Highly-indebted Seadrill has been skating on thin ice ever since oil prices diverged to the downside nearly three years ago. Earlier this month it finall succumbed to its $10 billion debt load, announcing a comprehensive restructuring plan:
Seadrill Limited (“Seadrill” or the “Company”) has entered into a restructuring agreement with more than 97 percent of its secured bank lenders, approximately 40 percent of its bondholders and a consortium of investors led by its largest shareholder, Hemen Holding Ltd.
The agreement delivers $1.06 billion of new capital comprised of $860 million of secured notes and $200 million of equity. The Company’s secured lending banks have agreed to defer maturities of all secured credit facilities, totaling $5.7 billion, by approximately five years with no amortization payments until 2020 and significant covenant relief. Additionally, assuming unsecured creditors support the plan, the Company’s $2.3 billion of unsecured bonds and other unsecured claims will be converted into approximately 15% of the post-restructured equity with participation rights in both the new secured notes and equity, and holders of Seadrill common stock will receive approximately 2% of the post-restructured equity.
The company believes the plan is a comprehensive solution to Seadrill’s liabilities and debts. However, I believe Seadrill is simply kicking the can down the road.
Seadrill’s Debt/EBITDA Would Still Be At Junk Levels
The company believes the agreed upon plan addresses Seadrill’s liabilities, including funded debt and other obligations. I beg to differ. The current plan entails $1.06 billion of fresh capital, but only $200 million of new equity. The additional $860 million would comprise new debt that would not come due until later. An additional $2.3 billion of debt would be swapped into equity.
The following chart illustrates the $2.5 billion reduction in debt (debt swap and equity infusion), which brings total debt to 6.5x run-rate EBITDA (Q2 2017 results annualized).
Seadrill’s debt/EBITDA has been at junk levels since year-end 2016. Debt/EBITDA was 5.3x at year-end 2016. Debt/run-rate EBITDA at Q2 2017 had deteriorated to 8.9x. The current structure would reduce the metric to 6.5x – still junk levels. In my opinion, the optimal structure would be one that would provide the company with sufficient working capital and bring debt/EBITDA down to investment grade levels.
March 8, 2017 article highlighted how a $6.6 billion debt for equity
I estimate a debt-for-equity swap of $6.57 billion could relieve Seadrill’s liquidity strain and help rightsize its capital structure. Its debt of $3.36 billion would be less than Transocean’s Q4 2016 debt of $8.26 billion. Its 2017E 3.0x debt/EBITDA multiple would be less than Transocean’s which is now around 3.9x EBITDA.
With a $6.6 billion debt-for-equity (or some other type of equity infusion) Seadrill’s debt/EBITDA would have declined to 3.0x. It would have also given the company breathing room to maintain its investment grade rating even if its EBITDA continued to slide amid a slump in deepwater E&P.
Seadrill Might Have To Return To The Trough
In my opinion, Seadrill’s current capital structure appears to be a stop gap measure. It provides pushes some of its debt obligations out into the future and provides some amount of debt reduction. However, debt/run-rate EBITDA of 6.5x would be higher than it was at year-end 2016 (5.3x). Secondly, it likely does not give the company much breathing room if its EBITDA continues to slide. Any hiccups in its operations or if the deepwater E&P continues to slump and Seadrill’s credit metrics could deteriorate further into junk territory.
That is a long-winded way of saying the company might have to return to the trough for more money. I believe management has better negotiating power now, than it would at a later date. It would behoove the company to negotiate a deal that could keep the company out of bankruptcy. Having to re-negotiated with creditors at a later date could create an additional distraction for management and negative sentiment for all stakeholders involved.
Conclusion
Seadrill’s current debt restructuring appears to be kicking the can. If it re-emerges from a restructuring with debt still at junk levels then investors should avoid the stock.
