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Is Seadrill’s Failed Bond Issue A Concern

July 20, 2014 | About:
Faisal Humayun

Faisal Humayun

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I have remained bullish on Seadrill’s (SDRL) outlook and dividends in the past. At a current stock price of $37.5, the company still offers a strong dividend yield of 10%. This article discussed the company’s recent bond issue failure and its implications on dividends and growth.

The Planned Issue And Conversion

On July 8, 2014, Seadrill announced that it intends to issue US$1 billion in principal amount of convertible bonds with a five-year tenor. The bonds were expected to have an annual coupon in the range of 2.0% - 2.5% payable semi-annually in arrear and have a conversion premium of 30% - 35% over the reference share price based on the volume weighted average price of the Company's shares on the Oslo Stock Exchange and on the New York Stock Exchange between opening and closing of the market on July 8, 2014.

Besides this, Seadrill also planned to launch a voluntary incentive payment offer to convert any and all of the US$650 million principal amount of 3.375% Seadrill convertible bonds due 2017.

The Failure

On July 9, 2014, Seadrill announced that it has cancelled the bond issue and the conversion. Although the order book was covered, the adverse stock price movement led to an unattractive conversion price for the issue.

Consequently, Seadrill also cancelled the 3.375% US$650 million Seadrill convertible bonds conversion offer, which depended on the success of the $1 billion bond issuance.

Making Amends

On July 18, 2014, Seadrill launched a voluntary incentive payment offer to convert any and all of the US$650 million principal amount of 3.375% Seadrill convertible bonds due 2017.

According to the company, the cancellation of the bond issue and the subsequent conversion negatively impacted the bondholders due to the common practice of hedging during a conversion offer.

Seadrill therefore re-launched this offer in trying to make amends with the bondholders and its reputation in the markets.

Is Seadrill Overleveraged?

Seadrill’s shares reacted negatively on the day of the proposed bond issue launch and the stock has declined by 6.5% in the last one month.

The key concern for equity investors is the company’s leverage and the concern if the company can pay its dividends in a relatively challenging market environment.

Seadrill does have a high debt of $12.3 billion as of March 2014 and a debt to EBITDA (2014 annualized) of 5 for the same period. The debt is certainly high, but the company’s EBITDA interest coverage ratio of 5.1 provides easy debt servicing.

My main focus is the company’s 19 new rigs, which still have a pending payment of $5.4 billion. If all the new rig deliveries are financed through debt, the company’s debt is likely to increase to $18-$20 billion over the next 2-3 years.

The key point here is how the day rates will be over the next few years. The day rates have declined from the peak and 2014 has been a relatively challenging year for Seadrill. If this continues, there will be more debt concerns and the stock might be impacted negatively.

For now, Seadrill does have high debt, but debt servicing is not a matter of concern for investors. However, investors need to be cautious on the market outlook. The company also intended to use the proceeds from the failed bond issue for new rig financing. It now remains to be seen what alternatives the company will pursue. I believe that the company will launch a bond issue relatively soon.

The second option for Seadrill is to drop-down West Jupiter to Seadrill Partners (SDLP). The West Jupiter is one of eight 6th generation drillships currently under construction for Seadrill and is expected to be delivered from the Samsung Heavy Industries shipyard in Geoje, South Korea in August 2014.

Seadrill has already secured a $1.1 billion, 5-year contract for the rig and this makes it an eligible drop-down candidate. I therefore believe that Seadrill will raise case through this drop-down and Seadrill Partners might go for a bond issue or pay through internal accruals. In any scenario, Seadrill will get the funds it requires for the funding of new rigs.

Will Dividends Decline?

I don’t believe that the company’s dividend payment will be impacted by the failure of the recent bond issue. Seadrill had a cash and marketable securities position of nearly $2 billion as of March 2014.

Further, the company generated an operating cash flow of $656 million in 1Q14, which translates into an annual operating cash flow of nearly $2.5 billion. In comparison, the company has an annual dividend outflow in the range of $1.6 to $1.8 billion.

The company’s order backlog of $18.8 billion as of May 2014 also gives strong cash flow visibility and ensures that dividends will continue.

Conclusion

Seadrill is having relatively rough times with the cancellation of the bond issue and amidst relatively challenging market conditions. But I believe that the company is fundamentally strong enough to clear these headwinds and move ahead. And stock price depression from recent events is an opportunity to consider exposure to the stock.

Investors just need to watch the market dynamics more closely as a substantial decline in day rates can be a risk. However, I don’t believe that day rates will decline sharply in the foreseeable future.

About the author:

Faisal Humayun
Senior Research Analyst with experience in the field of equity research, credit research, financial modelling and economic research

Rating: 0.0/5 (0 votes)

Comments

Prudent Investor
Prudent Investor - 1 month ago

Seadrill can't pay its dividend and CapEx/Debt on a annual basis. Project out cash flow and you will see for yourself. Seadrill doesn't generate over $4-6 billion in annual cash flow.

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