Seadrill's Takeover Of Asia Offshore Drilling Is Very Good For Shareholders

| About: Seadrill Limited (SDRL)

In the summer of last year, Seadrill (NYSE:SDRL) acquired a stake in Asia Offshore Drilling, a company that had two jack-up drilling rigs under construction at the time. Seadrill spent $54 million to acquire its 33.75% stake in the company and Asia Offshore Drilling used this money to order a third jack-up rig. I discussed Seadrill's stake in Asia Offshore Drilling here.

Seadrill has now begun adding to its stake in Asia Offshore Drilling, with the intention of acquiring the entire company. At the time of writing, Seadrill has made five purchases of stock in Asia Offshore Drilling with undoubtedly more to come. Here are the purchases that have been made so far:

  • October 26, 2012: Seadrill acquires 12,190,858 shares in the company at a price of $5 per share. This increases Seadrill's ownership stake to 64.23%.
  • October 29, 2012: Seadrill acquires 611,449 shares in the company at a price of NOK 28.71 (about $5) per share. This increases Seadrill's ownership stake to 65.76% of Asia Offshore Drilling.
  • October 30, 2012: Seadrill acquires 38,961 shares of Asia Offshore Drilling for the same price, NOK 28.71 per share. This increases Seadrill's ownership stake to 65.85% of Asia Offshore Drilling.
  • October 31, 2012: Seadrill acquires 12,883 shares of Asia Offshore Drilling at a price of NOK 28.70 per share. This increases Seadrill's ownership stake to 65.89% of the company.
  • November 1, 2012: Seadrill acquires 18,500 shares of Asia Offshore Drilling at a price of NOK 28.71 per share. This purchase increases Seadrill's ownership stake to 65.93% of Asia Offshore Drilling.

As Seadrill discussed in its initial announcement (linked above), Seadrill has launched a mandatory cash offer for all of the remaining shares of the company. This would be a de facto takeover should Seadrill get all of the shares. But what would Seadrill get with this acquisition?

Asia Offshore Drilling has three jack-up rigs under construction at Keppel FELS in Singapore. This is the primary asset of the company and is clearly what Seadrill is interested in. These three rigs are expected to be delivered very soon, in the first, second, and third quarters of 2013, respectively. These are of the same MOD V-B design of high-specification jack-up that are commonly used by other drilling contractors and so will complement the company's existing fleet quite nicely. Each of these three rigs is capable of drilling wells up to 20,000 feet deep in up to 400 feet of water. This drilling depth is less than the 30,000 feet found on other rigs with the same design, including Ensco's (NYSE:ESV) ENSCO 107 and ENSCO 108 and Seadrill's doomed West Atlas. These will be the least capable jack-ups in Seadrill's fleet. Nevertheless, these rigs are more than capable of operating in their target markets of the Gulf of Mexico, Indian Ocean, the Southern North Sea, the Middle East, India, Australia, New Zealand, and Southeast Asia. The first of these rigs, AOR-1 has already been awarded a three-year contract with an unnamed operator. This contract is for $197 million plus a $39.5 million mobilization fee. This works out to an impressive dayrate of $180,000, which puts it at the very high end of Seadrill's benign environment jack-up fleet. If the other two rigs, AOR-2 and AOR-3, manage to achieve similar rates then Seadrill is essentially purchasing a ready-made, brand-new, high-earning jack-up fleet!

In fact, there is reason to believe that Asia Offshore Drilling's two remaining rigs may be able to achieve similar rates. In a recent article, I provided evidence that the jack-up market is strengthening. Seadrill has also made similar statements in its earnings reports. While there are a large number of newbuild jack-ups leaving shipyards over the next few years, industry executives believe that this will have the effect of pushing older, less-capable rigs into retirement. These rigs that Seadrill is obtaining through this acquisition would not be adversely affected if these executives are correct. Most signs do point to improving fundamentals in the market for modern high-specification jack-ups like these. This is having the effect of pushing up dayrates for this type of rig. I discuss these fundamentals in detail in the linked article.

Seadrill currently has 21 jack-up rigs, five of which are still under construction. The purchase of Asia Offshore Drilling would, then, increase this to 24 jack-up rigs, eight of which would be under construction. Seadrill thus has the potential to meaningfully expand its jack-up fleet with this purchase. What's more, the company will be doing it very cost-effectively. To date, Seadrill has spent approximately $118.36 million to acquire a 65.93% stake in Asia Offshore Drilling. Using this, we can calculate that Seadrill will pay approximately $179.5 million for the entire company or about $61.3 million for the remaining 34.15% of the company. That is less than the cost of a single jack-up rig! Asia Offshore Drilling also has no long-term debt so it appears that Seadrill is basically getting this company and its rigs for a steal. Asia Offshore Drilling had $5 million in cash and an additional $40 million in restricted cash as of its last quarterly earnings report which makes this deal look even better. While Seadrill would have to cover the remaining costs to complete the three rigs, that does not meaningfully change the fact that Seadrill is getting a very good deal here. This creates value for shareholders.

Disclosure: I am 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.