Seadrill: New Transaction With Bondholders

| About: Seadrill Limited (SDRL)

Summary

Seadrill agrees for another debt-for-equity exchange.

The implied discount is roughly the same as in the previous case.

The price of oil determines the trading of Seadrill's stock.

Seadrill (NYSE:SDRL) proceeded with small debt-for-equity exchanges. This time, the company announced that it exchanged $50 million of 2017 notes for 7,500,000 new shares. As a reminder, the previous exchange included 8,184,340 shares issued in exchange for $55 million of 2017 notes. This allows us to directly compare the first transaction with the following transaction.

Calculating at the latest market close, bondholders received $28.12 million, a 44% discount. The previous transaction implied a 45% discount. Those optimistic on Seadrill may point out that the transaction implied a $6.66 price for the company's shares, but this is a wrong conclusion because the bonds are not trading at par.

We now can be more or less certain that Seadrill is willing to follow on with small debt-for-equity exchanges at roughly a 45% discount for bondholders of nearest-maturity bonds. This reflects the situation on the bond market. Despite the recent upside in oil prices, the terms did not change for the bondholders and they still have to take a significant haircut to par value of the bonds. However, as was previously expressed by contributors and readers alike, these bondholders are likely opportunistic funds who purchased Seadrill's bonds at or near bottom so they are happy with the current terms.

Seadrill's shares have been recently under pressure, but the renewed rally in oil managed to push them higher. It currently looks like a $3-$4 trading range is enough for certain bondholders to agree to a debt exchange. However, please note that the above-mentioned discount was calculated on most recent closing price. It is obvious that the debt exchange was negotiated earlier, perhaps when Seadrill's shares traded lower. In this case the actual discount might have been bigger, but decreased due to increase in the price of Seadrill's stock.

The resulting dilution is small, so in the environment of rising oil prices, Seadrill's shares will likely enjoy some support after the transaction. The oil price upside did not change risks for Seadrill, according to the bondholders who participated in the exchange. It looks like bondholders share the view on the offshore drilling market with me - oil at $48 and oil at $52 are equal for the future contract activity.

However, oil at $48 and oil at $52 are absolutely not equal in terms of trading offshore drilling stocks, who enjoyed great support in recent trading days. The weakest companies North Atlantic Drilling (NYSE:NADL) and Pacific Drilling (NYSE:PACD) saw speculative money coming and their stocks are now traded by day traders and producing wild swings.

In this environment, you should probably look for the possibility of short squeezes everywhere, including Seadrill, although the stock did not show the signs of a really rapid action coming. My choice in this environment was Noble Corporation (NYSE:NE), who was lagging its peers without a serious reason. Whatever your choice, you should watch the oil price closely. Oil has not seen a significant rebound for a long time now. The bullishness in oil is now immense and it looks like some participants acquired the belief that it can only go up. The same sentiment was seen when oil was going down and looked bottomless. This is typically when the change of direction occurs, so enjoy the rides in offshore drilling stocks but be aware that a change of tide might be coming soon.

I would also like to comment on the recent news from North Atlantic Drilling, a company that, in my view, will be ultimately absorbed by Seadrill. North Atlantic Drilling extended its standstill agreement to defer the delivery of West Rigel by further three months until September 2. This news fueled some speculation in its shares. In my view, this shows the current bullish sentiment in offshore drilling shares. The news is absolutely neutral, but, with some imagination, they could be interpreted as bullish and the traders' minds follow the path of least resistance which is now to the upside. I'd like to remind that stocks like North Atlantic Drilling and Pacific Drilling should be avoided by everyone except those who have short-term trading skills due to their low float, great volatility and highly dubious fundamental prospects.

All in all, watch out for the price of oil which currently determines the short-term fate of Seadrill's shares. In my view, fundamentals did not change and the recent transaction which implied roughly the same discount as the previous one shows that I'm not alone in this thinking.

Disclosure: I am/we are long NE.

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.