Seadrill: Investment Portfolio Adds To Earnings Volatility, Could Benefit Company Overall

| About: Seadrill Limited (SDRL)

One factor that sets SeaDrill (NYSE:SDRL) apart from other drilling companies is the company's large investment portfolio. This investment portfolio has, in the past, resulted in large impacts to SeaDrill's net income. In fact, it is likely the singularly largest reason why SeaDrill's net income displays much more volatility than that of its competitors. For example, the company took a $463 million paper loss in the fourth quarter of 2011 due to its position in Archer Ltd. The company also saw a gain of $416 million in the second quarter of 2011 because of its position in Pride International prior to that company's acquisition by Ensco (NYSE:ESV). Each of these items resulted in large impacts to SeaDrill's net income despite having no impact on the company's operating cash flow. The company's portfolio includes a number of other companies besides these and this could represent interesting opportunities for investors.

North Atlantic Drilling (OTCPK:NATDF)

North Atlantic Drilling was formed in a 2011 equity carve-out of SeaDrill's European harsh environment drilling activities. North Atlantic Drilling operates a fleet of six harsh environment drilling rigs with an additional two rigs under construction including one semi-submersible which was ordered in April and partially financed by proceeds from a private placement that the company conducted at the end of April.

North Atlantic Drilling is positioned to be a beneficiary of renewed interest in the North Sea. This is a region that was just recently thought to be mature but technological advances have now allowed the older fields in the area to either restart or increase production. Additionally, as Statoil (NYSE:STO) showed just last year, there have been some exploration successes in the North Atlantic and other nearby areas such as the Barents Sea. This interest has increased demand for harsh-environment rigs in general and for North Atlantic Drilling's services in particular. This is the reason why the company has ordered two more rigs (increasing the size of its fleet by 33%) since it was created last year.

SeaDrill is likely to profit off of any growth in North Atlantic Drilling. SeaDrill owns 74% of the outstanding stock of the company.

Asia Offshore Drilling

Asia Offshore Drilling is an offshore drilling company that currently has three jack-up rigs under construction at Keppel FELS in Singapore. These three rigs would give the company substantial shallow-water exposure with no exposure to other offshore environments. As I stated in a recent analysis of Ensco, however, that may not be a bad thing. I provided a chart in that article which showed that the Asia Pacific region has offshore reserves of 71.1 billion barrels of oil equivalent. Of this amount, more than half is in areas that can be drilled with a jack-up rig. Interest from customers in tapping these reserves should allow Asia Offshore Drilling to contract out its rigs as each comes out of the shipyard.

Asia Offshore Drilling needs to strengthen its equity base in order to take delivery of the three rigs under construction so that it can begin operating. SeaDrill has begun discussing this situation with Asia Offshore Drilling and may ultimately have to contribute to this strengthening. SeaDrill has expressed a willingness to contribute 33.75% of the capital needed to strengthen the company's equity base. This shows that SeaDrill is firmly committed to maintaining its current ownership stake at 33.75% of Asia Offshore Drilling.

Sevan Drilling (OTCPK:SDRNF)

Sevan Drilling is an offshore drilling company that owns and operates two ultra-deepwater drilling rigs with two more under construction. These two newbuilds are scheduled for delivery in the fourth quarter 2013 and the second quarter 2014, respectively. SeaDrill currently owns 28.5% of Sevan Drilling.

Sevan Drilling provides excellent exposure to the extremely promising ultra-deepwater market. Sevan Drilling's two operating rigs (Sevan Driller and Sevan Brazil) are both under contract to Brazil's national oil company, Petrobras (NYSE:PBR), and on assignment in Brazil. Brazil is one of the fastest growing markets for ultra-deepwater drillers and Petrobras is by far the largest customer in this region. The relationship that Sevan Drilling has with Petrobras could serve the company well. SeaDrill itself already has significant exposure to the ultra-deepwater space through its own fleet. The company's investment in Sevan Drilling increases that exposure to this segment of the market.

Varia Perdana

Varia Perdana is an Asian offshore drilling company that owns and operates five self-erecting tender rigs. These rigs operate primarily in the waters offshore Thailand and Malaysia.

Varia Perdana's rigs are all tender barges and not the more profitable semi-tender rigs which I have previously written about. Despite this, Varia Perdana does provide SeaDrill with additional exposure to the promising Asia Pacific market as well as provides a relatively small amount of income. SeaDrill's stake in Varia Perdana contributed $10 million to SeaDrill's fourth quarter 2011 earnings. The company contributed $9 million to SeaDrill's first quarter 2012 earnings.

SeaDrill directly owns 49% of Varia Perdana but indirectly owns a larger stake for reasons that are about to become clear.

SapuraKencana Petroleum Berhad

SeaDrill obtained its ownership interest in SapuraKencana through the recent acquisition of SapuraCrest by Integral Key Sdn Bhd (which renamed itself to SapuraKencana Petroleum). SeaDrill owned a 23.6% stake in SapuraCrest prior to the cash and stock acquisition. SeaDrill paid out the cash that it received from this acquisition in the form of a special dividend recently. The company obtained its ownership stake in SapuraKencana through the stock portion of this acquisition.

SeaDrill owned 23.6% of SapuraCrest prior to the acquisition. SapuraCrest owned the remaining 51% of Varia Perdana and this is the source of SeaDrill's indirect stake in Varia Perdana which I alluded to in the previous section. This stake transferred to SapuraKencana after the merger.

In addition to its stake in Varia Perdana, SapuraKencana provides a variety of other oil well services. The company is also entering into oil production services and ownership. SeaDrill states that the combined company has a very strong position in the rapidly growing oil service market of Far East Asia and Australia. The company's management believes that SapuraKencana could have significant upside assuming proper management.

Despite this, SeaDrill sold approximately $200 million worth of SapuraKencana stock on May 30, 2012. Prior to this sale, SeaDrill owned approximately 11.8% of SapuraKencana. After the sale, SeaDrill now owns 6.4% of SapuraKencana.

Archer Limited

Archer is an international oilfield service company. Over the past year, Archer has had a larger impact on SeaDrill's earnings than any other company in SeaDrill's portfolio. In the first quarter of 2011, SeaDrill recorded a $477 million financial gain incurred due to deconsolidation of well services. This was the result of a merger of SeaDrill's former subsidiary Seawell to Allis-Chalmers Energy. The combined firm resulting from this merger renamed itself Archer Limited.

Archer would again have an impact on SeaDrill's quarterly results in the fourth quarter. SeaDrill took an impairment charge of $463 million due to its stake in the company during this quarter. SeaDrill's management still strongly believes that Archer Limited has significant upside despite the current issues plaguing Archer. SeaDrill stated in its fourth quarter press release:

"Seadrill is as a major long-term shareholder clearly disappointed in the recent developments in Archer. However, the Board of Seadrill sees fundamental strength in the Archer business model, and expects that recent changes in management will increase the Company's operational focus and make it possible for the stock to recover all or a significant part of the decrease in share price experienced in the second part of 2011."

Disclosure: I am long SDRL, STO.

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Tagged: , Oil & Gas Drilling & Exploration
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