DSV valuations in an uncertain world: Love isn’t all you need… Credible commitment is more important…

“Residual valuation in shipping and offshore scares the shit out of me”

Investment Banker in a recent conversation


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


The FT recently published this Short View about how the bottom may have been reached for rig companies and that there may be upside from here. The first thing I noted was how high rig utilisation was, the OSV fleet would kill for that level, and yet still the fleet is struggling to maintain profitability (graph not in the electronic edition but currently about 65%). The degree of operational leverage is a sign of how broken the risk model is for the offshore sector as a whole. A correction will be needed going forward for new investment in kit going forward and the obvious point to meet is in contract length. Banks simply are not going to lend $500m on a rig that will be going on a three year contract. Multi- operator, longer-term, contracts will be the norm to get to 7G rigs I suspect (no one needs to make a 6G rig ever again I suspect). The article states:

No wonder. Daily rental rates for even the most sophisticated deepwater rigs have tumbled 70 per cent, back to prices not seen since 2004. Miserly capital spending by the major oil companies, down more than half to $40bn in the two years to 2016, has not helped. Adding to this lack of investment from its customers is a bubble of new builds, which is only slowly deflating.

Understandably, the market is showing little faith in the underlying value of these rig operators. US and Norwegian operators trade at just 20 per cent of their stated book values. The market value of US-listed Atwood Oceanics suggests its rigs are worth no more than its constituent steel, according to Fearnley Securities.

What the article doesn’t make clear, but every OSV investor understands, is that in order to access more than the value of the steel rigs and OSVs have very high running costs. The market is making a logical discount because if you cannot fund the OpEx until operating it above cash break even or a sale then steel is all you will get: it’s the liquidity discount to a solvency problem. That tension between future realisable value and the option value/cost of getting there is at the core of current valuation problems.

The OSV fleet is struggling with utilisation levels that are well under 50% for most asset classes and even some relatively new vessels (Seven Navica) are so unsellable (to E&P customers I don’t think Subsea 7 is a seller of the asset) they have been laid-up.  From a valuation perspective nothing intrigues me more than the North Sea DSV fleet: The global fleet is limited to between 18-24 vessels, depending on how your criteria, and with a limited number companies who can utilise the vessels, they provide a near perfect natural experiment for asset prices in an illiquid market.

North Sea class DSVs need to be valued from an Asset Specific perspective: in economic terms this means the value of the asset declines significantly when the DSV leaves the North Sea region. Economists define this risk as “Hold Up” risk. In both the BOHL and Harkand/Nor case this risk was passed to bondholders, owners of fixed debt obligations with no managerial involvement in the business and few contractual obligations as to how the business was run.

The question, as both companies face fundraising challenges, is what are the DSVs worth? Is there an “price” for the asset unique from the structure that allows it to operate?

In the last BOHL accounts (30 June 2017) the value of the Polaris and Sapphire is £74m. I am sure there is a reputable broker who has given them this number, on a willing buyer/ willing seller basis. The problem of course is that in a distress situation, and when you are going through cash at c.£1m per week and you have less than £7m left it is a distress capital raise, what is a willing seller? No one I know in the shipbroking community really believes they could get £74m for those vessels and indeed if they could they bondholders should jump at the chance of a near 40% recovery of par. A fire-sale would bring a figure a quantum below this.

Sapphire is the harder of the two assets to value: the vessel is in lay-up, has worked less than 20 days this year, and despite being the best DSV in the Gulf of Mexico hasn’t allowed BOHL to develop meaningful market share (which is why the Nor Da Vinci going to Trinidad needs to be kept in context). Let’s assume that 1/3 of the £74m is the Sapphire… How do you justify £24m for a vessel that cannot even earn its OpEx and indeed has so little work the best option is warm-stack? The running costs on these sort of vessels is close to £10k per day normally, over 10% of the capital value of the asset not including a dry dock allowance etc? Moving the vessel back to the North Sea would cost $500k including fuel.  The only answer is potential future residual value. If BOHL really believed the asset was worth £24m they should have approached the bondholders and agreed a proportionate writedown and sold the asset… but I think everyone knows that the asset is essentially unsellable in the current market, and certainly for nowhere near the number book value implies. Vard, Keppel, and China Merchants certainly do… The only recent DSV sale was the Swiber Atlantis that had a broker valuation of USD 40-44m in 2014 and went for c. USD 10m to NPCC and that was not an anomaly on recent transaction multiples. If the Sapphire isn’t purchased as part of a broader asset purchase she may not return to the North Sea and her value is extremely uncertain – see how little work the Swordfish has had.

Polaris has a different, but related, valuation problem. In order to access the North Sea day rate that would make the vessel worth say a £50m valuation you need a certain amount of infrastructure and that costs at c.£5-8m per annum (c.£14k -22k per day), and that is way above the margin one of two DSVs is making yet you are exposed to the running costs of £10k per day. Utilisation for the BOHL fleet has been between 29%-46% this year and the market is primarily spot with little forward commitment from the customer base. So an investor is being asked to go long on a £50m asset, with high OpEx and infrastructure requirements, and no backlog and a market upturn needed as well? In order to invest in a proposition like that you normally need increasing returns to scale not decreasing returns that a depreciable asset offers you.

