Seahawk Is in Deep Water 15 comments
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Seahawk Drilling (HAWK) $34.28 on 9-23-2009
Spinoff: August 24, 2009
Price | $35.50 |
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| 2009E | 2010E |
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FD Shares | 12.2 | EPS | ($3.48) | ($4.56) |
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Mkt Cap | 431.6 | EBIT | (61) | (85) |
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Debt | 0.0 |
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Cash | (45.0) | Yr end | |||||
EV | 386.6 |
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Revolver - zero drawn, up to $36MM of availability only for Capex on existing rigs and 20% for the Mexico Tax Liability surety bonds.
Recommendation
We recommend a short of Seahawk Drilling (HAWK). The company is facing terrible end market fundamentals as a result of focusing solely on the very high cost shallow water Gulf of Mexico offshore basin as well as many company specific issues and contingent liabilities that no sell-side analyst is discussing. Despite the many issues discussed below, the stock is up over 40% since the spin off.
Description
HAWK was spun off from Pride International (PDE, $4.5BB market cap) on August 25th, with Pride shareholders receiving 1/15 share of new HAWK. HAWK leases and operates solely in the shallow water Gulf of Mexico for PEMEX on a contractual basis and a day rate basis for U.S. customers (small independents). The shallow water Gulf of Mexico is an extremely mature natural gas production area and the most profitable areas have already been drilled. The decrease in demand for rigs has increased competitiveness in bidding contracts to supply rigs.
Why is it a short?
1) Fundamentals: The shallow water GOM is among the highest cost offshore basins in North America. Independent operators we’ve talked to said they need $6-7 to justify drilling new prospects in the gulf and this will be harder to achieve given the plethora of new shale plays with much lower cash costs. Spot prices remain well below economic levels and the forward strip through December 2010 remains below levels that would justify GOM drilling programs. HAWK’s rigs are operating at a 30% utilization rate today on its way to 15-20% in November as its PEMEX rigs roll off contract.
2) Bad Assets: There is a good reason the smartest money in the space is trying to divest their GOM mat jackups (PDE divested, Seadrill has discussed spinning theirs off, RDC and ESV are cold stacking or moving to different geographies). Unlike RDC and ESV, HAWK’s assets are old (avg age 29yrs) and can’t work in other basins. The new finds in the GOM are in the deep water where mat jackups can’t operate due to water depth. Pride kept their deep water and IDC’s GOM rigs which could operate at these depths.
3) Customer Concentration: 60% of sales and roughly 80-90% of EBITDA comes from PEMEX. In Q2 PEMEX asked the Mexican government to increase their budget and was denied, and has recently released 3-4 rig contracts from both HERO and HAWK. HAWK’s mgmt has stated that they expect to lose one of the four current contracts with PEMEX. As of June HAWK had 4 contracts with PEMEX, all of which have or will roll off contract by October 2009. HERO has seen 40% sequential declines in day rates in newly renegotiated PEMEX contracts and HAWK is expected to follow suit. The bigger concern is that PEMEX has made a decisive move away from mat jackups to focus on Independent Leg Cantilever (IDC) rigs because of the mat jackups capabilities and the accident on the Usmacinta that killed 18 workers. Coincidentally NE and RDC have both stated that PEMEX has tendered 7 IDC rigs while there are 7 mat jackups rolling off contract. We think HAWK could lose all but one of their rigs contracted with PEMEX. The small independent contractors that work in the US GOM don’t have the ability to hedge (production is sold at spot prices), and are witnessing less access to capital markets. Therefore, natural gas prices volatility must stabilize before US GOM contractors will start production. Favorability has been observed from the small independents to derisk by being more involved with the onshore shale plays. The Secretariat of Energy, Georgina Kessel, passed a law taking effect on September 23, 2009 that gives veto power over every PEMEX project and permit, authorization verifications, inspections and decrees for zones where oil will be extracted among other data.
4) Mexican Tax Liabilities: The Mexican government states that HAWK owes $120MM in back taxes from 2001-2004 and potentially another $150MM from 2005-2006. To put this in context, the entire market capitalization of $432MM
5) Imminent Dilutive Capital Raise: With respect to the 2001-2004 Mexican tax issue, PDE has posted a $50MM surety bond. HAWK must post a $70MM surety bond by the end of 2009. HAWK has already exhausted 15 of their 20 rigs as collateral for their secured revolving credit facility, and therefore will need to cash collateralize the remaining of the surety bond. In addition, HAWK will likely have to post a $150MM surety bond for the 2005-2006 Mexican tax claims when it is finalized in 2010. Given the lack of remaining collateral, the only way HAWK will be able to post bonding is through an equity raise. Management has indicated that their Mexican subsidiary will have to file bankruptcy if they lose their Mexican tax lawsuit.
