Seadrill Ltd. (SDRL) made a tender offer in November of last year to acquire all of the outstanding shares of shallow-water specialist Asia Offshore Drilling. Although Seadrill failed to get the entire company, it did manage to increase its stake to 66.16% of Asia Offshore Drilling. This roughly doubles Seadrill's position in that company and expands the company's position in the shallow-water sector of the offshore drilling industry. There has been much speculation in the comments to several of my articles as well as elsewhere that this may not be the last of Seadrill's acquisition attempts. I agree with this viewpoint and would not be surprised to see Seadrill make a tender offer for another drilling company sometime in the near future.
Late last year, Seadrill announced that it is selling its tender rig division to SapuraKencana for total consideration of $2.9 billion. This amount includes $363 million in remaining capital expenditures on the company's newbuild tender rigs, $187 million in a seller's note, and $350 million worth of new shares of SapuraKencana. SapuraKencana will also assume all of the debt of Seadrill's tender rig division, an amount totaling approximately $800 million. Seadrill also expects to receive approximately $1.2 billion in cash from this transaction which the company has already stated will be used to fund investments in newbuildings or M&A in the shallow-water and ultra-deepwater sector.
An acquisition would make a lot of sense to expand Seadrill's presence in the ultra-deepwater sector. One reason for this is the build time that is required in order to construct a new rig. At a minimum, this build time is two years. Typically, however, it takes between two and three years to construct an ultra-deepwater drilling rig depending on factors such as rig classification and design requirements. For example, Seadrill ordered two ultra-deepwater drillships in February 2012 that will be completed in the second and third quarters of 2014. This represents a construction time of between two and two-and-a-half years.
As another example, Seadrill's majority-owned subsidiary North Atlantic Drilling (OTC:NATDF) ordered a harsh environment semi-submersible ultra-deepwater rig in April 2012 that will not be completed until the first quarter of 2015. This represents a total construction time of nearly three years. Therefore, an estimated construction time of two to three years seems pretty solid.
Another issue that arises with building new rigs is shipyard capacity. A shipyard can only build so many rigs at one time due to constraints on space, manpower, equipment, or other resources. There is currently a construction boom going on in the offshore drilling industry with many companies building new rigs to meet the demands of their customers. As a result of these capacity constraints, the industry has been unable to build as many rigs as the offshore drilling contractors may otherwise want to be able to meet customer demand. Seadrill has discussed this in its quarterly reports over the past year.
Seadrill itself, however, has secured build slots at various shipyards so it may be able to construct new rigs even with the current capacity constraints. The company's statement that it is considering using the money from the sale of its tender rig division to invest in newbuildings supports this conviction. After all, why would management even consider investing in newbuildings if the company did not have the build slots to actually construct these rigs?
An acquisition would not have either of these problems. By acquiring a competitor, Seadrill would get a ready-made fleet of rigs without having to wait for two or three years to obtain and begin using the rigs. This would enable the company to grow its operating fleet more rapidly and begin generating revenues, cash flows, and profits from the new rigs (in this case, the acquired rigs) much more rapidly than it could if it built the rigs itself. This will result in more rapid growth and, possibly, more rapid dividend growth than if the company built new rigs. Of course, Seadrill's major competitive advantage in the industry is its modern fleet of high-performing rigs so the company would need to make sure that the fleet of any acquisition target is similarly high-quality if Seadrill wishes to preserve its competitive advantage.
One company that would make a good acquisition target for Seadrill is Sevan Drilling (OTCPK:SDRNF). Sevan Drilling is an ultra-deepwater specialist that is primarily focused on the Brazilian market. Sevan Drilling has a fleet of two modern ultra-deepwater rigs with two more under construction. Because of these two rigs under construction, Sevan Drilling has strong growth prospects which I discussed in a previous article.
One of Sevan Drilling's biggest advantages in the marketplace is its rig design. All four of Sevan's ultra-deepwater drilling rigs use the Sevan Cylindrical Drilling Unit design, which is unique and patented by Sevan Marine, the former parent of Sevan Drilling. Sevan Drilling has the right to use this rig design into perpetuity. As the name implies, the company's rigs have cylindrical hulls as opposed to drilling rigs with a traditional design. This cylindrical hull design offers several advantages over a traditional rig design:
- Easier station keeping: The company's rigs are equipped with a dynamic positioning system that enables it to remain secured in place through the use of azimuth thrusters. A conventional mooring system can also be installed if needed.