This link between the asset specificity of DSV and the complementary nature of the infrastructure required to support it is the core valuation of these assets. Ignoring the costs of the support infrastructure from the ability of the asset to generate the work is like doing a DCF valuation of a company and then forgetting to subtract the debt obligation from the implied equity value: without the ability to trade in the North Sea the asset must compete in the rest-of-the-world market, and apart from a bigger crane and deck-space the vessels have no advantage.

It is this inability to see this, and refusal to accept that because of this there is no spot market for North Sea class DSVs, that has led to the Nor position in my humble opinion. The shareholders of the vessels are caught in the irreconcilable position of wanting the vessels to be valued at a “North Sea Price”, but unable or unwilling to commit to the expenditure to make this credible. It would of course be economic madness to do so, but it’s just as mad to pretend that without doing so the values might revert to the historically implied levels of depreciated book value.

The Nor owners issued a prospectus as part of the capital raising in Nov 2016 and made clear the running costs of the vessels were c. USD 370k per month per vessel for crewing and c. USD 90k per month for SAT system maintenance. In their last accounts they claimed the vessels value at c. USD 60m each. Given Nor raised USD 15m in Nov last year, and expected to have one vessel on a 365 contract ay US 15k per day by March, they are so far behind this they cannot catch-up at current market rates.

Again, these vessels, even at the book values registered, require more than 10% of their capital value annually just to keep the option alive of capturing that value. That is a very expensive option when the payoff is so uncertain. If you are out on your assumption of the final sale value by 10% then you have wasted an entire year’s option premium and on a discounted basis hugely diluted your potential returns (i.e. this is very risky). Supposedly 25 year assets you spend more than 2.5x their asset values to keep the residual value option alive.

Three factors are crucial for the valuation of these assets:

  • The gap between the present earning potential and the possible future value is speculation. You can craft an extremely complicated investment thesis but it’s just a hypothesis. The “sellers” of these assets, unsurprisingly, believe they hold something of great future value the market simply doesn’t recognise at the moment. Sometimes this goes right, as it did for John Paulson in the subprime mortgage market (in this case a short position obviously) and other times it didn’t as owners of Mississippi Company shares found to their discomfort. We are back to the “Greater Fool Theory” of DSV valuation.One share.png
  • Debt: In the good old days you could finance these assets with debt so the equity check, certainly relative to the risk was small. In reality now, for all but the most blue-chip borrowers, bank loan books are closed for such specialist assets. And the problem is the blue-chip borrowers have (more than) enough DSVs. The Bibby and Nor DSVs are becoming old vessels: Polaris (1999) will never get a loan against it again I would venture and the Sapphire (2005) has the same problem. The Nor vessels are 2011 builds and are very close to the 8 year threshold of most shipping banks. As a general rule, like a house, if you can’t get a mortgage the vessel is worth less, substantially so in these cases because all diving companies are making less money so their ability to find equity for vessels is reduced. Banks and other lenders have worked out that the price volatility on these assets is huge and the only thing more unsellable that a new DSV is an old DSV. It will take a generation for internal risk models to reset.
  • You need a large amount of liquidity to signal that you have the commitment to see this through. At the moment neither Bibby or Nor have this. From easily obtainable public information any potential counterparty can see a far more rational strategy is to wait, the choice of substitutes is large and the problems of the seller greater than your potential upside.

Of course, the answer to liquidity concerns, as any central banker since Bagehot has realised, is to flood the market with liquidity. Bibby Line Group for example could remove their restrictions on the RCF and simply say they have approved it (quite why Barclays will agree to this arrangement is beyond me: the reputational risk for them foreclosing is huge). As the shareholder Bibby Line Group could tell the market what they are doing, in Mario Monti’s words, “whatever it takes”. Of course, Mario Monti can print “high powered money” which is not something Bibby Line Group can, and that credibility deficit is well understood by the market. A central bank cannot go bankrupt (and here) whereas a commitment from BLG to underwrite BOHL to the tune of £62m per annum would threaten the financial position of the parent.

I have a theory, untestable in a statistically significant sense but seemingly observable (e.g. Standard Drilling, the rig market in general), that excessive liquidity, especially among alternative asset managers and special situation funds, is destroying the price discovery mechanism in oil and gas (and probably other markets as well).  I accept that this maybe because I am excessively pessimistic, but when your entire gamble is on residual value in an oversupplied market, how can you not be? In offshore this is plain to see as the Nor buyers again work out how to value the assets for their second “super senior” or is that “super super senior” tranche, or however they plan to fund their ongoing operations. The Bibby question will have to be resolved imminently.

At some point potential investors will have the revolutionary notion that the assets should be valued under reasonable cash flow assumptions that reflect the huge increase in supply of the competitive asset base and lower demand volumes. Such a price is substantially lower than build cost, and therein lies the correction mechanism because new assets will not be built, in the North Sea DSV case for a considerable period of time. Both the Bibby and the Nor bondholders, possessors of theoretically fixed payment obligations secured on illiquid and specialised assets will be key to the market correction. Yes this value is likely to be substantially below implied book/depreciated value… but that is the price signal not to build any more! Economics is a brutal discipline as well as a dismal one (and clearly not one Chinese yards have encountered much).