6) Pride Wyoming Liability: In addition HAWK may be responsible for collateral damage from when their Pride Wyoming jack up hit other infrastructure during hurricane Ike. We believe it is uncertain as to whether PDE’s insurance will cover the losses associated with the damage, including loss of revenue. The owners have claimed damages of $148MM.
7) Bribery: The Company is subject to bribery accusations with the Mexican government. Although PDE has agreed to indemnify HAWK for its US FCPA penalties over $1MM, HAWK is fully liable for any fines levied on them by the Mexican government.
8) Irrational Competition: HAWK is primarily competing against Hercules (HERO) in the GOM. HERO is a levered company and has a $4k lower operating cost structure per rig per day than HAWK with virtually the same type of “commodity rigs”. In order to stay solvent, HERO has bid very aggressively to levels slightly above their cash costs. HAWK has said HERO has underbid them by up to $10k/day and are stealing market share. HAWK has recently alluded to having to start bidding more aggressively to hold its market share. We believe this will be at or below their cash breakeven and much bigger losses based on all in costs.
9) Hurricane Risk: HAWK decided to forgo wind storm insurance citing high insurance premiums. We believe management is taking an unconscionable business risk in terms of self insuring a GOM fleet.
10) Management: Management is delusional at best with their recent statements that $4.50 gas prices would stimulate significant GOM drilling. We also question management’s judgment given the FCPA violations, Mexico tax issues and recent decision to forgo insurance.
11) FCF Burn Rate: HAWK has guided to burning $10MM- $20MM if they have 3 rigs working in Mexico and 3 rigs working in the US GOM for the remainder of 2009. Currently they have 2 in Mexico and three in the US. They also stated at the Barclay’s Energy Conference that they have $38-$42MM in one time charges coming due in 2H2009.
12) Sell Side Revisions: After Q2 earnings call, the sell-side analyst at Barclays revised the EPS for 2009 and 2010 to a -$2.95 from -$2.60 and to -$2.60 from -$2.35 respectively. Sell-side expectations are for 6 working rigs, no issues with contingent liabilities, very little pricing pressure, and no regards to the collateral backing the surety bonds due in 2009. Jesup & Lamont downgraded HERO to “SELL” with a target price of $4.00 and lowered estimates to -$.70 from -$.65 for 2009. J&L’s downgrade came after HERO’s fleet report showed a loss of 2 US Gulf of Mexico contracts. This is bad news for HAWK considering HERO offers the same commodity rigs at a $7k-$10k discount.
Worth
In a perpetual depressed gas price scenario, only 3 of the company’s rigs would operate (15% utilization rate). In this case the company would be burning -$8.12EPS. NAV would be roughly $20/share based on the price assigned by Pride International’s Insurance reimbursement value for the Pride Wyoming after being destroyed, compared to a rig sales consultant‘s valuation over the aged commodity rig class.
Value
- Fair Estimate: Represents a normalized GOM Jack-up rig market
- NAV Fully Diluted Share $22.16
- Price (35.50)/NAV 160.2%
- NAV Discount: Represents a depressed GOM Jack-up rig market.
- NAV Fully Diluted Shares $17.95
- Price (35.50)/NAV 197.8%
Catalyst
We have several different ways to win:
1. The company receives a negative judgment with respect to one of the contingent liabilities
a. FCPA
b. Lawsuits over damages from Pride Wyoming
c. Mexican tax liabilities
2. Depressed natural gas prices keep utilization rates and day rates at today’s levels causing wall street to cut estimates
3. Pricing pressure from competitors
4. PEMEX moves to IDCs in November
Risks
The market overlooks near and medium term end market weakness and values the company based on a major recovery in natural gas drilling in the GOM. We believe this is unlikely given all the slated shale capacity.
Natural Gas
Current spot prices of $3.6/MMBtu are realizing pressure from net injections approaching storage capacity that is estimated at 3.5-3.9 Tcf. Natural gas spot prices have increased in the past few weeks, but the forward curves (which are what matter) haven’t been influenced. During the week ending Sept 11, implied net injections were 66Bcf into underground storage. Working gas in underground storage was estimated at 3,458 billion cubic feet, which is 496Bcf above the 5 year average. NYMEX futures prices decreased as supply has shown to be more than adequate to sustain the immediate demand for heating-related increases for the 2009 winter.
The arduous task of locating the natural gas in the Gulf of Mexico has created a higher risk factor correlated toward the nat gas price to necessitate drilling. Let alone, Finding and Development costs are $4, and Cash Costs $2. This dictates a gas price of $6. Southwestern energy has assigned values as high as $8/MMBtu to maintain drilling for natural gas in the Gulf of Mexico.
