I usually do not post analysts' research notes, but today is an exception.
As Mike once said, everything is in the detail of the contracts.
Excerpts from the note:
Morgan Stanley\DW (Lovoi, John V. 713-512-4481) SLB DO ESV
Schlumberger (SLB): Pushing the Edge of the Integration Envelope,
Maintain Strong Buy and $105/Shr Target
John V. Lovoi (713) 512-4481
P. David Chiaro (713) 512-4485 Date: December 22, 1997
Industry: Oil Services and Equipment Type: Sales/Earnings Analysis
______________________________________________________________________
Rating: Strong Buy Price: 74
52-wk Range: 49 - 94 Price Target: 105
KEY POINTS
- Over the last week, Schlumberger announced two meaningful newbuild
drilling rig contracts using the company's proprietary Sedco Express
deepwater drilling rig design. We believe the structure of these
contracts and the nature of the assets deployed have important future
implications for the industry, the most important a closer working
relationship between contract drillers and oilfield service companies.
- One of the things that we admire most about SLB is the company's
strong cultural orientation towards the delivery of cost effective
drilling and production solutions. This company clearly understands
that its long-term success is fundamentally premised on its ability to
lower drilling and production costs for the operator.
- Current market speculation is that SLB underpriced these assets and
that dayrates within the high-specification floater market have
peaked. We believe the ultimate return to be earned by SLB will be
significantly higher than the speculated below-market dayrate and we
further believe that future dayrate fixtures for high-specification
floaters will continue to rise.
- Our rating on the shares of SLB remains Strong Buy and our 12-month
target remains $105/share.
DETAILS:
New Contracts
Over the course of the last couple of weeks, Schlumberger's Sedco
Forex (contract drilling) division has entered into two separate 5-
year drilling contracts utilizing the company's Sedco Express
deepwater drilling rig design. The first rig will be leased by Elf
Aquitaine for drilling operations Offshore West Africa. The second
rig will be contracted by Texaco for five years for work in the
deepwater Gulf of Mexico. Both rigs are scheduled to go to work in
the fourth quarter of 1999.
Towards the end of last Thursday and throughout last week, energy
service stocks performed poorly, largely in response to concerns that
SLB had entered into below market dayrate contracts for these two
newbuilds. According to market speculation, the dayrate for these
assets is believed to approximate $160,000 - $165,000/day, roughly 25%
below current market, assuming the construction costs for the assets
will approximate $225 million to $250 million.
In our opinion: (1) there is much more to the speculated dayrate than
immediately meets the eye, (2) the value-added potential of this type
of rig should prove to be significant (benefiting both the operator
and SLB and its shareholders), (3) the nature of these contracts
signals a closer working relationship between offshore drillers and
oilfield service companies, and (4) the negative price impact on oil
service equities last week was yet another sentiment-driven
overreaction.
Economic Implications
To repeat, the dayrate for these assets is believed to approximate
$160,000 - $165,000/day, which would be roughly 25% below current
market, assuming the two newbuilds will cost roughly $225 million to
$250 million to construct. Our belief is that the ultimate structure
of the agreement between Schlumberger and the two operators will
likely include three components (1) a base dayrate, which may very
well be nominally below existing market, (2) agreements to use the
full suite of SLB oilfield services - directional drilling,
measurement-while-drilling, pressure pumping, drilling fluids, and
wireline logging - over the five-year term of the contract and (3) a
significant performance bonus in the event that the integrated nature
of this asset does truly deliver value-added to the customer in the
form of a clean well drilled in a significantly shorter period of
time. In short, we think there will be much more to this contract
than $160,000 - $165,000/day. In our opinion, the final structure of
these contracts will be such that the total return on capital for SLB
will be higher, and most likely significantly higher, than what the
company would earn under a traditional contractual arrangements.
There is absolutely no reason whatsoever for SLB to enter into below
market contracts for new-build high-specification semisubmersibles.
The company is the largest oilfield service company in the world and
among the largest in the area of offshore drilling. More importantly,
SLB is the most profitable oilfield service company in the world.
Furthermore, SLB recently sold two second-generation semisubmersibles.
When questioned as to why it sold these assets, which were earning and
had the potential to continue to earn extremely attractive rates of
return on invested capital (indeed a much better return than the
return underlying a five-year contract at $160,000/day for a $225
million newbuild), the company stated that it was interested in
substituting higher capability assets - i.e. the Sedco Express - for
lesser capability assets.
First Call Corporation - all rights reserved. 617/345-2500
END OF NOTE |