How these existing assets are financed will provide an insight into the current market “price discovery” mechanism. For Nor the percentage of the asset effectively that the new cash demands, and the fixed rate of return for further liquidity, will highlight a degree of market pessimism or optimism over the future residual value. If you have to supply another USD 15m to keep the two vessels in the spot charter market for another 12 or 15 months how much asset exposure do you need to make it work? Will the Nor vessels really be worth $60m in a few years if you have to spend USD 7.5 per annum to realize that? What IRR do you require on the $7.5m to take that risk? Somewhere between the pessimism of poor historic utilisation and declining structural conditions and the inherent liquidity and optimism of the distressed debt investors lies a deal.

The Bibby valuation is more binary: either the company raises capital that sees the assets tied to the frameworks of their infrastructure, and implicit cross-subsidisation of both, or the assets are exposed to the pure vessel sale and purchase market. The latter scenario will see a brutal price discovery mechanism as industrial buyers alone will be the bidders I suspect.

Shipbroker valuations work well for liquid markets. The brokers have a very good knowledge of what buyers and sellers are willing to pay and I believe they are accurate. I have severe doubts for illiquid markets, particularly those erring down, that brokers, like rating agencies, have the right economic incentives to provide a broad enough range of the possibilities.

Although the question regarding the North Sea DSVs wasn’t rhetorical it is clear what I think: unless you are prepared to commit to the North Sea in a credible manner a North Sea DSV is worth only what it can earn in the rest-of-the-world with maybe a small option premium in case the market booms and the very long run nature of the supply curve. The longer this doesn’t happen the less that option is valued at and the more expensive it is to keep.


[P.S. Around Bishopsgate there is a theory circulating that Blogs can have a disproportionate impact on DSV values a theory only the most paranoid and delusional could subscribe to. I have therefore chosen to ignore this at the present time. The substance of the message is more important than the form or location of its delivery.]

Great Exepectations and Asset Values in The New Offshore…

“Suffering has been stronger than all other teaching, and has taught me to understand what your heart used to be. I have been bent and broken, but – I hope – into a better shape.”

Charles Dickens, Great Expectations

Further evidence of the narrative turning to shale:

When the facts change … ” Hall wrote to investors in his Stamford, Connecticut, hedge fund, Astenbeck Capital Management LLC, in a July 3 letter obtained by Bloomberg News. “Not only did sentiment plumb new depths but fundamentals appear to have materially worsened.”

U.S. shale drilling is expanding “at a surprisingly fast rate, thus raising the odds for significant oversupply in 2018, even if OPEC maintains its production cuts.”

“When the facts change … ” Hall wrote to investor… “Not only did sentiment plumb new depths but fundamentals appear to have materially worsened.”

U.S. shale drilling is expanding “at a surprisingly fast rate, thus raising the odds for significant oversupply in 2018, even if OPEC maintains its production cuts.”

Reuters notes:

“The market is in trouble and looks very vulnerable to lower numbers,” PVM brokerage said in a note.

I can’t help wondering if some of the private equity money that flooded the North Sea when the price declined in 2015/16 isn’t getting a little worried. The investors behind Siccar Point and Chrysoar for exmaple are some of the largest private equity funds in the world, and the transactions were de-risked by paying a contingent amount on prices following the transaction, but prices are lower than the dominant narrative was at closing and they surely weren’t based on a mid 40s oil price but rather a long-term appreciation trend? Both are very different as well with Siccar Point exposed to Clair Ridge and some new deepwater projects where as Chrysoar is more exposed to the legacy Shell assets. But even still the only viable exit is another massive private sale or preferably a listing and both these companies offer very poor growth prospects in a high cost environment in what are officially declining basins. For North Sea contractors the implications for future demand are serious given how well the new players like Ineos have been at driving down OpEx in other markets. And E&P company spending obviously drives spending for offshore contractors and therefore asset values…

I have gone on about this before but I think the downturn in 2008/09 has a lot to answer for when a short price dip was followed by a very healthy five year boom, but shale simply wasn’t such a big deal and OSV supply was more limited. Just as in offshore fields so in offshore support vessels: those who piled into the Harkand/Nor bonds were typical: Justin Patterson of Intermarket (www.intermarket.us) proudly announced he was a holder of record of the Nor/Harkand bonds in November 2016. Constrained in the number of opportunities in the sector they could buy into they were not interested in understanding the assets or the market, they would just buy and hold… what could go wrong?

The investment is of course now worthless. The Nor investors are discovering either you have a North Sea diving operation or the vessels are only worth what someone in Asia will pay, and that is an order of magnitude less than the implied depreciated value of a North Sea class DSV. There is no magic solution here and as I don’t believe the Demand Fairy will save people here. With a load of sellers of similar assets who would be willing to sell or charter for $1 cheaper than the Nor investors, whatever the price, they need a good story to tell here if they want to convince anyone there is value in their investment.

