Seadrill (OTCQX:SDRL) has just provided its second-quarter report which confirmed the obvious – the company is ready for its second restructuring. Let’s start with the main announcement from Seadrill: “We continue to evaluate capital structure proposals from our financial stakeholders; whilst no agreement has been reached at this point, it is expected that potential solutions will lead to significant equitization of debt which is likely to result in minimal recovery for current shareholders.”
Its capital structure is absolutely not sustainable in the current environment. In the second quarter, the company generated $277 million of revenue and reported a net loss of $183 million. Operating cash flow was negative at -$162 million. Since the beginning of the year, Seadrill burned $278 million of cash in operations. Not surprisingly, its cash position declined from $1.1 billion in the first quarter to $849 million in the second quarter, while restricted cash also declined by $71 million. In the second quarter, the company spent $92 million for interest on its debt, so the need to equitize the majority of the debt is obvious.
Seadrill’s historic problem is that its secured debt is spread across 43 institutions, which makes negotiations extremely hard. In this light, the company was not able to achieve the amendments on its credit facilities that would have provided it with more financial flexibility, so it will likely have to opt for in-court bankruptcy to solve this issue.
The company’s fleet status report looks bleak due to the lack of new contracts. Seadrill’s semi-sub segment has only two working rigs, and the majority of stacked semi-subs are likely destined to the scrapyard. The drillship segment looks better with four rigs on contracts, although West Gemini was suspended until January 2021. Stacked jack-ups will also have big problems with returning to the market anytime soon, if ever. Put simply, Seadrill’s fleet size will likely get significantly smaller after restructuring, and the company has previously announced its decision to scrap up to 10 rigs. In addition, Seadrill Partners (OTC:SDLPF), in which Seadrill has a substantial stake, will likely face a situation when none of its rigs will be working after November 2020. In my view, a re-combination of restructured Seadrill and Seadrill Partners makes sense.
Just like its peers, Seadrill does not expect an increase of offshore drilling activity until mid-2021. Similar views have been provided by Valaris (VAL) and Pacific Drilling (PACD). I expect that the initial rebound in offshore drilling activity, when it happens, will not lead to an increase in dayrates because the current supply of rigs is significantly bigger than demand, while rigs continue to roll off their existing contracts into an empty market.
This is the second restructuring season for drillers in recent years, but I think it’s important to remind those investors who are new to the industry that a bankruptcy will not stop Seadrill from providing its services, since it is a process of changing the capital structure when previous creditors become the new owners of the company.
While the restructuring process will likely be a challenging exercise, Seadrill’s creditors will ultimately have to agree to some plan, since the alternative – dissolution – will lead to catastrophic losses, given there is no market for used or new rigs due to the complete absence of demand. Thus, Seadrill will emerge from bankruptcy with a cleaner balance sheet that will hopefully provide it with the necessary flexibility to get through the acute phase of the current crisis.
In comments sections of my offshore drilling-related articles, I noted that a number of traders and investors have hopes that mass restructurings will help the “last man standing” – Transocean (RIG). This will happen only if these restructurings lead to dissolutions and the companies get wiped out of business. At this point, the available information about their restructurings shows that they will ultimately reach consensus on their restructuring plans and emerge with cleaner balance sheets, although their long-term survival will still depend on the industry situation and the ability to wipe out as much debt as possible.
In Seadrill’s situation, the elimination of debt and the mass scrapping of rigs should materially improve the outlook, while the remaining cash on the balance sheet provides it with time to sort things out in case the company manages to complete its restructuring in a quick fashion. Thus, Seadrill will likely hurry with its own bankruptcy filing.
In the upcoming Seadrill bankruptcy, common shareholders will either get completely wiped out or receive warrants that will be hopelessly out-of-the-money.
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