From HERO To Zero - Yet Again?

| About: Hercules Offshore (HERO)

Summary

The company disclosed a dispute with some of its term loan lenders.

Entered into a forbearance agreement effectively preventing Hercules Offshore from taking delivery of the Hercules Highlander.

A quick and amicable solution is imperative in order to save the Hercules Highlander contract and avoid another potential bankruptcy filing.

Not that investors of Hercules Offshore (NASDAQ:HERO) weren't already badly stricken enough when their company was the first victim of the ongoing unprecedented downturn of the offshore drilling industry and had to file for bankruptcy roughly ten months ago.

While shareholders weren't wiped out entirely in the reorganization, the 3.1% stake in the restructured company's new equity in combination with some badly out-of-the-money warrants wasn't exactly something to write home about. Moreover, after emerging from bankruptcy, the re-listed stock almost immediately went on a major tailspin, losing more than 90% from its November 10, 2015 re-opening price over the next two months, with the share price even dropping again below the Nasdaq minimum bid price requirement of $1 for several weeks.

But then seemingly things finally started to turn for the better as the company decided to explore strategic alternatives in February. Given that the bankruptcy reorganization actually helped Hercules Offshore into a $100 million net cash position, there clearly seemed to be a chance to get picked up by a competitor despite the company's mostly outdated rig fleet. I already discussed this possibility in detail shortly after it emerged from bankruptcy.

Moreover, the much-anticipated contract start for the company's newbuild high-specification jackup rig, the Hercules Highlander (currently still under construction), was slowly getting in sight. The rig has been contracted to Maersk Oil at a great dayrate of $230,000, with the potential to substantially improve the company's current quarterly cash burn of roughly $40 mln. In fact, this contract represents roughly 40% of Hercules Offshore's entire remaining backlog.

Combined with an ongoing recovery in oil prices, the shares actually picked up some strong momentum over the last few weeks, running a whopping 400% from their recent lows on strong volume. The stock peaked at $4.23 at the beginning of this week.

But on Thursday morning, the company filed an 8-K with the SEC, essentially disclosing a dispute with some of the lenders under its new $450 mln credit facility. Obviously, Hercules Offshore failed to timely comply with two seemingly minor affirmative covenants set forth in the original credit agreement constituting defaults.

As a result, the company decided on April 18 to enter into a forbearance agreement with its lenders over an initial period of ten days, currently ending April 28.

Investors interested in the details of the alleged defaults should take a look into the 8-K as well as the attached "forbearance agreement and first amendment to credit agreement".

But the most disconcerting paragraphs for investors can actually be found at the very bottom of the filing, under "Item 8.01 - Other Events":

During the Forbearance Period, as provided in the Amendment, the Company will not be able to receive funds held in escrow under the Credit Agreement. Accordingly, the Company will not be able to fund or accept delivery of the Hercules Highlander during this time. The Company is in communication with the shipyard and its customer regarding these matters.

During the Forbearance Period, the Company has agreed with the Lenders who are parties to the Amendment to negotiate in good faith an agreement with respect to a potential recapitalization, business combination or other alternative strategic transaction with respect to the Company, including a potential restructuring of the Loans under the Credit Agreement.

Ouch. So the forbearance period wasn't actually granted to provide Hercules Offshore some more time to cure the alleged defaults, but rather, to negotiate just another debt restructuring.

Obviously, some of the lenders under the new credit agreement have recently gotten cold feet given the ongoing measly state of the offshore drilling market and Hercules Offshore's very weak position in particular. With the entire credit amount still in the company's bank accounts, they seemingly decided to use some more or less insignificant defaults in order to push for a better deal or very likely simply get their money back.

It should be noted, though, that the forbearance agreement only relates to a handful of the roughly fifty different creditors subject to the original credit agreement, but unfortunately, the consequences couldn't be worse here.

With the company currently being prevented from funding the upcoming delivery of the Hercules Highlander, the contract with Maersk Oil is now facing elevated risk of getting re-negotiated to the material disadvantage of the company, or even terminated entirely. Given that the Hercules Highlander has been built to the particular specifications of the customer, I would rather expect a substantial downward adjustment to the dayrate instead of an outright termination, but this would actually assume that Hercules Offshore would be able to take delivery of the rig by advancing the remaining balance of the purchase price to the shipyard.

Clearly, these latest developments neither bode well for the highly important Hercules Highlander contract nor for the company's ability to sell itself at a substantial premium to the current share price.

Hercules Offshore shareholders should keep their fingers crossed for these issues to be resolved in a timely manner and with no damage to the company's current capital structure and the all-important Hercules Highlander contract. Unfortunately, the odds seem to be against a mutually beneficial solution to all parties involved here at this point.

In a worst-case scenario, Hercules Offshore might very well end up in bankruptcy within short notice once again - and this time, might even face dissolution in the end.

Not surprisingly, the share price took a large hit during today's session, ending the day down 40%. There might be more downside potential given the vastly increased uncertainty with regard to the company's future prospects.

Investors would be well served to stay on the sidelines while watching this latest drama unfolding.

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.