Noble Corp. Is Selling At A 20% Discount To Intrinsic Value - With Catalysts

Feb.12.14 | About: Noble Corporation (NE)

Noble Corp (NYSE:NE) announced it is experiencing a cyclical pause in the market. The news drove down the stock to $30.70. It's now selling at an attractive entry point because it is conservatively worth $37.47 per share (22% discount). The management raised the quarterly dividends to $.375, annualized at $1.50 (5% yield). While the dividend increase is welcome when free cash flows are available, I fear this action was partially a preemptive move to stem a stock price decline and potential activist investor involvement (see Icahn and RIG). Perhaps better use of cash would have been to repurchase shares at current levels.

According to management, 78% of operating days are contracted in 2014. Compare this to reported 82% days contracted in 2008 (mgmt. projected in 2007, so actual number went up during the year as the company picked up contracts mid-year) during one of the most profitable years in company history and the 2014 utilization isn't a disaster that's inferred by the share price.

The bottom line: Profitability is reflected in utilization rates and day rates generated by the rigs, less contract drilling services, sg&a, depreciation, interest, & taxes. Noble Corp transformed from an unlevered entity with a good fleet in mid-2000's (~15% debt/equity in '07) to a levered high spec fleet (~66% debt/equity) in 2014. As a result, the depreciation expenses came up from around $200m in 2007 to ~$900m in 2014. Profitability was directly affected because the fleet transformation from 2007-2014 was capital intensive with the new assets expected to turn into a substantial source of cash. If those assets do not produce returns on capital significantly in excess of invested capital, then the company's business cannot be deemed attractive. Essentially, Noble Corp is going through a rebirth by spinning off its standard assets that will reduce depreciation expenses in the new company. If the spin-off turns out to be an IPO, excess cash can be used to reduce debt and the resulting balance sheet may represent the nimble, profitable company it was in mid-2000, but with state of the art assets.

Noble Corp, a well-managed company, saw 99% utilization rates in 2009 (results report for year 2008 before recession downturn caught up on contracts a year later). Undoubtedly, the peak of the drilling cycle due to astronomical oil prices increased investments in new build programs as capacity expanded to profitably capture anticipated demand. As we already know, risky/levered capital expenditures combined with the financial crisis forced many rig operators to sell their assets at a large discount or go out of business (therefore the opportunistic Frontier purchase by Noble).

Perhaps the cycle is turning downward again now, only without a pronounced peak this time like in 2008. Since 2011, capacity expansion has been voracious, finally resulting in deteriorating marginal profitability of drillers competing for contracts, and that's while the oil price has been stable around $100 per barrel. If oil price drops lower for a sustained period of time, supply/demand economics will not be pretty for the drillers. According to Noble management, only 10-12 older units are currently taken out of the market (cold stacked or scrapped), compared to 50 units coming online. While capacity increases, demand is currently stoic as demonstrated in the chart from rigzone.com, resulting in reduced utilization rates.

Current

Month Ago

6 Months Ago

1 Year Ago

Rigs Working

623

614

628

600

Total Rigs

757

749

721

697

Utilization

82.3%

82.0%

87.1%

86.1%

Click to enlarge

(Source)

VALUATION OF SPINCO & NOBLE CORP

Spinco valuation may reach from $4-5B at 7x EBITDA multiple (in an IPO or spinoff) if corresponding rigs can generate $705m EBITDA in 2014. That level of EBITDA can be supported by about $1.3 or $1.4b of revenues on the spin fleet. See projection tables below.

SPINCO

projected revenues standard spec

jackups

semi-sub

drillships

other

1

units

34

3

5

4

2

days per yr

365

365

365

365

3

utilization

80%

80%

80%

50%

4

total working days

9928

876

1460

730

5

available days

12410

1095

1825

1460

6

dayrate (low/avg spec)

$90

$150

$200

$62

7

annual rev (4*6)

$893,520

$131,400

$292,000

$45,260

$1,362,180

Spinco Potential Valuation:

full year projections

rigs

floaters

other

# of Rigs spun off in new entity

34

8

4

EBITDA generated by those rigs, 2014

705

mm

Minus: Cash Taxes (10% assumption UK)

70.5

mm

Minus: Capex

184

($4m per rig)

Distributable CF - Spinout

450

mm

Spinco will not carry any debt!

Potential Distributions

400

mm

unlike originally thought to carry $1B

at

7.0x

EBITDA

Likely worst case yield

8%

likely valuation

conservative equity valuation: $4 BB

4935

Click to enlarge

The remaining Noble Corp will be a high spec business with anticipated higher rig utilization and several new-builds coming online in the second half of 2014, then two more drill ships in 2015. Noble Corp revenues may resemble the following numbers in 2014 and should rise in 2015 as new drill ships begin operation:

NOBLE

projected 2014

Jackup

semi-sub

drillships

1

units

13

11

8

under construction

2

0

1

2

days per yr

365

365

365

3

utilization

87%

84%

85%

4

working days

4128

3373

2482

5

available days

4745

4015

2920

6

dayrate

$235

$402

$348

7

annual rev (4*6)

$970,115

$1,355,785

$863,736

$3,189,636

combined

$4,551,816

Click to enlarge

Combined, all rigs can generate $4.5b of revenues in 2014. Debt maturities are evenly spread across the next decade to avoid an excessive payment burden in any given year. Note that the company capitalizes some interest (puts it on the balance sheet by increasing the debt burden, and delays cash payment). Debt table below outlines the repayment schedule.

debt maturity schedule
5.88% $ 299,985 2013
7.38% $ 249,799 2014
3.45% $ 350,000 2015
3.05% $ 299,952 2016
2.50% $ 299,852 2017
7.50% $ 201,695 2019
4.90% $ 498,900 2020
4.63% $ 399,527 2021
3.95% $ 399,095 2022
6.20% $ 399,891 2040
6.05% $ 397,613 2041
5.25% $ 498,257 2042
credit facilities
commercial paper $ 339,809
total $ 4,634,375
Click to enlarge

The company is worth $37.47 if Spinco can generate $705M EBITDA and if Noble Corp gains a realistic $1.5B EBITDA (in 2013, ~50% margin after drilling contract expenses and sg&a). At a 7x EBITDA multiple for Spinco & Noble Corp and subtracting $6b of debt (including 2014 new build CAPEX), the equity value is ~$9.48b / 253m shares = $37.47 with a 22% MOS to current $30.70 price.

Disclosure: I am long NE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.