Is Atwood Acquisition Positive for Ensco?

High-quality assets is key positive with sluggish industry recovery being the biggest concern

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Jun 01, 2017
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As challenging conditions for the offshore drilling industry continue, it is increasingly likely that there will be mergers and acquisitions. While well-timed acquisitions can be a big catalyst for any stock, expanding at a time when the industry outlook remains uncertain poses certain risks as well.

This article will examine the acquisition announced by Ensco (ESV, Financial) with the company having reached a deal to acquire Atwood Oceanics (ATW, Financial) in an all-stock transaction.

In the past, I have written about both companies, and there is little doubt of the acquired entity's asset quality, but this article will discuss factors beyond the asset quality to assess the potential stock direction for Ensco in the medium to long term.

Deal overview and positives

In an all-stock transaction, Ensco will be acquiring Atwood Oceanics with 1.6 newly issued Ensco shares per Atwood Oceanics share. This represents a premium of approximately 33% to Atwood’s closing price on May 26. Post acquisition completion, Ensco shareholders will own 69% in the company with 31% with Atwood shareholders.

From a shareholder value perspective, the acquisition is likely to translate to $65 million in pretax annual expense synergies. On acquisition completion, the combined entity will have 26 floaters and 342 jack-ups.

In terms of positives, the first point to note is that Atwood Oceanics has a young and quality fleet and the acquisition adds to a high quality portfolio for Ensco. The acquisition will ensure that Ensco has the second-largest floater fleet with a large UDW presence.

Further, the acquisition increases the global footprint for Ensco and also widens the quality customer base. I mention this point specifically as there is minimal customer overlap and for Atwood Oceanics, 75% of the customers are investment grade.

From a balance sheet and liquidity perspective, the combined entity will have $3.9 billion in cash and available liquidity and $3.7 billion in contracted backlog. Further, net debt to capitalization ratio of 29% ensures high financial flexibility.

The combined entity will also have debt maturity only on and after 2019, and this ensures no immediate debt refinancing pressure. Overall the balance sheet is likely to remain strong for the combined entity with enough resources to navigate challenging industry conditions.

Key concerns

When considering the combined entity asset quality and a long-term outlook, the acquisition makes sense, but my key concern is the pace of recovery for the offshore industry.

Oil prices have stabilized around $45 to $50 per barrel, but for the offshore industry to deliver good numbers and high rig utilization, oil should be at least in the $60 to $70 per barrel range. With that unlikely to happen anytime soon, I see this as the biggest challenge.

It is worth mentioning here that as of the May fleet status report, Atwood Oceanics had several idle rigs. The company also has four rigs that will be going off-contract before December. If industry conditions fail to recover, one or more of the rigs will be idle and that will impact the combined entity.

The acquisition makes sense from an asset quality perspective, but considering the industry's health, it is unlikely that high-quality assets will deliver strong returns in the next 12 to 18 months. In the medium term, I see the stock reaction being negative.

Conclusion

The offshore industry is going through one of the most challenging times; even if rigs are contracted, day rates will remain depressed and even advanced rigs will deliver a low rate of return.

In the next 12 to 18 months, EBITDA margin is likely to remain suppressed along with potential cash flows. While Ensco has expanded its fleet, I see the stock reacting positively only after there is significant change in the fleet utilization.

Disclosure: No positions in the stocks discussed.