Seadrill: Credit Facility Amendments Are A Big Deal

| About: Seadrill Limited (SDRL)

Summary

Seadrill earned a victory last week by reaching an agreement with its banks to amend its credit facilities.

Credit facility extensions buy Seadrill crucial time to work out a comprehensive debt deal.

Agreement demonstrates that lenders are willing to back highly levered offshore drilling companies.

Like most companies that depended on a price-driven oil boom, offshore drilling company Seadrill Ltd. (NYSE:SDRL) has seen its share price collapse on the back of a global crude oil supply glut and tailspin in commodity prices. Include falling contract rates and an oversupply of drillships in the market, and you'll begin to understand why the offshore drilling company's share price has slumped ~64 percent in the last year.

Seadrill has fallen victim to reduced capital budgets of oil companies, while supply levels have been growing ever since. OPEC's inability to agree on production limits to stabilize prices has further hurt Seadrill and other oil companies in the oil patch.

With crude oil prices in free-fall, investor sentiment has also taken a hit. However, the latest developments have given Seadrill investors new hope. One reason for improving investor sentiment was that oil prices have begun to recover and have traded up to $46/barrel.

Further, Seadrill's shares popped in March on speculation that Seadrill's main shareholder, shipping tycoon John Fredriksen was preparing a lifeline for the struggling and highly levered offshore drilling company. A gigantic short squeeze magnified Seadrill's recovery, with shares soaring as high as $7.49 on March 4, 2016.

Though Seadrill's shares have come down to earth lately, largely due to profit-taking, the company nonetheless added to its streak of good news by informing shareholders last week that it struck a deal with its lenders to amend its credit facilities.

We have seen agreements with lenders to amend credit facilities before; Chesapeake Energy Corp. (NYSE:CHK) and Linn Energy, LLC (NASDAQ:LINE)(LNCO) both announced amendments to their credit facilities that buy the companies crucial time to hammer out a larger debt deal with its creditors. Seadrill is only the latest company that has been able to negotiate some beneficial amendments including facility extensions and covenant relief.

Seadrill said that it was able to extend three credit facilities worth $450 million, $400 million, and $2.0 billion, which helps the company navigate a severe downturn in the offshore drilling market on the back of significant capex cuts in the sector. Further, Seadrill gained covenant relief from its lenders, which, again, is beneficial for the offshore drilling company and substantially reduces the probability of a near-term default. Covenant relief includes:

  1. A reset of the leverage covenant.
  2. A revised definition of the Equity Ratio to exclude the impact of any change to the market value of our rigs.
  3. A suspension of the provision that allows lenders to receive a prepayment under their secured credit facilities if rig values decline below a minimum value relative to the loan balance outstanding.

Your Takeaway

Seadrill's credit facility extensions and covenant relief are a big deal for the company and its shareholders because they underscore that lenders are willing to back the company up in light of a brutal price crash and sector downturn that few foresaw. The credit facility amendments are the first step for Seadrill to secure a bigger refinancing package, and it is good news for the company's investors that its lenders are not just pulling the plug, but rather playing a supportive role in putting together a new balance sheet with a more sustainable capital structure.

Disclosure: I am/we are long SDRL.

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.