Shares in Seadrill (SDRL, Financial)(SDLP, Financial) plunged by around 30% Tuesday after the company warned that it would have to raise $1 billion as a capital lifeline to avoid Chapter 11 bankruptcy in the next few weeks.
The company, currently in discussions with its lenders over a potential restructuring, has been hit hard by a downturn in spending in the oil and gas industry. This downturn hits Seadrill more than most because the company had used debt to fund its expansion, and debt was tied to earnings potential. Now that the earnings potential has evaporated, Seadrill’s debt has become a noose around the company’s neck.
Debt danger
Seadrill is looking to raise at least $1 billion as talks to restructure its debt and liabilities of $14 billion are taking longer than expected. The company is in negotiations with its 42 banks and bondholders regarding the restructuring and is trying to arrive at a solution that achieves the best result for parties involved. The deal is being made more complex by the fact that any restructuring would involve several Seadrill subsidiaries, including North Atlantic Drilling Seadrill Partners, Archer, Sevan Drilling and Asia Offshore Drilling.
Along with the $1 billion capital raise the company is seeking to extend bank maturities to the period from 2021 to 2023, reduce fixed amortization and amend financial covenants and extend the maturity of unsecured claims to mature in the period from 2025 to 2028. The company has $8.2 billion and secured debt, $2.3 billion of unsecured debt and contingent liabilities of $3.5 billion.
After Tuesday’s slump, Seadrill has a market capitalization of just under $1 billion.
The company has warned that if it cannot restructure its debt by mid-February, it will look to file for Chapter 11.
Unfortunately, it is tough to find any reason at all to be optimistic about Seadrill’s outlook. The company’s problems go far beyond its debt.
Asset value crumbling
Seadrill built its fleet at the top of the market, using debt to fund the construction of drillships costing over $600 million apiece. For the most part this debt has been tied to future cash flows from these assets, a method of financing that allowed the group to grow quickly but has left little room for maneuver as the market has turned over. Now Seadrill faces an enormous problem. The drillships of the company brought at the top of the cycle for over $600 million could now be worth as little as $65 million.
While the value of these assets has collapsed, the value of debt tied to these assets has remained constant meaning that asset sales to reduce debt are now completely out of the question.
The good news is that the depressed value of drilling assets is most likely encouraging Seadrill’s creditors to reach a deal with the company. If it was possible to seize the assets and sell them in the market for a suitable price, allowing creditors to redeem their investments, it’s likely they would have pushed the company into bankruptcy several months ago.
Now, it seems the only asset creditors will be able to get their hands on is Seadrill equity, which ultimately means dilution – really bad news for investors.
Jump ship
Even though Seadrill’s management continues to put up a good front, claiming that talks are ongoing with creditors, it’s clear the company only has a few weeks left in its current form.
Lenders are likely to demand a huge chunk of the business in return for debt forgiveness. How much dilution is in the cards is not yet possible to tell but considering Seadrill’s total debt and market capitalization, even a 10% debt haircut in exchange for shares would see an increase in the share count of 150%. The only other option is that creditors take a haircut on their holdings of the company’s debt with no financial compensation. This is extremely unlikely.
All in all, despite management’s optimism, it could be game over for Seadrill.
Disclosure: The author owns no share mentioned.
Start a free seven-day trial of Premium Membership to GuruFocus.