Valuation
(dollars in millions) | ||||||
2007 | 2008 | 2009E | 2010E | 60% Rig Utilization | 15% Rig Utilization | |
Ttl Sales | 707 | 554 | 204 | 109 | 253 | 45 |
COGS | (349) | (303) | (180) | (118) | (158) | (80) |
GP | 358 | 251 | 23 | (9) | 95 | (35) |
SG&A | (26) | (33) | (28) | (23) | (23) | (23) |
D&A | (63) | (57) | (56) | (54) | (56) | (56) |
Other 1 | (1) | (3) | 1 | 1 | (3) | (3) |
EBIT | 269 | 159 | (61) | (85) | 13 | (152) |
margin | 38.0% | 28.6% | -29.9% | -78.1% | 5.3% | -336.2% |
EBITDA | 332 | 215 | (5) | (31) | 69 | (96) |
Interest | 0 | 0 | 0 | 0 | 0 | 0 |
EBT | 269 | 159 | (62) | (85) | 13 | (152) |
Taxes | (93) | (56) | 19 | 30 | (5) | 53 |
NI | 176 | 103 | (42) | (55) | 9 | (99) |
FD Shares | 12.16 | 12.16 | 12.16 | 12.16 | 12.16 | 12.16 |
EPS | $14.47 | $8.47 | ($3.48) | ($4.56) | $0.71 | ($8.12) |
Capex | (35) | (35) | (20) | (12) | (35) | (10) |
OCF | 297 | 180 | (25) | (43) | 34 | (106) |
FCF | 204 | 125 | (6) | (13) | 30 | (53) |
EV/EBIT | 1.0x | 1.8x | -4.6x | -3.3x | 20.8x | -1.8x |
EV/EBITDA | 0.8x | 1.3x | -61.4x | -9.0x | 4.0x | -2.9x |
EV/EBITDA-Capex | 0.8x | 1.1x | 17.9x | -14.7x | 2.7x | -3.2x |
P/E | 1.9x | 3.3x | -8.0x | -6.1x | 38.9x | -3.4x |
FCF Yield | 60.4% | 37.0% | -1.7% | -3.9% | 8.8% | -15.6% |
Comps
Seahawk ENSCO Rowan Hercules
EPS08 | 8.47 | 8.12 | 3.84 | 0.91 |
EPS09 | (2.00) | 5.51 | 3.13 | (0.75) |
EPS10 | (4.56) | 4.11 | 1.90 | (0.85) |
EV/Revenue09e | 2.07 | 2.46 | 1.40 | 1.71 |
EV/Revenue10e | 3.40 | 2.68 | 1.56 | 1.68 |
EV/T12EBITDA08 | 1.73 | 2.95 | 3.38 | 3.25 |
EV/Forward EBITDA09 | 41.78 | 4.15 | 3.51 | 7.07 |
EV/Forward EBITDA10 | (12.03) | 4.95 | 4.67 | 6.58 |
P/E08 | 4.19 | 4.67 | 5.43 | 5.19 |
P/E09 | (17.78) | 6.88 | 6.65 | (6.29) |
P/E10 | (7.79) | 9.23 | 10.97 | (5.55) |
Disclosure: Short HAWK
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This article has 15 comments:
HERO recently announced dilution in the form of a second and this looks like more of a balance sheet “shore up” but still I would watch the action on HERO after the secondary release that I believe is set for September 30th as of today but don’t quote me on that date.
HAWK seems to just have bad timing with the current energy markets, if they can hold on until energy prices recover and remain solid then they should make it without much of an issue.
The HAWK IPO with the energy markets reminds me of the REIT IPO action that we are seeing lately; the timing seemed to be way off in terms of market conditions.
On Sep 24 11:51 AM littlebighornriver wrote:
> nice writeup. its even more telling how much HERO has fallen over
> the past few days. i'd expect to see a continuation as the remaining
> pemex rigs roll off
On Sep 24 09:47 PM BullnBear wrote:
> I’m a HERO bull and have been long HERO for quite some time and quite
> painfully at times but long term I believe that HERO has the GOM
> locked up.
>
> HERO recently announced dilution in the form of a second and this
> looks like more of a balance sheet “shore up” but still I would watch
> the action on HERO after the secondary release that I believe is
> set for September 30th as of today but don’t quote me on that date.
>
>
> HAWK seems to just have bad timing with the current energy markets,
> if they can hold on until energy prices recover and remain solid
> then they should make it without much of an issue.
>
> The HAWK IPO with the energy markets reminds me of the REIT IPO action
> that we are seeing lately; the timing seemed to be way off in terms
> of market conditions.