- Independence of environmental directionability: The design of the vessel results in very low pitch and roll motions when acted on by wind or waves. This allows the operator to always be able to select the optimum heading based on current needs.
- Simplified construction: The rig's cylindrical hull may be built using traditional pre-fabrication techniques.
- Protected moon pool: The drilling operation is executed through the centre moon pool which allows for the protected launch and recovery of the blow-out preventer and the marine riser. The completely enclosed moon pool also protects the riser and allows the vessel to safely operate even in ice-infested areas.
- The lower hull can be used for storage. While this is not unique, it is still an advantage over older designs.
As you can see, Sevan's rigs are very capable and are built using a very good rig design. The company's rigs are also just as modern as the other rigs in Seadrill's fleet. Sevan Driller, the oldest rig in Sevan Drilling's fleet, was built in 2009 and first began operating in June 2010. Sevan Brasil, the second of Sevan Drilling's rigs, was delivered in 2012 and began operating that same year. The remaining two rigs are expected to be delivered in 2013 and 2014 respectively. So, these rigs would fit perfectly into Seadrill's modern, technically-capable fleet.
Seadrill has also expressed interest in Sevan Drilling in the past. In December 2011, Seadrill made an all-or-nothing bid to acquire a 28.5% stake in Sevan Drilling. Seadrill's bid succeeded and the company still holds that stake today. Seadrill stated in its third quarter report that the company views this investment as opportunistic and that the company will continue to evaluate it compared to opportunities to further grow Seadrill. That does not sound as though Seadrill's management is planning a takeover, or at least they were not at the time, but the wording is vague enough that it could be interpreted in either way.
One of the most important numbers to use to determine the price that Seadrill would have to pay to acquire Sevan Drilling is the company's enterprise value. Investopedia defines enterprise value as,
A measure of a company's value, often used as an alternative to straightforward market capitalization. Enterprise value is calculated as market cap plus debt, minority interest, and preferred shares, minus total cash and cash equivalents.
Think of enterprise value as the theoretical takeover price. In the event of a buyout, an acquirer would have to take on the company's debt, but would pocket its cash. EV differs significantly from simple market capitalization in several ways and many consider it to be a more accurate representation of a firm's value. The value of a firm's debt, for example, would need to be paid by the buyer when taking over a company, thus EV provides a much more accurate takeover valuation because it includes debt in its value calculation.
At the time of writing, Sevan Drilling had a market capitalization of $253.28 million. Sevan Drilling had total short- and long-term debt of $870.9 million at the end of September 2012, according to its most recent financial report. The company also had $78.3 million in cash as of the same date. This gives Sevan Drilling an enterprise value of $1,045.88 million.
Seadrill could thus use this $1.2 billion in cash to flat-out buy Sevan Drilling in its entirety and pay off all of that company's debt and still have money to spare. An ultra-deepwater rig costs approximately $600-$700 million to build from scratch so building four ultra-deepwater rigs would cost Seadrill from $2.4-$2.8 billion. By acquiring Sevan, Seadrill could get the same benefit from those four rigs at a much lower cost.
The analysis is slightly more complicated than that. For starters, the bulk of the cost of Sevan's two newbuild rigs must be paid at delivery. This amount totals $946.8 million of which $420.8 million is due in the fourth quarter of 2013 and $526 million is due in the second quarter of 2014. This brings Seadrill's total acquisition costs up to $1,992.68 million, some of which will be offset by payments received from the COSCO shipyard. This is still less than what it would cost Seadrill to build the four rigs that it could acquire through a takeover of Sevan Drilling.
Seadrill's actual costs to obtain Sevan Drilling will be less than this due to the company's existing stake in Sevan. Considering this, Seadrill's total costs would be approximately $1,929.5 million to acquire all of Sevan plus make the remaining payments on the rigs and assuming no acquisition premium. This is significantly less than what it would cost Seadrill to construct four new ultra-deepwater rigs.
At the moment, Seadrill has said absolutely nothing about acquiring Sevan and this is all just speculation. The combination does appear to make a lot of sense, however, and as a shareholder of both companies, I would not be opposed to this use of the money from Seadrill's recent deal with SapuraKencana.
Additional disclosure: My holdings of Sevan Drilling are the shares that are traded on the exchange in Norway and not the U.S. pink sheets shares.