Seeking Alpha
Long/short equity
Profile| Send Message| ()  

Seahawk Drilling's (HAWK) asset sale and bankruptcy filing marks the end of the troubled company's short history as a spin-off from Pride International (PDE). While the company had very little debt, its outstanding tax obligations to former parent Pride International of 600 million pesos ($49 million) were enough to force Seahawk to stop seeking better strategic alternatives and instead sell out its assets to Hercules Offshore (HERO) at fire-sale prices while declaring Chapter 11 bankruptcy. The shares of both Seahawk and Hercules made large moves Monday following the news. With Seahawk shares cut in half and Hercules surging almost 20 percent to a new nine-month high, investor excitement is clearly high. Is there significant value at either company?

Somewhat surprisingly, Seahawk Drilling shares have retained a significant valuation despite the bankruptcy filing. Shares gapped down over the weekend from $7.90 to $3.50, but staged a sharp rally to close Monday at $4.65. While some of this rally can probably be credited to short sellers covering their bets, there is significant buying interest in the shares of Seahawk despite the bankruptcy filing. The reason appears to be that Seahawk believes it can fight the obligation to Pride International that it currently owes.

Seahawk stated in its filing

The Company believes that it has defenses to the claims set forth in the Notice and expects to contest such claims in the Bankruptcy Case. The ability of Pride to seek remedies to enforce its rights under the Tax Support Agreement is automatically stayed as a result of the filing of the Bankruptcy Case, and Pride's rights of enforcement are subject to the applicable provisions of the Bankruptcy Code.

Seahawk will need to succeed in nullifying some of its obligations if shareholders are to receive much of anything after the dust clears.

In Seahawk's last quarterly report, the company claimed $397 million of property plant and equipment, more than the entire claimed shareholder equity. Since this point, the company's assets have further declined and obligations have risen, leaving even less equity for shareholders. By selling the $397 million of assets for just over $100 million to Hercules, the company wiped out just about all shareholder equity, as the cash received from Hercules will go to paying off accounts receivable, short-term debt, and its outstanding obligation to Pride International.

I estimate that at best, depending on the fluctuations of the value of Hercules shares used to finance the acquisition, there will be a dollar or two per share left over for Seahawk shareholders. While the company will receive just over $100 million from Hercules, it has to pay back the $49 million to Pride plus its short-term debts. What's left will be well under the present $4.40 a share the stock fetchs. This analysis, of course, discounts Seahawk's chance of winning relief from some debts in court. If Seahawk should win in court and discharge the debt to Pride, shares would probably be worth a bit more than the current $4.40 as Seahawk's float is a rather miniscule 11.96 million shares. If a substantial chunk or all of that $49 million debt was discharged, up to $4 per share of value could be added to Seahawk's remaining worth.

While there is good reason for Seahawk shares to be traded significantly above zero, they seem like an unnecessarily risky bet presently at more than $4 a share. If courts favor Pride International's debt claim rather than interests of the common stockholders, Seahawk shares will almost certainly lose significant further value. A bet on Seahawk at this point is a bet on a court ruling, which only the most sophisticated and risk-tolerant of investors should take. Also, it is worth noting that Seahawk should face additional downside pressure in the short-term as indices including the S&P Smallcap 600 remove Seahawk from their indicies, which will force index funds to sell Seahawk shares.

On the other hand, investors have been eager to invest in the apparent winner of this deal, Hercules Offshore, which consolidates its leading position in shallow-water Gulf of Mexico drilling by picking up lots of rigs on the cheap while eliminating a competitor. Hercules shares surged nearly 20 percent Monday as investors favorably contemplated its improved prospects. I'd caution that eager speculators should take a second look, however.

Hercules has been struggling for several years to profitably utilize the fleet of jackup rigs it already has, and the Deepwater Horizon disaster last spring added further environmental concerns and regulatory issues to an already heavily regulated industry. With a rather unfriendly-to-drilling president in the White House and with a significant number of rigs already sitting idle, it is hard to see a lot of value for Hercules in this acquisition. In all likelihood, Hercules will scrap most of Seahawk's rigs at near breakeven or a small gain while keeping only the best of Seahawk's assets active. With permitting going at a snail's pace and with Seahawk having lost its entire revenue stream from its former largest customer – Mexico's Pemex – it is difficult to see this acquisition adding much of anything to profits or even revenues in Hercules' near future.

Hercules still faces a crippling debt load of nearly $900 million, which greatly exceeds its market cap, and the company's operations continue to generate negative earnings with each passing quarter. While Hercules can continue to string things along for awhile with more debt and share dilution, it is difficult to see much upside until the regulatory environment clears up, which could still be quite awhile into the future. At best, I think Hercules' shares represent dead money for at least the next year, and there could be substantial downside, as there is not likely to be consistent profitability for quite awhile into the future. While optimists point to Hercules' price-to-book ratio of 0.52 as a strong indicator of value, it's worthwhile to remember that Seahawk recently had a stated book value of more than $30 per share. As long as demand for drilling in the Gulf remains low and regulatory pressures remain intense, it is hard to see much of any upside for drillers located there. It seems wise to avoid the shares of both Seahawk and Hercules at this point.

Source: In Wake of Seahawk's Asset Sale to Hercules, Investors Eyeing Both Companies