Surely at some point auditors are going to insist on more cash-flow based assessments of vessel values and that is likely to cause chaos in such investments because they all rely on the Greater Fool Theory at the moment? The Harkand/Nor DSVs are an egregious example of where the valuation of USD 58m per vessel for their last set of accounts simply bears no relation to any realistic sale price the assets may fetch, it may help people like Intermarket show a positive Fair Market Value in their accounts but it isn’t a real number. Similarly Bibby held their DSVs combined at over GBP 100m in the last accounts… collectively this means that 4 North Sea class DSVs that cannot be operated at even cash flow break even are worth in excess of USD 240m, despite no credible reports of an uptick in day rates and other comparable vessels such as the Vard Haldane for sale? Something will have to give and it won’t be economic reality or the “cash flow constraint” as Minsky recoognised.

Expectations of future cash flows are the main driving force of offshore asset transactions at the moment (as opposed to “valuations”) not concerns over lack of supply (so 2014) or the ease of selling the asset to someone else (so 2013). Barring a major change in demand therefore expect asset values to have been permanently impaired and wait for the auditors to start calling time as liquidity needs continue to strain companies that have made it this far despite the hoped for Great Expectations of the 2015/16 investment class.

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.


Morton’s Fork, Nor Offshore, and the North Sea DSV market

John Morton was my kind of optimist (and economist actually): as the Archbishop of Canterbury (1486-1500) he devised the logic for imposing forced loans on people that those who were rich could obviously afford to pay, and those whom lived frugally obviously had savings buried away somewhere (and could therefore afford to pay). This somewhat quaint logic is the origin of Morton’s Fork, a bifurcation that leads to no good options.

An article in the FT today on the increasing free cash flow of North Sea oil producers highlights the Morton’s Fork for the Nor bond holders. In November last year, after raising money again they had the decision to make of continuing the spectacularly unsuccessful strategy of sitting in Blyth, with no diving contractor,. waiting for work when all the dive contractors had excess DSV capacity, or changing. Admittedly the decision was a Morton’s Fork, work anywherre is hard and there is excess capacity everywhere. But serious work in the North Sea, given the industry structure and regulations, was never possible. Suddenly the USD 15m liquidity issue, having been depleted roughly a third, without a day of work and absolutely none in the schedule, just on OPEX, doesn’t seem like such a big number (and there appear to be valid questions about the technical condition of the Atlantis where the crane for example has been downrated to 50t).

However, the bond holders decided they would wait for the mountain to come to them. After a recent fiasco where the Contracts Department/ Nor were awarded a five day job, and then couldn’t close it commerically, the mountain is looking strangely distant, and the FT article shows why:

Alongside cuts to operating expenses, North Sea operators reduced project investments during the downturn — last year only two relatively modest field development plans were approved, involving BP and Apache. Up to six new projects could get final approval from operators this year, and a further eight in 2018, said Oil & Gas UK, but it warned in a report published on Tuesday that these are “not certain to be delivered and may be subject to delay or cancellation”.

As I have stated before until the construction work returns the maintenance market will not save these vessels. It’s worth pointing out that Clair Ridge, the BP project above, used no DSV days, nor will any West of Shetland (except for potentially some minor riser hook-up work).

Subsea 7 recently reactivated the DSV Seven Pelican, currently off to do 200 days for Apache, and the Seven Osprey, which is having a new thruster installed in Gdansk and then heading East. Subsea 7 and Technip are recommitting to diving because the work is there and they can. With huge engineering and tendering teams they can move old assets back into the market to take advantage of what little work there is. I have been told, but I have no idea of the veracity, that market rates are GBP 65-75k, strip out GBP 50k for divers/project crew and no one is making much money here, but neither are they losing it tied up. But the North Sea DSV fleet will not face a demand driven recovery until the tie-backs/tie-in market, which soak up huge amounts of DSV days return.

Any serious hope the bondholders had that a mild uptick in maintenance work would lead to a charter in the North Sea must now have vanished to all but the most die-hard optimists. Setting up a tin-shed operation in the most regulated market in the work (bar Norway) was simply a bad idea, even had the market returned, but looks even worse in a poor market. The Nor vessels will move before the mountain one would assume.

How much is enough?

How much equity and working capital do you need to be a UKCS saturation dive contractor? And just as importantly, how much can you make from such an investment? Two different groups of North Sea DSV bondholders are pondering this question at the moment.

On the one hand are the Bibby Offshore Holding Ltd (“BOHL”) bondholders who must realise now that a financial restructuring is coming. Moodys noted in November that:

Bibby Offshore cash generation has been negative since the beginning of the year resulting in a reduction of cash on balance sheet of approximately GBP40 million out of the GBP97.1 million it had at the start of the year. Moody’s believes that cash generation will remain negative in 2017 to approximately GBP30 million with increased pressure in the first half of 2017 due to seasonality. Cash generation in the second half of 2017 should slightly improve due to the anticipated positive effects of the renegotiation of charter rates.

In anything things have only got worse… Let’s leave out the fact that the only charter open for renegotiation in 2017 is the Bibby Topaz and here BOHL have a problem: give the vessel back and the bond holders know they are not getting paid back in full as BOHL can’t generate enough revenue; or, keep the vessel, and spend some of the remaining cash on a vessel with little backlog.

Moody’s estimated Bibby will generate EBITDA of GBP 12m for 2017 and means leverage rises to more than 20x EBITDA (including operating lease calculations): a totally unsustainable number. The only hope could have been a really busy 2017 summer with extraordinarily high day-rates; however, despite high tendering levels, rates are rock bottom and the volume of work is small. The question for BOHL is only the size of the financing gap not the reality of the need for one.

