevron and in Africa.

Normally DIP (“super senior”) is provided by banks and starts the dilution process for unsecured crditors. I didn’t think this gave providers preferential rights to assets etc (other than secured for collateral). Frankly SS7 has too many ships, and I would have thought Chiyoda had had all the fun it could handle in subsea, so I will be interested to see what comes of this…

The cynic in me says here comes Chap 11 for EZRA…

I have to hand it to the SGX: You can be a listed company and make no announcement when a creditor takes control of a USD 500m asset, and its spoolbase is also reposessed; but incorporate a minor subsidiary with 200 shares at a nominal price and you rush out an announcement. I would have asked for a please explain? But who am I? You can’t make this up.

For what its worth I see this as EZRA seeking protection under US Chapter 11 rather than trying their luck with the new Singapore code which has very little precedent. All you basically need is a US Co. and a bank account. I could be wrong but I don’t really get the point of this otherwise.

 

 

EZRA and Bibby…the bigger issue remains.

If Stupidity got us into this mess, then why can’t it get us out?

Will Rogers

As the above document makes clear it looks like Bibby have managed to get an arrest warrant on the Lewek Express and have therefore secured  a maritime lien on the vessel barring legal arguments from EZRA/ EMAS Chiyoda. I am not a lawyer, and clearly don’t want to comment on the legal intracies, my view is clearly Bibby performed the work and EMAS Chiyoda are simply refusng to pay because they do not have the money, or do not want to pay to make the Angostura project appear more profitable than it was while they try and raise capital. Bibby cleartly have the moral right here.

I didn’t realise that working in conjunction with a vessel would generate a maritime lien but having read the deposition and having spoken to a lawyer I think it could here. Its certainly arguable as the favourable judgement shows. The core action here is against the vessel (“against the world”) and not against EZRA as charterer to EMAS Chiyoda. The bush lawyer in me says if successful it could re-define how offshore projects are contracted, but that also means a long legal battle here, with appeals all but certain. Bibby are basically arguing that the contract to deliver the tie-in scope in Angostura could not be delivered without the diving and it doesn’t matter who owns the ship the action is in rem against the vessel not the owner. It makes a lot of sense and if held EZRA and their banks have a real issue as this lien outranks the mortgage holders and owners rights.

But the bigger issue (given EZRA has USD 1bn in short term debt) is this: How could EZRA/ EMAS Chiyoda credibly claim to be raising capital with these sorts of issues remaining unresolved? Do they need to pay USD 15m on a project or not? Will Forland wind them up or not? You can’t warranty your way out of those sorts of issues or bury them in transaction schedules.

Aside from that you cannot run a project company without a myriad of subcontranctors and any company extending credit to this mess must undertand they risk not getting paid. It’s terminal now, whatever the machinations over the next few weeks, without massive infusions of cash (working capital) to settle such claims. No overarching deal has been announced with a strategic investor, instead there have just been a series of announcements where one-by-one creditors break off with different strategies and EZRA gets a trading suspension.

The moral positon that Bibby (and the other subcontractors) need to be paid is clear but it just highlights how absurd the current situation is.DBS and OCBC must be having a sense of humour failure over a supplier potentially getting the first USD 15m of any sale of the Lewek Express.

I simply don’t believe this rumour that Siem/ Subsea 7 is going to buy the NYK stake. Why? If you are too long on ships and contracting capacity  (as Siem/ Subsea 7 are) why buy more and expose yourself to the running cost as a minority? Siem clearly went long on Golar last week and I don’t see reasons to buy assets, no backlog, and a the certainty of a capital injection in this market.

OY and EZRA… the ties that bind…

Caustic are the ties that bind” Trivium

As you can see from the photo the Lewek Connector is a fine looking vessel, its good for a number of things, unfortunately all of them are connected with relatively deepwater oil and gas construction and maintenance. Such is the plight EZRA and Ocean Yeild (“OY”) now find themselves in.

The plain fact of the matter is OY was forced to accept the current four month charter for USD 40 k per day from a position of weakness not strength. OY are some of the smartest people in ship finance so you can be sure this is as good as a deal can be. For what its worth I suspect the deal is with a debt free subsidiary that managed to get some sort of assignment earnings related to the work the vessel is needed for, and therefore guaramtee them at least some payment. Then when EZRA goes into administration that company will still trade and OY will be paid. I just don’t believe OY went to this much trouble not to get paid.

However, with the OY charter in place it was going to be near impossible for EZRA/ EMAS Chiyoda to actually raise any equity. Raising capital just to pay OY and others is a very difficult sell and it highlights the same problem the banks have: when a company is in this much trouble everyone effectively has equity risk. The banks need to do what OY has done and forgive some claims if EZRA and EMAS Chiyoda is to have any chance. The amount of time it has taken to make minimal progress doesn’t ‘t fill me with hope. You would think any potential “White Knights” would have been flushed out by now and the size of the trade creditor claims must surely be offputting for even those with high risk appetites.

The deal highligts how few options ship owners have in this market. Similar vessels are going for USD 20k per day, barely covering OPEX, when they can find work. OY have no operational infrastructure and when the charter finally ends, unless they are extraordinarily lucky, they will simply have to pay a ship management company USD 10-12k per day and lose the charter hire. Given ~12% of OY’s EBITDA is generated by this asset you can see why they are having to look at every available option. However, you can delay the inevitable in this market… but not for ever.

In the background other creditors circle for material amounts of money and Bibby appear to be having some success in the US courts. Affiliated Marine (who apear to be a catering suplier), and Waskey Bridges, an engineering firm, have joined them in seeking to have the vessels arrested on the basis of a maritime lien. It feels like the last stages of Downfall.