After reading fellow contributor Alpha Shark's article "Pacific Drilling - Opportunity For Investors Who Understand Risks", I felt compelled to write a response in the form of an article. I certainly appreciate Alpha Shark's contribution to investors, and mean no disrespect with my opposite viewpoint. There is always someone out there who is buying when someone else is selling. Opportunities are nearly non-existent for Pacific Drilling (NASDAQ: PACD) investors at this point, and one should be motivated to stay away from the company.
Pacific Drilling has fallen an astounding but understandable 80% in the past year as crude oil continues to decline. Companies no longer are interested in the now expensive offshore drilling Pacific Drilling and its competitors provide. With continued increased onshore production from the continued innovation behind coupling horizontal drilling and hydraulic fracturing and OPEC continuing to drill, drill, drill, suddenly high-cost offshore drilling has the potential to be a typewriter of sorts in upcoming years. Certainly a bold claim, but only the strongest companies have the opportunity to make it through this downturn unscathed, which is a class Pacific Drilling is not a part of.
Pacific Drilling's last contract began in January 2015, and the future looks extremely bleak. No companies are offering new contracts with current oil prices and forecasts. Though 4 of 7 Pacific Drilling's rigs are currently in use, the 4 contracts will expire in August 2016, January and April 2017, and September 2019. Though 4 of 7 may not seem like a bad percentage, with the Pacific Khamsin's contract recently expiring, Pacific Drilling will start to lose money in 2016 (according to analysts following the company). As each ship's contract expires, the loss will continue to increase every quarter with the absence of new work.
In the Q1 earnings call Senior Vice President Michael Acuff summarized what needs to happen for Pacific Drilling to succeed and start new contracts. First off, a continued decrease in the number of offshore rigs. Oil prices stabilizing in the mid 70's. And companies who employee offshore drilling companies returning to a focus on reserve replacement instead of more exploration drilling. Investors who believe in Pacific Drilling are simply betting these three items will occur before the company goes bankrupt.
It is no surprise as mentioned by Alpha Shark, Moody's downgraded Pacific Drilling's Corporate Family Rating to Caa2 (poor standing and significant credit risk) and Default Rating to Caa2-PD which both will continue to fall. This is by no means an optimistic sign for Pacific Drilling. The junk rating is certainly warranted for Pacific Drilling with their weak outlook. With $2.9 billion in debt, and no new revenue streams in the near future, rates will be sky high for Pacific Drilling. Since they are projected to lose money in 2016, they must re-finance their debt or open up new obligations.
The hope of some Pacific Drilling investors is a buyout that has been consistently brought up throughout their downfall. Conferring with my colleague and energy analyst Jacob Urban, the situation seems extremely unlikely. First off, a company buying Pacific Drilling would also take on their massive debt load when there are other assets available. Additionally, companies like Chevron (NYSE: CVX) and Total (Pacific Drilling's 2 current customers) or a larger player in their own industry (ex: Diamond Offshore) must manage their own cash flow first, and since money to spend is so limited for them, only the best options will draw their attention. My colleague highlighted the fact that Pacific Drilling's largest customer Chevron has a plan in place to become cash neutral by 2017. Adding on Pacific Drilling's high interest expenses and operating costs would greatly disrupt this plan while not being a meaningful contributor to cash flow going forward. This isn't to say an acquisition is impossible, but it does suggest that acquiring the company does not make economic and business sense for many of the players big enough to conduct such an acquisition today.
Bankruptcy is certainly not out of the picture for Pacific Offshore Drilling, a task already completed by Hercules Offshore (NASDAQ: HERO). In early April 2015 SA contributor Steve LeBlanc wrote an article titled "Hercules Offshore - Bankruptcy? Not A Chance" sighting Hercules's ability to cover debt obligations in the near-term until oil recovered. Fast forward to August 13th, and Hercules had declared for Chapter 11 bankruptcy. The same situation could certainly occur for Pacific Drilling, with the array of reorganization advantages it brings. Chapter 11 can include the adjustment of interest rates, ability to continue business operations, deferment of payments, and even adjustment of interest rates. Though I am not calling bankruptcy, the advantages it would bring to Pacific Drilling are undeniable giving them a chance to stall, hoping for higher oil prices.
Unless you see oil prices stabilizing in the mid 70's in the medium term, the time is certainly not right to take a position in Pacific Drilling. Instead the bears will continue to feast, as Pacific Drilling continues to follow in the footsteps of Hercules Offshore.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.
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