OFFSHORE DRILLING BITS
February 13, 1999
Number 27
Written by Mike Simmons, Offshore Rig Broker and Industry Consultant
Write to Mike at mailto:mike@loosbrock.com
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NEW OFFSHORE RIGS DON'T COME CHEAP
...BUT WHAT'S IT WORTH AFTER IT LEAVES THE SHOWROOM FLOOR?
Thumbing through the pages of the latest reports on the offshore drilling
sector I am usually attracted to the representations of rig values. What's
a rig worth? That's the sixty-four billion dollar question.
Without exception there are rig values listed in these fine investment
banking reports. Usually, two rig values are given - liquidation value and
replacement cost.
Liquidation value, I assume, is the price the company could sell the rigs
for on a "prompt" basis. Read "fire sale".
While the so called liquidation value may have some meaning in financial
wizardry world (maybe to establish a rock bottom asset-based price support
for the stock), it has little to no meaning in the world of reality.
Ok, maybe for one or two or a few rigs. ABC Drilling Company could ask me
to sell a few 300-ft. jackups today and I could likely find a buyer to pay
something near the liquidation prices commonly listed.
But what if I wanted to sell (liquidate) a fleet or a large portion/segment
of a fleet - TODAY! Who would be the buyers? Count them on one hand. They
would be the larger drilling companies with lots of cash and/or low debt.
Who else could further leverage the balance sheet by adding more assets that
are working at day rates barely above direct operating costs and have dismal
prospects for higher rates? The smart-money drillers will add capacity with
low cost-basis rigs when prices are low and conditions are dismal. Not yet,
but stay tuned.
Would an investor or speculator be a buyer? Nope. Maybe for one or two or
three rigs -- but not for a fleet.
With such a short list of potential buyers, and these buyers aren't
dummies -- they know they are the only buyers -- do you think a bidding war
would ensue? Not a chance. Do you think the "liquidation prices" would
hold? Not a chance.
An offshore driller is really nothing but a company that owns and operates
rigs. Oil companies insist on a certain level of safety and performance,
and the drillers as a whole have an excellent track record of providing what
the customer wants. But take away the rigs and the company is empty,
without value. A good track record is important, but by and large the
bottom line is the bottom line. The lowest bid wins the contract.
If the company is without value once the rigs are gone, then the liquidation
prices of the rigs may be a critical number in evaluating the companies.
But why not use a real-world liquidation value? Why not contemplate what
ABC Driller could actually get for the fleet if he had to sell it today?
The numbers would be much lower than the one-off rig liquidation values
commonly seen.
Replacement cost value is a useful number, but not in assessing or
determining the value of a rig. Yes, to replace the all the rigs in ABC
Driller's fleet would even set most Texans back a few weeks wages. But a
better use for the replacement cost value number is to be able to determine
how high day rates can go.
Not many people are worried about doing that particular calculation today,
but the day will again come when day rates soar, and it is important to know
there IS a ceiling. That ceiling was touched in the last boom in the
deepwater semi market. For jackups there was still room at the top for
further increases.
Day rates will only rise to the point where a driller can justify building a
new rig. At the day rate point where new rig construction makes economic
sense for a driller then multiple drillers will be bidding rigs at that
price and the rate will not move higher. The exception would be for the
time value of existing rigs. Assuming an oil company couldn't wait the 24
months for a new construction rig and had a current/urgent need for a rig,
the day rate could move above "construction cost economics". But only on a
temporary basis.
With the latest round of high day rates, the market for deepwater floaters
edged above $200,000. It is not just a coincidence that the rate climb
topped out at that level. At around $200,000 a day for a 4-6 year contract,
and considering the driller's desired rate of return, it made sense to build
a new rig. If it makes sense for one driller, it makes sense for many
drillers. And there follows the built in market mechanism that auto-limits
day rate increases.