BullnBear: You've had a tough past few days... Are you buying now to help the cost basis?
HERO's Q2 was carried by their 65 liftboats (HAWK only has Jackup rigs). Every other part of HERO's business did terrible. The diversification has helped as international prices (excluding Mexico),especially the jackup mkt, are much higher. Also HERO stated this week that they lost two rigs in the GOM. Look at the current nat gas strip. You have over a year maybe even two of trying to survive before GOM rigs go back to work. I'm not willing to take that kind of risk on top of the litigation on behalf of HAWK. Even if they do survive, I prefer to make money in the next two years. I don't view the 17.5 million common stock secondary from HERO as good. Sorry bullnbear, they are broke and they need capital before they can't meet their covenants. The bank already eased the covenants for HERO this Q and they still are having to go to the equity market... Ok i'll play devils advocate, HERO's a levered bet with larger upside than comps, lowest cost producer in GOM and Mexico offshore, diversified assets, and diversified areas. All of which HAWK doesn't have. Personally I wouldnt own either, but if I MUST own one, the secondary of hero would be a place to enter. BUT I wouldn't put a penny of my friends or family's money into either.
On Sep 24 09:49 PM BullnBear wrote:
> HERO recently announced dilution in the form of a second and this
> looks like more of a balance sheet “shore up” but still I would watch
> the action on HERO after the secondary release that I believe is
> set for September 30th as of today but don’t quote me on that date.
>
and in terms of "timing of IPOs" ... it depends on who's perspective you are talking about... the blackstone IPO... bad timing for investors... great timing for the sellers... could HAWK follow similar path?
On Sep 24 09:49 PM BullnBear wrote:
> HERO recently announced dilution in the form of a second and this
> looks like more of a balance sheet “shore up” but still I would watch
> the action on HERO after the secondary release that I believe is
> set for September 30th as of today but don’t quote me on that date.
>
On Sep 25 10:38 PM Randomanalyst wrote:
> Read the Form 10, Pride will guarantee the surety bond to contest
> the Mexican Tax Liability.
Call Randy and he can explain to you the same thing I have.
Direct Line: 713-369-7310
Within the latest Q: Table of Contents, Gulf of Mexico Business of Pride International, Inc, Notes to Unaudited Combined Financial Statements (continued)
"We anticipate that bonds or other suitable collateral will be required no earlier than the fourth quarter of 2009 in connection with our challenge to these assessments. We anticipate that the Mexican government will make additional assessments contesting similar deductions for other tax years. If the Mexican tax authorities were to apply a similar methodology on the primary issue in the dispute to remaining open tax years, the total amount of future tax assessments (inclusive of related penalties and interest) could be approximately $100 million as of June 30, 2009. In addition, we recently received an unrelated observation letter from the Mexican government for another tax period that could ultimately result in additional assessments. While we intend to contest these assessments vigorously, we cannot predict or provide assurance as to the ultimate outcome, which may take several years. Additional security will be required to be provided to the extent future assessments are contested, which security may include
our five rigs that are not collateralized under the Seahawk Revolving Credit Facility or other forms of security permissible by the Mexican tax authority."
The 5.00 HERO November strike calls were trading strong today and I assume that is some show of support for the secondary.
I noticed that HAWK slipped today as well so again nice call.
On Sep 25 08:58 AM Blake Plotz wrote:
>
>
> BullnBear: You've had a tough past few days... Are you buying now
> to help the cost basis?
>
> HERO's Q2 was carried by their 65 liftboats (HAWK only has Jackup
> rigs). Every other part of HERO's business did terrible. The diversification
> has helped as international prices (excluding Mexico),especially
> the jackup mkt, are much higher. Also HERO stated this week that
> they lost two rigs in the GOM. Look at the current nat gas strip.
> You have over a year maybe even two of trying to survive before GOM
> rigs go back to work. I'm not willing to take that kind of risk on
> top of the litigation on behalf of HAWK. Even if they do survive,
> I prefer to make money in the next two years. I don't view the 17.5
> million common stock secondary from HERO as good. Sorry bullnbear,
> they are broke and they need capital before they can't meet their
> covenants. The bank already eased the covenants for HERO this Q and
> they still are having to go to the equity market... Ok i'll play
> devils advocate, HERO's a levered bet with larger upside than comps,
> lowest cost producer in GOM and Mexico offshore, diversified assets,
> and diversified areas. All of which HAWK doesn't have. Personally
> I wouldnt own either, but if I MUST own one, the secondary of hero
> would be a place to enter. BUT I wouldn't put a penny of my friends
> or family's money into either.
> On Sep 24 09:49 PM BullnBear wrote: