One accounting concept that all investors should be familiar with is consolidation of results. This is a technique by which a parent company combines the revenues, expenses and earnings of all of its subsidiaries and then applies a variety of adjustments such as the elimination of all transactions between the various subsidiaries. This essentially allows the parent company to report the results of all of its subsidiaries as though it was the parent company doing all of the business as one unified company. This technique works quite well for most companies and many publicly-traded firms are technically structured as holding companies with a variety of subsidiaries which they own outright. However, results consolidation can begin to create problems in the case of those companies that have subsidiaries which are also publicly-traded. This is because the parent company reports all of the operating results of the subsidiary companies as though these are the results of the parent even though the parent does not own 100% of the subsidiary and so does not have a claim to the subsidiary's revenue or profit in its entirety. As the publicly-traded subsidiary will also report its results, this money ends up being counted twice and it creates a confusing picture for investors. One company where this problem is particularly pronounced is Seadrill (NYSE:SDRL), which consolidates the results of several other companies into its own. These other companies are Sevan Drilling (OTCPK:SDRNF), North Atlantic Drilling (NADL) and Seadrill Partners (NYSE:SDLP). In this article, I will attempt to resolve some of the confusion that results from Seadrill's practice of consolidating the earnings from all of these companies.
North Atlantic Drilling
In the fourth quarter of 2013, North Atlantic Drilling reported total revenues of $310.4 million or approximately 21% of Seadrill's $1.469 billion during the same period. North Atlantic Drilling also generated an EBITDA of $137.6 million in the fourth quarter. This represents approximately 17.9% of Seadrill's EBITDA of $768 million over the same period. North Atlantic Drilling also generated total cash flow from operations of $121 million in the fourth quarter. Seadrill's reported cash flow from operations in the fourth quarter was $492 million. Thus, North Atlantic Drilling was responsible for approximately 24.6% of Seadrill's cash from operations in the fourth quarter.
Therefore, it appears that North Atlantic Drilling was singularly responsible for around 20% of Seadrill's results. I will admit that it is actually much more complicated than this, but I'm just trying to provide a basic overview here. However, the money that Seadrill itself actually got out of North Atlantic Drilling was limited to the dividends that Seadrill received from its stock ownership stake in North Atlantic Drilling and the interest that North Atlantic Drilling paid to Seadrill due to the outstanding loans that North Atlantic Drilling has to Seadrill. North Atlantic Drilling paid out a total of $205.4 million in 2013 in the form of dividends. As Seadrill owns approximately 73% of North Atlantic Drilling, Seadrill actually received approximately $149.9 million from North Atlantic Drilling in 2013. Clearly, this is substantially less than the company's consolidated results would lead one to believe. While Seadrill also did receive some money from North Atlantic Drilling as the latter company makes payments on its debt (which was paid off during the first quarter of 2014) and from other transactions, the bulk of the money that Seadrill receives from North Atlantic Drilling comes from the dividend.
Sevan Drilling is the smallest of the subsidiaries that are consolidated into Seadrill's results. It is also the one in which Seadrill owns the smallest stake. However, as Seadrill owns more than 50% of Sevan Drilling's outstanding stock, the latter company's results are still consolidated into Seadrill's in full.
In the fourth quarter of 2013, Sevan Drilling reported total operating revenues of $67.7 million, accounting for 4.61% of Seadrill's fourth quarter reported revenues. Sevan reported $5.5 million in EBITDA during the quarter, a relatively small 0.72% of Seadrill's EBITDA. Unlike the other companies under Seadrill's umbrella, Sevan Drilling had a negative operating cash flow and so the consolidation of Sevan Drilling's results would have had an adverse impact on Seadrill's reported results. In the fourth quarter, Sevan Drilling had an operating cash flow of -$19.6 million. This represents 3.98% of Seadrill's fourth quarter operating cash flow of $492 million. Of course, as mentioned earlier, the consolidation of Sevan Drilling's cash flow into Seadrill actually had an adverse impact due to Sevan Drilling's operating cash flow being negative.
The consolidation of Sevan Drilling's results into its own thus appears to increase Seadrill's revenues somewhat and decrease the company's reported operating cash flow but otherwise appears to have a very limited impact on Seadrill's reported consolidated results. Once again, backing out the results of the subsidiary companies to determine how Seadrill performed in isolation is much more complicated than this because we would need to add back in things such as the transactions that take place between the various companies. However, since I'm only trying to provide a basic top down overview, this will suffice for now.
