As most of you already know, Ocean Rig (NYSE: ORIG) has just purchased a drillship for $65 million. I presented my views on the topic in "Ocean Rig: Bravado Or Genius Move?" and fellow contributor Fun Trading shared his stance in "Ocean Rig Is Buying The Drillship 6G UDW Cerrado (2011) For A Whopping $65 Million Sold Through An Auction."
After reading hundreds of comments on Ocean Rig articles, I noticed that one's stance heavily depends on the perception of George Economou's incentives. While he is certainly a colorful man and the evaluation of his actions is important for valuing Ocean Rig, let's take a break from discussing his role in the story and focus solely on the ship and its ability (or lack thereof) to make money in the future.
Before the ship will be able to work again, it will have to go through the 5-year special survey. The 5-year SPS cost varies widely. Ocean Rig has a new fleet so we can't have much data points regarding the company's stance towards the process. However, when Eirik Raude went through its 10-year class special survey in 2012, the cost was $65.5 million. The cost for a 5-year drillship won't be that great, but we should take similar numbers into account when looking at the rig's future.
In the fourth quarter of 2015, the company's daily operating expenses were $131,600 per rig. This was a dramatic improvement from $190,000 per day in 2014. I don't think that expenses can be pushed lower, and frankly, I'm somewhat skeptical about the quality of such improvements. In the longer run, costs will likely have to rise to the $140,000-$150,000 range. I will factor costs of $140,000 per day in my calculations.
If the rig begins to work in 2019 and then works 87% of the time at a flat day rate of $242,000 per day until 2035, the purchase is justified. A 7% discount rate was used in the calculation. Of course, no one envisions flat rates until 2035, and this was just the first scenario to get a feel of what's going on.
The second scenario is much better for the purchaser. A rig starts to work in 2019 and works two years for $200,000 a day. For the next five years, the day rate is $400,000, followed by a $500,000 day rate in the following five-year period which ends in 2030.
Technology improves fast, and the rig is considered old in 2030, so the rate drops to $300,000. The net result of comparing DCF with the purchase price in this scenario is $303 million. That's not bad at all, although this scenario puts into heavy doubt the economics of taking delivery of $650 million drillships.
What can possibly go wrong? Let's look at the third example. The ship starts to work in 2019, but the rate environment is depressed as oil prices are stuck in $50-$60 range due to pressure from shale and the oversupply of rigs. The drillship works for $270,000 per day through 2025. Then the pressure resides, and the rig works for $400,000 per day until the end of its life. The net gain in this case is $217 million - still great for one purchase.
If we exclude Ocean Rig's problems and strengths and judge the purchase as if it were made in vacuum, the price paid was terrific. Numbers support what is already evident on an intuitive level - you can't be wrong purchasing a drillship at such a discount.
There are two ways how things can go wrong with this purchase - the buyer cuts corners in cost-cutting efforts and the ship turns into a wreck, or the offshore drilling industry goes bust as a whole.
You can also imagine that some technological breakthrough in 2020-2025 will make ships built in the teens useless, but I don't believe in such miracles. All viable scenarios seem to work for the purchase even without putting extra-high rates into the model.
There is just one more thought that I'd like to include in this article, as this topic will surely arise in the comments section due to the recent price action in Ocean Rig's shares and the bearishness of my previous articles on the stock.
My skepticism of the company's prospects is about the final outcome for Ocean Rig. Meanwhile, it can rise to $2, $3 or higher and I may participate in such moves. I am not changing my fundamental thesis until I see evidence from the real market, and I won't be looking at the price of the stock to guide my thoughts about the eventual outcome of the Ocean Rig story.
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.
Additional disclosure: I may trade ORIG.