BOHL needs a debt-for-equity swap. [Non-financially interested don’t need to worry about the specifics here but in essence the people who lent the company money on a fixed basis agree to turn this into shares accepting the may carry some upside potential].  In reality, I think there will be a raidcal restructuring of the BOHL. I believe the bondholders will seek a restructuring that takes the business back the 2005 model of 2 x DSVs based in Aberdeen. Singapore, Norway, and the US are gone. No offices outside Aberdeen appear to be cash flow generative at all even taking into account ROV utilisation. The bondholders are in for the Sapphire and Polaris anyway so the need to come up with the least cash exposure that offers them the maximum return. ROVs are not a BOHL specialty and there is no reason to fund that business with precious working capital beyond the DSVs own need. Its back to Waterloo Quay and 2005 for those of us who were there (and they were great days I can assure you).

Given the size fof the debt write-down the bondholders will be expected to take they will leave enough cash in to allow the business to trade for a few years in a way that maximises their chances of recovery and nothing more. So unless they can reach a revenue sharing agreement with the Volstad Topaz bond holders that won’t feature as well. The ramifications to the BOHL brand will be enormous but the cash call will be of a magnitude that will allow for little sentimentality.

What % of the business they demand for this is anyone’s gusess and will be dependent on any equity Bibby Line Group agree to put in.  These things are a matter for negotiation rather than hard-and-fast rules. Remember also this is a business that is going to have to be 100% equity financed for the foreseeable future as no one will lend to such specialist vessels without backlog (i.e. an asset and cash flow facility) for a long time. However what does seem reasonable is this:

EBITDA per DSV: GBP 8 – 12m; Corp Overhead: GBP 4m; Implied cash flow for debt multiple: GBP 16m (mid-point average). [Debt at 4.0x EBITDA: 64m]; [Debt at 5.0x EBITDA: 80m]. Outstanding debt: GBP 175m.

I get valuation and cash flow modelling are an art not a science and that I have made a lot of assumptions here. But also bear in mind most DSV operators will kill to get EBITDA of GBP 10m per vessel this year, many DSVs are going out at OPEX plus a small margin if they are lucky, and given the way discounting works I could be seen to be generous here front-loading cash flow. Don’t forget the risk either: this market is far more volatile than anyone, including me, ever thought possible. I think I am directionally correct here and I don’t need to to into greater detail in this forum. The core point is this: under any number of reasonable scenarios the bondholders are looking at writing off at least 50% – 66% of their debt and if a working capital call is made then way more than that; and that selling the DSVs in this market is probably the worst, but not unthinkable, option for them.

The BOHL bondholders are (rightly) terrified of getting the Polaris and Sapphire redelivered. Not only have the Nor/Harkand bondholders taken the vessels out of the market for them they have also highlighted what a shambles getting re-delivered such vessels can be. It is very doubtful the two BOHL DSVs could be sold at anything like the value implied by recent bond market prices (.60-.67) if at all. The bondholders knew the DSVs didn’t cover the value of the bond (i.e. it wasn’t fully secured) but they are currently spending funds they thought would be used to grow the business on basic working capital (that is the fault of the market not management it needs to be said and was a risk they took signing up to a huge unsecured portion of the bond for “general corporate purposes” in a cyclical industry). The cash position could be significantly worse than Moody’s forecast: I doubt EMAS has paid for the Angostura work and some sort of agreed deal with Borderlon, currently in arbitration, could see c. USD 5m handed over for a settlement for 10% of the outstanding claim. Anything more could mean a nuclear outcome for BOHL. Better to stem the exposure now…

At these sort of levels the bondholders are going to ask for a significant dilution of the Bibby Line Group stake (potentially all of it if a signficant amount isn’t invested with the bondholders in the new working capital facility). But the most logical option here is therefore to cut the business back to what could realistically trade at a profit and cauterise the loss making exposure. That means everything apart from the core UK dive business with maybe a couple of ROVs to support it. But the BOHL bondholders are disparate and international. And while M&G (who have their own workout team) are the largest I believe, and may have some interest in a controlled restructuring, this was a “US 144 issue” meaning that a lot of the bonds will be held by US institutions who may just write this off as it becomes to complicated. In such a situation a rump business being sold is the most likely option as there is some value there, just nothing like GBP 175m + working capital.

I think we are looking at a pre-pack here with a “credit bidding” element where the bondholders, or new investors, agree to buy the vessels, backlog, IP and management system and very little visibly changes apart from the closure of international operations and the redlivery of the Topaz and the Olympic vessels with the Borderlon claim left in the insolvent rump. Quite how far they will run the cash reserves down to before such a transaction happens will be the call of from the legal/financial advisers. Olympic, who would appear not have to any Bibby Line Group guarantee, will simply end up as an unsecured creditor and have to accept redelivery of their vessels for what in this market are essentially onerous charters. Borderlon in Houston potentially have the most to lose: having built a vessel for Bibby in the US the charter was cancelled when the market turned. I have no idea who was wrong or right legally, but UK companies traditionally do very badly in US Courts/ Arbitration and they must be hoping for a meaningful payout.

