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Summary

  • The motive behind the sale of SapuraKencana stake is to increase the cash position.
  • The increase in cash should allow the company to manage its debt.
  • The increased cash position should also allow Seadrill to get a better credit rating.

Seadrill (NYSE:SDRL) is enhancing its cash position - the concerns about the off-shore drilling sector and the slowdown in the short term has increased the need for the drillers to enhance their cash positions. Seadrill has lost more than 22% during the last six months. I have a bullish view on the off-shore drilling segment, and I believe these companies will derive substantial growth from their current assets over the next 2-3 years. However, these companies are trying to manage their assets well in the short term, in order to tackle the slowdown in the sector. In my previous articles, I have talked in detail how Seadrill is raising cash by dropping down assets to its partnership, Seadrill Partners (NYSE:SDLP), and also by freezing the growth in dividends. The fall in the stock price has created an opportunity for the long-term investors, in my opinion.

The most recent effort by the company to manage its cash is the sale of a portion of its shares in SapuraKencana Petroleum. Seadrill has sold 230 million shares for a total of about $300 million. As a result of this deal, Seadrill's total stake in the company will come down to 8.2% from 12%. If we look at the growth shown by the company and the rise in the stock price; it does indicate that the company is selling its stake just for the purpose of raising some cash.

SapuraKencana was created in 2012 after a merger between SapuraCrest Petroleum and Kencana Petroleum, which resulted in Malaysia's largest independent oil and gas contractor. The company has come a long way, and its order book has almost doubled. The future outlook of the company is very bright, and most of the analysts are bullish about the prospects of SapuraKencana. However, despite the positive outlook and analysts putting ambitious price targets [CIMB research has price target of RM 6.75 ($2.09) and Maybank IB Research has a price target of RM 5.30 ($1.64)], the stock has lost more than 9% since the start of the year.

This is the second time Seadrill has offered to sell its stake in the company. After the completion of the merger in 2012, the company sold 300 million shares. As a result of this sale, Seadrill's stake in the company came down to 6.4%. However, during the last year, Seadrill sold its tender rig business to SapuraKencana and received 490.8 million shares as part of the deal, which took its total holding to 12%. After this sale, the company will have around 490 million SapuraKencana shares, and it has also entered into the lockdown agreement for the reaming shares till the end of the current year. The total economic benefit from the sale is close to $165 million for Seadrill.

During the last earnings announcement, the company announced that it was expecting a slowdown in the sector over the next 12-24 months - as a result, the management decided to preserve cash - One of the most notable steps was to grow cash dividends by only 3 cents. Furthermore, the company also decided to drop down its assets to Seadrill Partners, and use the cash to decrease its debt (please refer to this link for further reading). The dropdowns are happening at a regular interval, and the proceeds from the SapuraKencana deal should further enhance the fund created for future dividends and debt payments. In addition, the decision to halt the purchase of new rigs will decrease the CapEx and leave more cash for the reshuffling of the debt. I am expecting some changes in the debt structure of the company over the next twelve months, as the company might want to shift its debt to long-term bonds from credit lines. In the above mentioned article, I mentioned that the company was waiting for a better time to get its credit ratings (increased cash position is likely to enhance the credit rating and result in better rates). Seadrill has now enhanced its cash position substantially, and I believe we will see further movement over the next few weeks. We might not see a large decline in the total debt of the company; however, we will certainly see some shift in the mix of the debt.

On the other hand, off-shore drillers continue to get negative news from the analysts - Morgan Stanley (NYSE:MS) was the most recent major bank to show pessimism about the sector, and showed concerns about Rowan (NYSE:RDC). However, as I have said in my previous articles, Seadrill and its subsidiaries (North Atlantic Drilling (NYSE:NADL) and Seadrill Partners) will continue to grow, as NADL has an asset base which will not be affected by the fluctuations in the sector, and SDLP also has a lot of room to grow.

Bottom Line

I do not think that Seadrill will try to make a major change in its capital structure. In my opinion, the management believes that they can continue to operate at the current leverage levels, and a further slowdown of low magnitude can be absorbed by the current asset base of the company. If the company is able to achieve its target of $4 billion in EBITDA, then the current debt-to-EBITDA ratio of ratio of the company will come down substantially. Nonetheless, the cash position of the company is getting better, which should allow it to get a better credit rating - as a result, the rates should be better when the company decides to go to the debt markets and shift its debt to the long-term bonds.

Source: Seadrill's Cash Position Is Getting Better