The stand out exception in the latest round was Diamond Offshore who stood
back and kept their powder dry -- and were routinely criticized at the time
for not joining in on the newbuilding train. Today, Diamond Offshore looks
like the driller in the strongest position to take advantage of market
conditions. It has tons of cash, low debt and one of the lowest cost-basis
rig fleets in the business. Look for Diamond to be the strong contender
when/if asset sales begin. It's a cyclical business. It makes sense to
play the cycle.
Jackup day rates never rose to the point to justify new construction. Only
a handful of jackup orders were placed. The most notable pure speculation
orders were from Chiles Offshore for two MLT 116's at a total cost of about
$175 million. No operating company, no contracts.
The Chiles rigs will be delivered this year -- one in April and one in
September. Considering debt service and direct operating costs, these rigs
need roughly $40,000 per day each to break even on a cash basis (not
considering debt structure). Since they can work in slightly deeper water
than most other jackups (360-ft.), they will earn top dollar and likely have
high utilization being the newest rigs on the block. But with current
300-ft. jackup day rates somewhere between $15,000 and $20,000, it is
unlikely the Chiles jackups will approach that break even number on
delivery.
What if they wanted to sell (liquidate) the rigs today? Maybe $45-50
million each. This fleet consists of only two rigs, so the liquidation value
numbers would hold. Debt on these two rigs is over $100 million, the equity
is gone before they are even delivered. Speculating with offshore rigs can
pay off handsomely, but the downside can be sure and swift.
Offshore drilling rigs are not bought and sold in efficient markets, as are
stocks. Or houses, or cars. Therefore, offshore rigs carry spreads between
the bid and ask price that would embarrass an OTC market maker.
The lack of desire or motivation to sell an offshore rig naturally results
in the rig owner setting a fairly high asking price since he really doesn't
want to sell. The potential buyer is only there to buy at "bargain prices"
so the bid is naturally quite low.
Non-industry buyers include investors, speculators and assorted financial
wheeler-dealers. They only buy "on the cheap" and therefore always have low
bidding prices. This crowd spends most of the "boom" times counting their
money from the previous cycle while waiting for rig prices to come down
again. They could, arguably, be considered the smart guys of the industry,
living out the adage of buying low and selling high. (Yes, there is a
category of not-so-smart guys, but it is not proper to talk about bankers in
mixed company. Their habit seems to be to make loans when values are high
and pour good money after bad to prop up what they have already lost when
values and markets are low. Will they ever learn?)
It's easy to price a new rig. The shipyard inputs the cost of all the
materials, equipment, labor and profit and out comes a number that is the
cost of construction. But just like a new car that is driven off the
showroom floor, when the new rig is delivered the window sticker can be torn
off and thrown away because now the marketplace is in charge of the value of
your shiny new rig.
Obviously all rigs started out new, but today they are all worth more or
less than the original construction costs. Earnings power, for today and
the future expectation, is the most powerful driver of rig value.
Willing buyer, willing seller valuation is difficult in today's market due
to the significant spread between bid and asking prices. Buyers are afraid
to buy, but are willing to buy at low prices. Sellers, due to comfortable
cash and debt service positions (for now) are not willing or motivated to
sell.
Result - low bid prices and high asking prices and no way to value the rig
based on this method. It is not uncommon for a buyer to be willing to pay
$20 million, but a seller not willing to sell for less than $60 million.
Both numbers reflecting the uncertainty of the market.
Investors should be wary of buying offshore drilling stocks based on the
perceived valuation of assets. Thinking that the value of the rigs will
provide some bottom support for the price of the stock is dead wrong. When
employment prospects and the earnings power of rigs turns bleak, the value
of the rigs are going nowhere but down - and fast.
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Offshore Drilling bits is written by Mike Simmons.
Companion web site: loosbrock.com
Comments and questions to Mike at mailto:mike@loosbrock.com
Copyright 1998, 1999. Loosbrock Offshore, Inc. All Rights Reserved.
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