I am not sure the scale of the problems are acknowledged. The company has 10 Directors now, and seems to be focusing on such diverse strategies as small pools (which offer the prospect of cost with no immediate revenues). It’s the ultimate re-arranging of deck chairs on the Topaz  Titanic. I undertand why. I have been in a similar position and there is an element of cognitive dissonance involved. But to believe the bondholders would write off at least half their debt and fund an international expansion for a loss-making business is about as likely as believing the UKCS SAT diving market will miraculously recover. Stranger things have happened.

The only other option would seem to be an investor throwing millions into this business to keep it going until the market recovers and would involve keeping the bondholders whole. I just don’t see it and it pains me to say that. Because the answer to the first question is of course, like all post-modern phenomena, the answer is relative. BOHL not only need enough working capital to satisfy their creditors they need enough to outlast other players in the market especially DOF Subsea.

The marionette Nor Bondholders and their puppet-master Maritime Finance Corporation have a plan so cunning Blackadder would be confused. The top secret idea is to do exactly what they did last year and tie the DSVs up in Blyth and wait for the market to recover and thus, without any investment in infrastructure and systems that the other five SAT dive companies have spent millions per annum on; they will ride a demand wave and recover their investment. Like all cunning plans it involves an element of risk, namely, exactly like last year where they end up spending USD 350k per vessel per month and get no work. But hey I realise I’m a glass half empty guy…

The Nor bondholder have gambled that USD 15m is enough. However, they have burned through at least USD 2.1m since November when they raised the money and appear no closer to some paid days. The problem for Bibby isn’t that they are seriously threatening work its that it is artifically depressing DSV asset prices. I’ll discuss my views on the Nor vessels in depth later. But while their strategy is economically irrational it isn’t depressing rates because 1) E&P companies buy a system + DSV (i.e. engineering, HSE, etc); or 2) the current SAT dive companies all have excess tonnage.

The amount of working capital and the financing gap BOHL have is dependent on all these factors and there is no firm answer here. Keep the debt high and you need a lot. But whatever the agreement is it represents a number in the low tens of millions each year until a market recovery and no one can supply any quantitative information suggesting one, in fact a lot can be shown to make the opposite: this is a period of structural decline for UKCS DSVs.

Waiting for Godot: Nor DSVs

In a previous article, I outlined why I believe the market for North Sea class DSVs is as structurally unattractive as could possibly be designed. The investors backing Nor/Harkand are Waiting for Godot. With their own Vladimir and Estragon, parked quayside at Blyth, they don’t know when Godot is coming, and they don’t exactly know what it looks like apart from an unexpected increase DSV days in the North Sea, but at the moment they can’t agree to leave either. This is totally unsustainable given the running costs and there is clearly an oversupply of North Sea class DSVs, a situation that hasn’t existed since 2002. I believe the offshore industry (globally) will only reach back to a new equilibrium when a focus on economics forms the core of decision-making, and at the moment we appear to be some way off that.

One of my real (and clearly biased) issues with offshore has always been the dominance of engineering and operations people who were feted as their skills became so scarce in the boom. Offshore contracting isn’t at a base level a complicated industry, the execution can be, but the economics is relatively simple. Yet for years the “black magic” of operations has been allowed to obfuscate the economic issues, engineering could dominate all other disciplines because there was no cost pressure. First oil mattered to the exclusion of everything else.

But in order for the industry to move ahead, financial investors need to face reality as well. How low could subsea vessel prices go? Look at the rig market: Ocean Rig purchased Cerrado at c. 10% of cost and the Deepwater II cost NOK 7.3bn (USD 870m) and sold for USD 210m.  Subsea 7 sold the ROV vessel Petrel for c. 7, maybe 1/3 of book value. A wave of bankrupt OSVs are coming to market and some sales are close to being announced which may set new benchmarks. OSVs in general are a classic case of asset specificity. But what gives them such high values in a boom market also works in a counter-cyclical way on the way down. That’s a complicated way of saying if you build a ship that’s really good at one thing, and that thing isn’t needed anymore, it’s not worth a lot regardless of how much it cost to build.

Nothing seems more financially irrational than the behaviour of the Nor/Harkand bond-holders. Having taken re-delivery of the vessels from the Harkand administrator in 2016 they then proceeded to move the vessels to Blyth in hope of getting work. The fact that no consultants were engaged to provide some guidance on the regulatory requirements and operational realities of getting work shows how truly out touch these investors and advisers were. Even a basic knowledge of the North Sea DSV market shows that there are only five serious companies and all were too long on tonnage, with massive (non) utilisation issues of their own fleet, and therefore these vessels were simply going to be tied-up quayside. There are enough data providers out there for this not to have been missed.

Apart from Technip, who had used the Da Vinci before, anyone wanting to use these assets would have had to invest in bridging documents from the vessel dive operating system to their company HSE system and then get HSE approval. Its not impossible, ISS did it with the Polaris when they brought it to the North Sea, but its probably 4-5 people taking at least 4-6 weeks. It’s time-consuming, process oriented, work. Then you need to get HSE approval which needs a few weeks best case scenario. And that’s before you tender for work because no one is going to award you work on the off-chance something goes wrong on your approval process. And more importantly, why would you bother? There are five companies in the market with really good assets and track record and they don’t have enough work for their own boats and are bidding at less than OPEX just to get the vessels away from the quay? Economists call this market an oligopoly: a few firms dominate it. In a period of oversupply it leads to an efficient market where there are no economic rents to be made by these firms. In plain English it means they compete on price and there is no economic room for new entrants.

