Seadrill's West Saturn Contract Promises To Deliver Forward Growth

| About: Seadrill Limited (SDRL)


Seadrill was recently awarded a two-year contract for the use of the West Saturn, one of the company's new ultra-deepwater drillships.

This contract will result in ExxonMobil paying Seadrill $497 million over a two year period.

This contract should generate incremental EBITDA growth of 5.61% over the first quarter.

This contract should also generate incremental operating cash flow growth of 5.03% over the first quarter.

On Friday, August 8, offshore drilling giant Seadrill Ltd. (NYSE:SDRL) announced that it has been awarded a contract for the use of its new ultra-deepwater drillship West Saturn. This contract award promises to enable Seadrill to continue to deliver on its long-term growth potential, which I have written about many times in the past. The contract will also expand Seadrill's presence in West Africa, a region that is rapidly emerging as one of the most important for the industry.

The West Saturn is an ultra-deepwater drillship that is currently under construction at the Samsung Heavy Industries shipyard in South Korea. A sixth-generation drillship, the rig uses the SHI S10000 design and is capable of drilling wells that are up to 40,000 feet deep in up to 12,000 feet of water. These specifications make West Saturn one of the most modern and technically capable ultra-deepwater rigs in the world. Construction of the rig is expected to be completed in September of this year, at which time the rig will be moved to West Africa to begin work on its first contract.

The contract that was awarded to the rig calls for it to operate for a firm period of two years performing drilling operations for a wholly-owned subsidiary of Exxon Mobil (NYSE:XOM) off of the coast of Nigeria. Over this period, Exxon Mobil will pay Seadrill a total of $497 million. This works out to approximately $681,000 per day including the amortization of the mobilization fee. The reason why the mobilization fee is included in this total is because the company will be amortizing it over the full two-year term of the contract instead of recognizing all of it in a single quarter. However, investors are advised to keep in mind that the mobilization fee is simply a reimbursement of money that Seadrill needs to spend to move the rig to its assigned location in Nigeria. As such, it does not truly represent new money coming into the company in the same way that dayrate does.

Unfortunately, Seadrill did not disclose exactly what the mobilization fee is so we have no way to determine the exact dayrate for West Saturn. However, we can look at similar contracts and approximate the mobilization fee. I made such an estimate in a recent article regarding the company's contract for the West Jupiter rig. Since both West Jupiter and West Saturn are being moved from South Korea to Nigeria, it stands to reason that the costs to move each rig to its assigned location should be relatively similar. Thus, the mobilization fees for the two contracts should also be relatively similar. My estimate of the West Jupiter's mobilization fee was $40 million. Please consult the linked article for the reasoning behind this. We will therefore assume that the West Saturn has the same mobilization fee for the purposes of this analysis.

If we assume that the mobilization fee is approximately $40 million, the remaining $457 million of the contract total would be dayrate. This works out to approximately $626,000 per day. From this, we can proceed to calculate the impact that this new contract will have on Seadrill's EBITDA and cash flow.

Now that we have an idea of the revenues that this contract will bring Seadrill, we need to determine Seadrill's costs of generating this revenue. Fortunately, Seadrill itself provides some idea of these costs. In a presentation at the Credit Suisse 2013 Energy Summit, Seadrill provided a chart that shows the economics of operating different types of rigs:

Source: Seadrill

According to this chart, it costs Seadrill approximately $170,000 per day to operate an ultra-deepwater floating rig like West Saturn. It is worth noting, however, that Seadrill has used this same chart with only minor changes in various presentations over the past few years. Thus, it is possible that this figure is outdated by now and, indeed, it is significantly lower than the estimates that both Seadrill's peers and industry analysts use when making projections. For example, Pacific Drilling (NYSE:PACD) recently announced that its direct per rig operating expenses were $177,800 per day in the second quarter of 2014. That same company also used an estimate of $200,000 per day of operating expenses on a per rig basis in a recent presentation. This $200,000 per day figure is also the figure that is generally used by industry analysts to estimate the cash flow potential from a given rig. As this is the figure that will give the most conservative estimate of the West Saturn's incremental cash flows, it is the figure that I will use in this analysis.

A dayrate of $626,000 and operating expenses of $200,000 per day would result in incremental EBITDA of $426,000 per day. This is approximately $38.34 million per quarter. In order to calculate the cash flow potential from this rig however, we need to subtract the amount that Seadrill will have to pay in taxes. In the chart above, Seadrill estimates that its tax expenses on a per rig basis are approximately 4% of revenues. While the actual taxes that Seadrill has to pay to operate West Saturn will be subject to Nigerian tax laws, 4% is still a reasonable estimate. That is because it is very much in line with figures provided by peers and Seadrill's presence in numerous countries around the world allow the high tax regimes and the low tax regimes to balance each other out. At 4% of revenues, Seadrill will pay approximately $25,040 per day in taxes on West Saturn. Thus, the rig will generate an incremental operating cash flow of approximately $401,000. This is approximately $36 million per quarter.

In order to generate this much incremental cash flow, West Saturn would need to operate continuously over the full contract term. This is unrealistic. In reality, offshore drilling rigs are extremely sophisticated pieces of machinery that require regular periods of downtime in order to receive maintenance and occasional repairs. Rigs do not receive compensation for time that they spend receiving this maintenance. Thus, estimating the amount of time that the rig will spend out of operation is vital to estimating its incremental cash flows.

The easiest and most logical way to do this is to look at the historical downtime record of Seadrill's fleet. In the first quarter 2014, Seadrill's floater rigs had downtime totaling 9% of the total time during the quarter. This same figure was 6% in the fourth quarter of 2013. In order to estimate the downtime that West Saturn will incur, we will average these two figures as the assumption is that West Saturn will perform in line with the rest of Seadrill's fleet. This gives an estimated downtime of 7.5% for the rig over the contract term.

This downtime assumption reduces West Saturn's incremental EBITDA to approximately $35 million per quarter and incremental operating cash flow to approximately $33 million per quarter. This represents increases of approximately 5.61% and 5.03% over the company's first quarter numbers, respectively. Clearly, this contract is quite beneficial for both Seadrill and its shareholders.

Disclosure: The author is long SDRL, PACD. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.