In 2005, John Fredriksen founded Seadrill Ltd. (NYSE:SDRL) with $200 million in equity and five deepwater rigs. Seven years later, the company boasts 48 rigs, and its shares trading in Oslo have increased six-fold to around 230 kroner a share - $40.25 - as of September 2012, giving Seadrill a $18.7 billion market capitalization, the highest in the business.
Fredriksen, Seadrill's chairman, wants the company to win the race for new sources of oil thousands of feet below the seafloor in such places as the Gulf of Mexico. Fredriksen doesn't consider offshore business 'fun' like the tanker business, but he's certainly very good at it. Fredriksen pockets $1 million a day in dividends from his 24.6% stake in SDRL.
In 1960, Fredriksen left school and took a job at a local shipping brokerage as a courier. After leaving Norway, he spent the 1960's working as a broker. After long-term charter rates for tankers fell to historic lows from 1973 to 1977, Fredriksen bought the contracts and earned $40 million in 1978 when rates rebounded.
Fredriksen settled in London and Cyprus. He eventually became a citizen of Cyprus, a country that doesn't tax dividend-based income, which helps to explain why Fredriksen's companies pay such generous dividends to shareholders. To diversify his investments beyond the tanker business, he started Seadrill in 2005. The reasoning behind Seadrill was simple. The average age of a deepwater rig at that time was 20 years, and yet there was only one new vessel on order. This was because other major contract drillers like Transocean (NYSE:RIG), Ensco (NYSE:ESV), Noble (NYSE:NE) and Diamond Offshore (NYSE:DO) preferred the cheaper route of refurbishing them.
After discussions with several oil firms, Fredriksen found there was sufficient interest for leasing new rigs, so after taking over five older rigs, he ordered six new ones for $2.7 billion without having long-term contracts in place ahead of time. The gamble paid off as day rates for Seadrill's rigs doubled to more than $600,000 between 2005 and 2009.
Fredriksen and Seadrill's success will mostly depend on Seadrill's current $7 billion gamble paying off. Although the company has leased its rigs - BP (NYSE:BP) recently agreed to pay $4 billion for three rigs for 19 years - Seadrill's total debt is more than double the revenue it expects to collect in its current fiscal year. The danger is always there that Seadrill and its rivals, which continue to order new builds as well, will end up overbuilding. That could potentially drive down day rates and start to squeeze profitability.
But for the moment, Seadrill continues its aggressive new build strategy with confidence. The $7 billion gamble includes five new UDW (Ultra Deepwater) unit announcements in 2012 alone. The company announced on April 30 that it's building a sixth $600 million UDW drillship with delivery expected from Samsung in mid-2014.
The company currently has five similar drillships under construction with delivery dates spanning from 2013 to 2014. Like its five predecessors, the new drillship sports a 2.5-million-pound hookload and is capable of working in water depths up to 12,000 ft. Seadrill is targeting deepwater operations in the Gulf of Mexico, Brazil, and the west and east coasts of Africa.
Separately, the company will build a second, harsh-environment semisubmersible UDW unit capable of drilling in waters up to 10,000 ft deep. Delivery on the $650 million unit will occur by year-end 2014. The vessel will be constructed at Hyundai Samho Shipyard, is fully winterized, and is targeted for the North Atlantic. The two semisubmersible units bring the number of newbuilds in Seadrill's ongoing construction program to 18.
Besides the six UDW drillships and the two harsh-environment semisubmersibles, the company is building five tender rigs and five jackups with expected delivery through 2015.
Seadrill is also planning to revive plans to list its Brazil-based Seabras unit next summer, as it seeks further funds to expand its fleet. But before the Seabras IPO takes place, the company intends to complete the listings of its three-quarters-owned offshore harsh environment drilling company North Atlantic Drilling (OTCPK:NATDF) by the end of 2012 or beginning of 2013 and its MLP subsidiary in the fourth quarter. The MLP is expected to have an interest in two semi-submersible drilling rigs, one drillship, and one semi-tender rig from Seadrill's fleet
When the Seabras's IPO finally takes place during the summer of 2013, the IPO is expected to raise up to $850 million (1.7 billion reals) by selling as many as 65.2 million common shares at a price of 20 - 26 reals each. The IPO has already been postponed twice from the original February 13 date after the company blamed weak equity markets for its delay. As Seadrill waits to offload these assets to raise capital for more new builds it intends to issue $1.0 billion in unsecured notes due 2017 in a private offering.
For the moment, it seems the funding situation is sustainable, and the company expects this will remain unchanged in the coming years: It's expected that the top contract drillers will see market growth of more than 50% over the next few years, and the market is indeed better now than when Seadrill and the other drillers started investing in this cycle.
Seadrill's modern fleet is in high demand after the BP oil spill, and the overall market is booming as oil firms, encouraged by rising oil prices, have increased exploration and have been forced to compete for available drilling capacity, leading to increasing high day rates.
Day rates for ultra deepwater rigs, which operate in waters at depths of more than 5,000 feet, have risen above $600,000 in this super cycle. When SDRL first made its investments for its first three UDW drillships, the market was significantly smaller than it is today, and the expectations of the market were lower than today.
So, it seems Seadrill's growth model will continue to work after all, even if we start seeing lower rates than we see today, but getting long-term contracts to ride out major downturns will remain important in order to ensure Seadrill's continued profitability. That profitability and growth will mean that Fredriksen and other Seadrill shareholders will continue to pocket their fat dividends going forward.
Disclosure: I am long SDRL, NE, ESV. 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.