For this reason there has never really been a spot market for DSV charters in the North Sea, it’s actually the opposite, you need to control an asset before being seriously considered for work. So in reality there was never any chance of the Nor/Harkand assets getting any work at all in 2016 as any independent party could have pointed out (saving millions in transit and operational costs).

But what the Nor/Harkand investors lack in humility and foresight they make up for in intractability. These vessels, having sat around for the better part of 9 months without any work, raised USD 15m in November last year giving them more time to pursue exactly the same strategy for longer. Like Haig at the Somme, no amount of money is too great to commit to proving their point, against the face of all evidence to the contrary, that the North Sea market is going to bounce back. The Nor/Harkand vessels, like Vladimir and Estragon, wait in Blyth to take advantage of a break-out of demand so extreme all the current dive contractors are going to suddenly go-long on two more vessels and allow the whole crazy cycle to start again. [And it’s actually more than that because with the Vard new-build and a couple of other you could add 20% capacity to the market almost instantly.]

To be fair I met one of the distressed investors who said to me “if they were going to win work with this strategy they would have done it last year, hopefully we’ll have to so another cash call and I can buy some more when people realise how bad it is”. I get that….It’s not quite as irrational as trying to put the Cal Dive band back together, but its not that far off either.

The Atlantis and Davinci are totally unsuited now to the North Sea market (where demand meets supply as opposed to strictly environmental factors). As DSVs go they clearly have the technical capability to operate in the region but the real question is who would need them and for what? One of problems with DSV is that because you cannot put a diver down more than 300m, the same technological boundary of 30 years ago, newer vessels offer few advantages over old ones, and certainly nothing price cannot fix.

E&P companies buy DSV time on 5 criteria : 1) the operator, 2) the SAT system, 3) the crane, and 4) deck space 5) schedule. A DSV is a compromised vessel on everything compared to a general purpose OSV unless it’s working as dive vessel. If you are not working as a dive vessel what are you?

Obviously as an operator the Nor/Harkand proposition doesn’t make sense. There is no infrastructure, management team, capital or long-term plan that would make someone buy a complex project off them. Using a bunch of subcontractors to replicate a solution that other integrated SAT dive companies could provides a solution for Nor but not for the customers. Nor seemed to have recognised this and have stated explicitly they are not seeking dive work… but then what are they seeking?

As ROV vessels the Atlantic and Davinci don’t work: they are over specified and too heavy on fuel. M2 have ROVs on board, but they have also struck a deal on the Go Electra, and need to build their first year campaign around this vessel (which is a great ROV vessel and full credit to the guys here). Who would cover tendering costs, bid bonds, warranty issues etc? I will write on ROVs soon, but they are shaping up to be an extremely competitive area with everyone from start-ups to established companies having access to a huge variety of custom ROV tonnage these assets simply aren’t needed in the market,

As a heavy-lift vessel they don’t work. The cranes are rated at 140t but that is double fall. More importantly, these vessels have not worked doing lift operations in a long time. Anyone looking to do a decent lift isn’t going to save a few dollars to have a temp crane driver do the lift offshore on an asset that hasn’t worked in a year with an offshore team that has never worked together.

In the current market where every asset type is oversupplied these assets simply have no logical market space. Simply being cheap doesn’t help because everyone is cheap. The Nor bondholders are soon likely to find that their USD 15m bazooka is actually a pea-shooter and simply will not convince potential customers or buyers they are here for a long time. Long-term DSV charters are extremely rare, and at the moment some of the most contested contracts around. Everyone is competing on price so Nor offer nothing. And there are NONE in the North Sea where their vessels are.

Nor have a basic commercial problem: no one wants to buy what they have to sell. Nor need a massive change in strategic direction. However, Maritime Finance Corp, the largest shareholder, appear committed to following this strategy to its logical conclusion (another fundraising round after months of no work) as to pull out now would mean owning up the residual value of the assets being significantly lower than they would like. MFC purchased about 37% of the bonds on issue meaning they put in c. USD 81.4m in 2014. In the current market you would be lucky to get that for both vessels implying that MFC would have to write off c.50m (i.e. 37% of USD 80m is USD 30.1m).

Moving the vessels out of the region means owning up to the fact that they aren’t worth all the extra money above an Asian or US flagged DSV. Keeping the vessels in the North Sea requires an act of faith, a contrarian view, that diving in the UKCS will bounce back. Sooner-or-later this strategy must fail. The core point is this (thanks to DNB):

The UKCS and NCS saw a boom in oil and gas investments post the financial crisis in 2009, particularly the former, where development capex increased by ~125% from 2010 to 2013. The rebound in the oil price made several smaller projects economically attractive, and a sizeable majority of these were developed as subsea tie-backs. In addition, ageing infrastructure needed significant upgrades to accommodate a much longer lifetime than originally envisaged, and new production from smaller fields…

The outlook on the UKCS does not look as strong, however, and we highlight that only ~GBP0.5bn of new investments was sanctioned in 2016, versus an average of ~GBP8bn in 2010–2015. In other words, we believe the recovery in activity in 2017– 2019 is likely to be limited to the NCS, which is a major difference from the 2010–2013 recovery in this region.