We can see evidence of this difficulty by looking in the notes to Seadrill's financial statements. Unlike with the other two companies, Seadrill disclosed the impact that the consolidation of Sevan Drilling had on its results in its fourth quarter 2014 report. In the third and fourth quarters, Sevan Drilling's consolidation increased Seadrill's reported revenues by $169 million and increased Seadrill's net income by $31 million. Please bear in mind that these are the totals between the two quarters in aggregate. Seadrill did not provide figures for either quarter in isolation in its fourth quarter report. However, the company did state in its third quarter report what the impact actually was from the consolidation of Sevan Drilling in that quarter. Seadrill stated that in the third quarter, Sevan Drilling added $66 million to Seadrill's reported revenues and reduced its net income by $15 million. Thus, the effect that this consolidation had in the fourth quarter was to increase Seadrill's revenue by $103 million and to increase Seadrill's net income by $46 million. Both of these latter two figures are substantially above what Sevan Drilling reported in the fourth quarter which illustrates the difficulty in determining the exact impact that consolidation of results will have on the parent company's results.
Unlike in the case of North Atlantic Drilling, Sevan Drilling does not pay dividends so Seadrill did not actually receive any money from the company. Seadrill has guaranteed a bank loan for $120 million for Sevan Drilling but the company has not disclosed whether or not it is paying any money to Seadrill for that purpose. If it is, then this is the only money that Seadrill is receiving from Sevan, otherwise Seadrill directly receives no money from Sevan Drilling despite the latter company increasing Seadrill's reported revenues by nearly 7.01% in the fourth quarter.
Determining the impact that the consolidation of Seadrill Partners' results had on Seadrill is much more complicated than either of Seadrill's other two subsidiaries. This is because Seadrill Partners itself does not have a 100% interest in every rig in its fleet. Instead, Seadrill actually owns an interest in a few of the rigs operated by the partnership. Thus, in the case of these rigs, we would need to determine how much of each rig's revenues should go to each of the two companies given their ownership stakes in each rig. We would also need to know exactly how much revenue, cash flow and net income each individual rig generated in the fourth quarter.
Seadrill Partners owns interests in two operating companies that actually own every rig in Seadrill Partners' fleet except for the T-15 and T-16 tender rigs, which Seadrill Partners owns outright. The two companies in which Seadrill Partners owns an interest are Seadrill Operating LP, which indirectly owns 56% of the West Capella and 100% of the West Aquarius, West Vencedor and West Leo, and Seadrill Capricorn Holdings LLC which indirectly owns the West Capricorn and West Sirius. Seadrill Partners owns 30% of Seadrill Operating LP and 51% of Seadrill Capricorn Holdings LLC. Seadrill itself owns all of the interests in these companies and rigs that Seadrill Partners does not own.
Given the fact that Seadrill owns a more substantial stake in most of these rigs than Seadrill Partners does, the actual money that it receives from these rigs (and does not actually go to the partnership) is presumably much higher than what the partnership receives. The partnership does receive all of the revenue and cash flow generated by the T-15 and T-16 but as both of these rigs are tender barges and the rigs in which the partnership does not own a full interest are ultra-deepwater rigs, Seadrill can be assumed to have actually received most of the revenue and cash flow that is generated by the partnership's fleet. We see evidence for this by looking at Seadrill Partners' distributable cash flow. In the fourth quarter of 2013, Seadrill Partners reported distributable cash flow of $62.0 million. However, $38.8 million of this went to Seadrill through its aforementioned direct and indirect ownership stakes in the partnership's rigs. This left $23.2 million available to be distributed to the members of the LLC.
In addition to owning stakes in some of the partnership's rigs, Seadrill also owns the majority of the partnership's outstanding common units and all of its subordinate units. At the end of the fourth quarter, Seadrill's total ownership stake in Seadrill Partners was 62.4%, which consisted of 21,485,465 common units and 16,543,350 subordinated units. This stake would have resulted in a distribution of approximately $16.9 million to Seadrill in the fourth quarter, partly due to the fact that Seadrill Partners actually distributed $27.1 million to its unitholders and not the $23.2 million of distributable cash flow that the partnership actually generated.
It is important to note, however, that Seadrill Partners will not be consolidated into Seadrill's results beginning with the first quarter of 2014. Seadrill will still receive the same amount of money from its stake in the partnership's rigs that it received in the fourth quarter but its reported revenue will still go down slightly because Seadrill's results will no longer include that portion of the revenue generated by the interests in the rigs and operating companies that are actually owned by Seadrill Partners.
Disclosure: I am long SDRL, NADL, SDRNF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: My shares of both North Atlantic Drilling and Sevan Drilling are the shares that trade in Oslo and not the ones that trade in the United States either on the NYSE or the OTC market.
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