Seadrill: Credit Facilities Amendment A Non-Event

| About: Seadrill Limited (SDRL)

Summary

Restructuring timeline extended until the end of 2016.

In exchange for some minor maturity extensions Seadrill is now prohibited from accessing its remaining credit lines.

Minimum liquidity covenant raised from $150 mln to $250 mln.

Negotiations on Seadrill's (NYSE:SDRL) advised comprehensive debt restructuring are seemingly taking considerably longer than initially expected by the company as evidenced by today's press release.

Contrary to management's statements in the company's Q4/2015 earnings release ("The company is currently working with its advisers to evaluate alternatives in light of industry and capital market conditions. We aim to communicate our financing plans during the first half of this year.), Seadrill now "aims to conclude negotiations with its stakeholders by the year end".

As of the time of this writing Seadrill's shares are up 15% in pre-market despite the news basically being a non-event at best.

But given the ongoing recovery in oil prices, virtually every little, seemingly positive news currently gets picked up by the momentum crowd in order to potentially cause another major short squeeze like the one experienced in early March when the stock shot up an astonishing 150% within just one trading session, adding roughly $2 bln in market capitalization on an interim basis.

At that time, the move was caused by news of Seadrill's largest shareholder, Norwegian born shipping tycoon John Fredriksen, having sold a roughly $500 mln stake in Marine Harvest ASA after salmon prices surged to new all-time highs. Investors were speculating that Fredriksen was freeing up cash in order to support Seadrill in the company's upcoming restructuring.

While I have no doubt that Fredriksen will indeed offer some major contributions to Seadrill's upcoming comprehensive debt restructuring plan, unfortunately his interests are not aligned with outside shareholders as already explained by me in detail in an article published after the company's Q4 earnings release.

That notwithstanding, Seadrill's shares have been on the rise as of late alongside its entire peer group given the ongoing recovery in oil prices.

So let's now take a short look at today's amendments to the company's credit facilities:

  • The maturity of the $450 million senior secured credit facility, relating to the West Eminence, has been extended from June 20, 2016 to December 31, 2016
  • The maturity of the $400 million senior secured credit facility, relating to the jack-up rigs West Cressida, West Callisto, West Leda and West Triton, has been extended from December 8, 2016 to May 31, 2017
  • The maturity of the $2 billion senior secured credit facility of the company's majority-owned subsidiary North Atlantic Drilling (NYSE:NADL) has been extended from April 15, 2017 to June 30, 2017.

Moreover some credit covenants were amended or waived:

    • Equity ratio: The company is required to maintain a total equity to total assets ratio of at least 30.0%. Prior to the amendment, both total equity and total assets were adjusted for the difference between book and market values of drilling units, as determined by independent broker valuations. The amendment removes the need for the market value adjustment from the calculation of the equity ratio until June 30, 2017.
    • Leverage ratio: The company is required to maintain a ratio of net debt to EBITDA. Prior to the amendment the leverage ratio had to be no greater than 6.0:1, falling to 5.5:1 from October 1, 2016, and falling again to 4.5:1 from January 1, 2017. The amendment retains the ratio at 6.0:1 until December 31, 2016, and then increases to 6.5:1 between January 1, 2017 and June 30, 2017.
    • Minimum-value-clauses: The company's secured bank credit facilities contain loan-to-value clauses, or minimum-value-clauses ("MVC"), which could require the company to post additional collateral or prepay a portion of the outstanding borrowings should the value of the drilling units securing borrowings under each of such agreements decrease below required levels. Subject to compliance with the terms of the amendment, this covenant has been suspended until June 30, 2017.
    • Minimum Liquidity: The company has previously been required to maintain a minimum of $150 million of liquidity. This has been reset to $250 million until June 30, 2017.

Lastly Seadrill has agreed to refrain from borrowing any undrawn commitments under its senior credit facilities, currently amounting to $467 mln, and to pay certain fees to its lenders in consideration of the above stated extensions and amendments.

So given the extended negotiation process, these amendments had to be done in order to prevent the company from defaulting on its debt obligations during this time.

As basically nothing in life comes for free, Seadrill in exchange is now prohibited from accessing its remaining undrawn credit lines and moreover has to comply with an increased minimum liquidity covenant in addition to paying the lender's fees associated with the amendments.

So nothing really changed except for the timeline for the company's upcoming comprehensive debt restructuring. I already outlined some potential scenarios in a previous article and while Seadrill's bonds have also shown a major recovery in recent weeks, they are still trading at deeply distressed levels currently ranging from 30-45% of face value. Clearly bond investors are still expecting a major haircut in the upcoming restructuring which of course does not bode well for the company's common equity, particularly in light of the interests of John Fredriksen not being aligned with the outside shareholders.

Should the recent recovery in oil prices continue, Seadrill's shares will continue to thrive but once the restructuring agreement will have been finalized, there's very little reason for John Fredriksen to leave much on the table for the company's current outside shareholders.

The upcoming comprehensive restructuring actually provides him with a great chance to potentially grab up to 90% of the restructured company, capturing a very large part of future earnings potential.

In my view, the most probable outcome remains John Fredriksen making a discounted cash offer for Seadrill's and North Atlantic Drilling's outstanding bonds and later convert this debt into equity. The lower the conversion price, the higher John Fredriksen's stake in the restructured company will be.

Furthermore I would expect Ship Finance International (NYSE:SFL), another company controlled by Fredriksen, to also convert roughly $300 mln in outstanding loans to new equity, further raising Fredriksen's stake in the restructured Seadrill.

Lastly Fredriksen will most likely agree to inject a substantial amount of fresh funds into the company, perhaps in the range of $500 mln to $1 bln, most likely also in form of new equity. Again, his incentive would be to pay the lowest possible price in order to get the highest possible stake in return for his money.

But until then Seadrill's shares, alongside its peers, will continue to basically move in close correlation to oil prices, as witnessed for a long time now. Currently large parts of the offshore drilling stocks, particularly the fundamentally weaker companies like Seadrill, North Atlantic Drilling, Ocean Rig (NASDAQ:ORIG) and Pacific Drilling (NYSE:PACD), have become a playground for the momentum crowd so investors should continue to prepare for outsized moves in both direction for the near future.

Today's news is actually a non-event and at this point it seems hard to imagine that the momentum crowd will be able to ignite another major move today like the one witnessed in early March based on some minor amendments and waivers to the company's credit agreements.

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: As a daytrader I have actively traded the shares of all companies mentioned in the article in the past and might decide to do so in the future.