Seadrill To Buy Aquadrill – Strategic Move At Good Price (NYSE:SDRL)

It’s been a busy fourth quarter for leading offshore driller Seadrill (NYSE:SDRL) so far, with the company returning to the Big Board in October following its emergence from bankruptcy earlier this year and subsequent completion of the previously announced sale of seven jack-up rigs, including $0.7 billion in backlog to ADES for $628 million in cash.

The transaction triggered a mandatory payment of $204 million under Seadrill’s second lien debt facility. In addition, the company made a voluntary payment of $269 million under the facility, thus bringing total repayments to $473 million (inclusive of principal, accrued interest, and exit fees). Debt principal reduction amounted to $442 million, which should result in approximately $75 million in annualized interest savings.

Seadrill also announced the sale of its remaining 35% stake in Paratus Energy Services, the holding company for its investments in SeaMex Group, Seabras Sapura, and Archer Ltd. for an estimated $30 million.

In early November, Sonadrill, the company’s 50:50 joint venture with Sonangol, bagged a $327 million contract for the managed drillship Libongos at a dayrate of $420,500.

Moreover, the company returned two previously leased rigs (West Hercules and West Linus) to former related party SFL Corporation (SFL).

But the most important news was last week’s proposed acquisition of former subsidiary Aquadrill (previously known as Seadrill Partners) for $958 million in common stock:

Upon completion of the transaction Seadrill shareholders and Aquadrill unitholders will own 62% and 38%, respectively, of the outstanding common shares in the Company. The transaction values Aquadrill at an implied equity value of approximately US$958 million, based on Seadrill’s 30-day volume-weighted average share price on the NYSE of US$31.25 as of 22 December 2022.

The combination creates an industry-leading offshore drilling company, with a modern and high specification fleet and a streamlined cost structure. The Company will be well-placed to realize estimated annual run rate synergies of at least US$70 million. The Company will also be well-positioned for further growth given its stronger credit and liquidity profile, and to provide attractive cash flows.

(…)

The transaction has been approved by the Boards of Directors of both Seadrill and Aquadrill. The required approval of Aquadrill’s unitholders has also been obtained. The transaction does not require Seadrill shareholder approval.

Following the closure of the previously agreed sale of Aquadrill’s three tender-assisted rigs to Energy Drilling for an aggregate purchase price of $74.4 million, the combined company will own 13 floaters (including seven 7th generation drillships and two harsh environment semi-subs) and five jackup rigs (including one CJ70 harsh environment jackup).

As of November 30, Seadrill and Aquadrill had a combined cash balance of US$628 million, including US$133 million of restricted cash, and a combined debt balance of US$521 million.

The acquisition adds approximately $350 million to Seadrill’s backlog with the combined number reaching approximately $2.8 billion.

To be perfectly honest, Aquadrill doesn’t really look like a bargain as, adjusted for the pending tender rig fleet sale, the company adds just four contracted drillships (Capella, Polaris, Auriga, and Vela) and a cold-stacked harsh environment semi-sub (Aquarius).

That said, the company has no debt and including the anticipated proceeds from the pending tender rig fleet sale should add at least $150 million in cash to Seadrill’s balance sheet upon closing next year.

Assuming another $100 million in net present backlog value and assigning a $50 million valuation to the cold-stacked Aquarius, Seadrill is effectively paying $650 million for four contracted drillships.

Clearly, the 7th generation drillships Auriga and Vela are Aquadrill’s most desirable assets with both units recently having been awarded lucrative follow-on work in the U.S. Gulf of Mexico. That said, the 6th generation high-specification drillship Capella is scheduled to commence a new contract offshore Indonesia in May at an impressive dayrate of almost $400k. Even the 6th generation drillship Polaris has recently been upgraded for the future use of a managed pressure drilling (“MPD”) system.

With Seadrill’s owned fleet mostly committed to long-term work at painfully low or entirely undisclosed rates, the acquisition of Aquadrill not only adds some much-needed high-margin contracts but also doubles the company’s presence in the currently red-hot U.S. Gulf of Mexico.

Please keep in mind that West Gemini and managed drillships Quenguela and Libongos are part of the above-discussed Sonadrill joint venture while the jackup rigs, West Castor, West Tucana, and West Telesto are bareboat chartered to GulfDrill, the company’s 50:50 joint venture with Gulf Drilling International in Qatar.

But even with the projected cost savings from the addition of Aquadrill, the combined company’s cash generation potential will likely remain limited for some time going forward due to the dismal average dayrates earned by the majority of the Seadrill rigs.

In fact, it could take another 3+ years until the combined company’s full earnings and cash generation potential will be reached:

While Scenario A in the slide above more or less reflects today’s market conditions, the company’s 2023 EBITDA and cash generation will be nowhere near the illustrative levels stated by the company with more than 70% of the fleet committed for at least another 18 months at dayrates substantially below current market rates.

That said, Seadrill remains dirt cheap when considering “implied steel value per ultra-deepwater equivalent rig”, a metric often used by industry analysts for valuation comparisons with steel value calculated using the equity market value, book value of debt, potential underfunded pension liabilities, newbuild capital commitments, and net present value of reactivation costs less cash and net present backlog value.

Please note that the slide above has been taken from a recent presentation released by competitor Valaris (VAL), but based on the above-discussed transaction numbers, the Aquadrill acquisition shouldn’t have a material impact on the combined company’s implied steel value per ultra-deepwater equivalent rig.

Bottom Line

Folding Aquadrill back into Seadrill is an important strategic move at a reasonable price as the combined company is increasing exposure to the red-hot U.S. Gulf of Mexico while also benefiting from substantial cost savings.

In addition, Aquadrill’s drillships are contracted at much higher average dayrates than Seadrill’s floater fleet thus adding substantially to Adjusted EBITDA and cash flow.

As the deal is all-stock and debt-free Aquadrill expected to contribute an estimated $150 million in cash, Seadrill should move to a net cash position once the deal closes next year.

But even considering projected cost savings, the combined company’s cash generation potential will likely remain limited for some time going forward due to the weak average dayrates currently earned by the majority of the legacy Seadrill fleet.

That said, the issue is very much reflected in the company’s industry-low fundamental valuation.

While it might take another couple of years until the combined company’s full earnings and cash generation potential will unfold, investors should consider taking advantage of Seadrill’s very low fundamental valuation by scaling into the shares on pullbacks.

At this point, I remain positive on the entire industry, including leading U.S. exchange-listed Valaris, Noble Corp. (NE), Diamond Offshore Drilling (DO), Transocean (RIG), Helix Energy Solutions (HLX), and offshore drilling support providers like Tidewater (TDW) and SEACOR Marine Holdings (SMHI).