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(Editors' Note: This article covers a micro-cap stock. Please be aware of the risks associated with these stocks.)

Near the end of 2011, Seadrill (NYSE:SDRL) acquired a 28.5% stake in a rather unique ultra-deepwater drilling specialist named Sevan Drilling (OTCPK:SDRNF). Sevan Drilling is based in Oslo, Norway but until recently earned the lion's share of its revenue in Brazil through two drilling rig contracts with Petrobras (NYSE:PBR). This changed, however, in April 2013 when the company entered into a contract for the use of its third rig, Sevan Louisiana, in the U.S. Gulf of Mexico. Seadrill acquired its shares from SV Unsecured Ltd. which acquired the shares only a week earlier as part of a restructuring process at Sevan Marine (OTCPK:SVMRF), Sevan Drilling's former corporate parent. Seadrill made additional purchases of Sevan Drilling's shares in 2013 that served to increase its stake in the company to 50.11% of the total common shares outstanding.

As Seadrill now owns the majority interest in Sevan Drilling, it will be consolidating Sevan Drilling's results into its own beginning with the third quarter results which should be released in November. Consolidation is an accounting practice required under GAAP that effectively combines the accounting figures of multiple firms in such a way as to appear as a single firm. This consolidation process will have the effect of significantly increasing Seadrill's third quarter revenues as reported on the company's consolidated income statement. Sevan Drilling reported a net loss in its most recent quarter and so may actually have a negative impact on Seadrill's bottom line in the third quarter. Ultimately though, this consolidation should prove to be accretive to Seadrill's bottom line as well. However, GAAP rules aside, it is important that investors do not lose sight of the fact that this upcoming revenue boost is due to accounting rules as does not directly represent an increase in the revenues that are actually flowing into Seadrill's corporate accounts.

In the second quarter, Sevan Drilling reported total operating revenue of $66.1 million. Seadrill reported total consolidated operating revenue of $1,268 million during the same period. Thus, the consolidation of Sevan Drilling's results into Seadrill's should increase the latter's operating revenue by approximately 5.21%. However, Seadrill could see an even larger impact than that as Sevan Drilling looks likely to post higher revenue in the third quarter than it did in the second. One of Sevan Drilling's two operating rigs, Sevan Driller, suffered from downtime in the second quarter and this negatively impacted the company's revenue in the quarter. The rig's downtime totaled five days in May and seven days in June. The rig will likely not suffer from this downtime in the third quarter and will thus have a positive impact on both revenue and profits on a quarter over quarter basis. The reason why this downtime had a negative impact on revenue is that the oil companies that hire these offshore drilling rigs (and are thus the customers of the offshore drilling industry) do not compensate the offshore contractor for time that a rig spends in activities resulting in downtime. The rig did not earn any money during those twelve days that it was not operating. As the Sevan Driller has an average dayrate of approximately $418,000 according to Sevan Drilling's most recent financial report, the foregone revenue from those twelve days of downtime was approximately $5 million. If we add this $5 million back into Sevan Drilling's revenue then the company would have had approximately $71 million in revenue in the second quarter. Thus, this should represent the approximate revenue boost that Seadrill can expect to see from the consolidation of Sevan Drilling's results assuming that the company does not suffer from any significant downtime in the third quarter.

As previously mentioned, Seadrill may see its net income suffer slightly due to the consolidation of Sevan Drilling's results, at least in the short-term. Sevan Drilling lost $35.5 million in its most recent quarter. This result is worse than either the previous quarter or the prior year quarter. However, Sevan Drilling did lose money in both of those quarters. Sevan Drilling did manage to turn an operating profit in the second quarter of 2013, representing a significant improvement over the operating losses that the company suffered in both the previous quarter and the prior year quarter. As with revenue, Sevan Drilling's operating profit will be added to Seadrill's own figure through the consolidation of results and its net loss will be subtracted from Seadrill's net income (a net profit would be added to Seadrill's net income).


(Click to enlarge)

Source: Sevan Drilling

It thus appears that the consolidation of Sevan Drilling would increase Seadrill's operating profit by $7.4 million assuming that the company repeats its second quarter performance in the third quarter. Seadrill itself had an operating profit of $507 million over the same period. The consolidation of Sevan Drilling's results would thus increase Seadrill's reported operating profit by 1.45%, barely enough to move the needle.

The consolidation of Sevan Drilling's results will have a more noticeable impact on Seadrill's EBITDA. Sevan Drilling had an EBITDA of $22.4 million in the second quarter. This is enough to increase Seadrill's EBITDA by 3.3% over its second quarter level. Sevan Drilling may be able to have an even larger impact on Seadrill's EBITDA in future quarters. Sevan Drilling's management has, in the past, confidently forecasted that the company could comfortably generate annualized EBITDA of $200 million once all four of its rigs have left the shipyard and begun operations. Assuming that the company can secure an average dayrate of $500,000 across its four rigs, management could very well be correct. This would work out to $50 million per quarter, representing a 123.21% increase over the company's current level and a 7.52% boost to Seadrill's second quarter 2013 levels.

Source: Sevan Drilling Consolidation Will Increase Seadrill's Q3 Results