CAPEX is at 1/16 of previous levels. The CAPEX vessels are trading in the OPEX market and will do for a significant period of time given lead times. A small CAPEX project could easily take 180-270 DSV days, that work simply doesn’t exist now, and Technip and Subsea 7 have moved their corporate resources back to IRM. A strategy to add capacity, without infrastructure, in a brutally declining market, against better-capitalised and more committed competitors, is economic madness.

One of the Nor DSVs off to Africa?


I’ve always had a soft spot for McDermott. I remember when it was J R McDermott. Who else but a good ole boy from Houston would start out barge lifting and build a great global contractor? I also still believe the franchise is good enough for them to become a proper SURF contractor if they commit over a multi-year period. Everyone in the industry knows that if something goes really wrong in a complex project McDermott has the intellectual horsepower, somewhere in their vast repository, to solve it. You might need French mathematical skills to drop 30″ PIP at 3000m in Brazil, but if you need a solid platform or jacket in the Middle East there is only one contractor of choice; and when clients come to make crucial decisionsMcDermott have enough heritage and balance sheet strength to be a serious contender on larger projects. A rights issue at the opportune time to buy some bargain assets would transform them quickly into a tier 1 SURF contractor.

McDermott, so I am told, are going long on one of the Nor Offshore vessels and taking it to Africa. McDermott has deep institutional roots in  Africa and they have won a lot of work in the region recently. Their current DSV in the region Emerald Sea  is a 1996 build with a small, single-bell, system and a carousel. McDermott could hugely reduce project execution risk with a twin-bell vessel and have enough ancillary work to get decent utilisation of the ROVs and crane.

I am not privy to the details but if I were McDermott I would go for a 5 year bareboat charter with a purchase option. The purchase option is going to be the killer for the current investors (and I understand it was on this point discussions earlier in the year broke down). Pitch it at USD 55-60m and the original bondholders will have a sense of humour failure but the late/distressed investors may be able to live with it. A near 1.7x straight money multiple (assuming the brought in c. .35-.38), excluding charter revenue, might be in play given the reduction in opex. McDermott don’t need to go any higher, they have the in-house skills to take the ex-Mermaid vessel and the yard is getting desperate there. Given the current outlook for Nor you could negotiate a day rate for 2017 that may be even less than the daily opex the owners face now: how hard are they really going to push you if you offer to escalate it over five years? Nor face residual value risk if their asset is redelivered after five years in Africa; but there are no good deals on the table at the moment and failure to do a deal like this will see them seeking more cash next year.

That leaves Nor with one DSV in the North Sea (and given they are likely to have to deliver the vessel in Africa it really raises the question again of why on earth the DSVs were brought to Blyth in the first place?) and a “commercial manager role” (Disclosure: I had a brief discussion about Stamford doing this). Its not looking good as a sub-scale ship owner but to be fair if they can close this deal I think this is as much as could be hoped for in the current market and there isn’t much credit risk with McDermott. As I have said before I think starting dive operations would be an act of economic madness and there are a lot of OSVs with large decks and 150t cranes at the moment so its hard to see what work the vessel can hope for on a regular basis.

With the remaining DSV I’d be trying to partner with DOF to make them a two vessel DSV operator in the North Sea and see what develops, because if you can’t strike a deal, and Bibby re-deliver the Bibby Topaz in June, DOF may well buy/charter it (although its such a good ship I think SS7 and Technip would look at it). The bondholders would surely take ~USD 50m given the competing vessels and this would set price expectations for every other DSV in the market. DOF would become a clear number 4 in the DSV/ IRM market with a much better balance sheet than Bibby, infrastructure, and some really good people, and the ability to cross-subsidise across the fleet to get utilisation.

The Bibby Topaz is the DSV wild card. Yes Bibby have an option on the dive system but who really believes they are going to spend USD 5-8m to take it out and restore the Topaz to original condition? (c. 10% of their remaining cash). Bibby cannot afford to give the Topaz back (because then the bondholders will realise they are never getting there money back at close to par) but they don’t have the forward order book to justify keeping the Topaz at the moment (because then the bondholders will be angry that their money is being spent on an idle vessel charter). Debt is a cruel master. In the current market the Volstad bondholders probably dream of Bibby redelivering it as an OSV… I think the rate at which Bibby can build up their summer order book will define how quickly they will approach the bondholders with a restructuring proposal because if they can sell enough days on the Topaz over summer their funding need will decline markedly.

But if DOF take the Topaz (and probably force Bibby to bring the Bibby Sapphire back to the UK), and Ocean Installer take the Vard new build as has been discussed, and the Chinese yards deliver all the DSVs on order, then the remaining Nor vessel will only be worth whatever an Asian operator will pay. I accept there are a lot of “if’s” but the Vard DSV will come (probably in a risk sharing deal) and at least some of the Chinese tonnage looks far enough through to make it to completion even if the contracted buyers don’t have take-out financing lined-up.

It’s like Kremlin watching but with boats…