Seadrill (NYSE:SDRL) this morning announced a rather small debt-for- equity exchange with certain holders of its outstanding 2017 senior unsecured notes. This $1 bln bond is actually the company's closest (and largest) public debt maturity and in fact represents more than 40% of Seadrill's overall bond indebtedness when including roughly $575 mln in bonds issued by the company's ill-fated subsidiary North Atlantic Drilling (NYSE:NADL) that are guaranteed by the parent.
The transaction has already been discussed controversely here on Seeking Alpha with some confusion about the numbers involved and how to assess the deal correctly. Hopefully I will be able to add at least some perspective here.
In sum, Seadrill agreed to exchange $55 mln in bonds into 8,184,340 newly issued shares of common stock calculating to a nominal exchange value of $6.72 per share, roughly 80% above the price the shares were changing hands prior to the announcement.
From a balance sheet perspective, the transaction will increase the company's equity while eliminating $55 mln in long-term debt.
The price will be a very moderate 1.7% dilution to existing shareholders but on the other hand the exchange will only address roughly 0.5% of the company's outstanding long term debt as of the end of FY2015.
Depending on the accounting method advised by the company's auditors, Seadrill might have to record a gain based on the difference between the nominal value of the bonds and the market value of the shares issued at settlement date. Despite Seadrill Ltd. being incorporated in Bermuda, the exchanged notes are actually governed by US law, so there might be some tax implications involved here.
Moreover the company would at least theoretically save a considerable amount of interest payments calculating to roughly $4.4 mln until the bond matures in September 2017. But investors need to remember the upcoming comprehensive debt restructuring which will most likely address the notes anyway, so we can't assign a definitive number of interest savings here.
There has been plenty of speculation about those "certain noteholders" now opting for the exchange with some investors even pointing to the company's largest shareholder, Norwegian-born shipping tycoon John Fredriksen.
Given the rather small size of the transaction, I don't think that Fredriksen or some of the entities controlled by him were involved here. Moreover Seadrill would have been obliged to disclose a material information like this.
That said, I would still expect John Fredriksen to come out and make a discounted public exchange offer for the vast majority or even all of Seadrill's outstanding bonds, once an agreement on all other aspects of the company's upcoming comprehensive debt restructuring has been reached with the respective creditors and subsequently exchange these bonds into equity, vastly increasing his personal holdings in Seadrill.
So with Fredriksen most likely being out of the picture for now, we are basically down to two remaining scenarios:
- Long-term bondholders afraid of the potential terms of the company's upcoming debt restructuring approached the company to avoid selling a substantial amount of notes into the illiquid bond market.
- Investors specialized in distressed debt investing accumulated the bonds in recent months at rather low prices. Investors should note, that prices for the 2017 notes have increased by more than 50% from recent lows set earlier in the year.
Both scenarios are perfectly feasible but personally I would tend to the second setting as the rather offensive strategy of approaching the company on a potential debt-for-equity exchange fits pretty much into the type of action you would expect from the usual hedge fund suspects.
In this case, the transaction would actually represent a win-win scenario, with Seadrill being effectively able to retire debt at a large discount to face value while the noteholders would be put in the position to pocket a potentially massive short-term gain.
Admittedly this is all pure speculation at this point.
But if this transaction could potentially serve as a blueprint for exchanging considerably more or even all of Seadrill's outstanding notes (including the NADL bonds) into new equity, I would actually applaud the company for limiting necessary dilution quite nicely. With roughly $2.4 bln in unsecured bonds outstanding as of the end of FY2015, Seadrill would have to issue slightly more than 350 mln new shares when applying the $6.72 nominal exchange price per share of today's transaction calculating to a roughly 40% dilution for existing shareholders. Admittedly, this still looks like an ugly number but would in fact be far below my previous expectations and moreover might already be priced into the shares at least to some extent.
The potential dilution might be even less given that the company's bonds with longer term maturity dates are actually changing hands at prices substantially below the levels of the 2017 notes.
Unfortunately I don't expect things to be this easy as other bondholders might very well demand a better deal in face of material losses suffered on their initial investment. Clearly it will be an extraordinary effort to come to terms with a majority of the noteholders, given that seven different bonds issued in three currencies will have to be addressed. But as stated above I would actually expect John Fredriksen to step up to the plate with a discounted cash offer at a premium to current price levels quite similar to the rescue of his drybulk venture, Golden Ocean (NASDAQ:GOGL), in 2009.
Fredriksen's incentive would actually be to subsequently negotiate a preferably low exchange price in order to maximize his personal holdings in the company and potential gains from the transaction.
But even the difficult task of addressing the company's bonds might prove rather simple compared to the ongoing negotiations with the company's 46 banks in order to re-negotiate the terms of 16 different credit facilities amounting to a combined $7.4 bln in debt as of the end of FY2015.
Moreover it is widely expected that the banks in return for ongoing support will demand Fredriksen to inject fresh cash into the company in the amount of up to $1 bln. In this case, Fredriksen again would be inclined to set the purchase price for the new shares as low as possible, in order to maximize his potential gain.
Clearly things won't be easy for Seadrill going forward, as evidenced by the recently extended timeline for the company's ongoing restructuring negotiations.
So obviously it will take more than one swallow to make a summer for Seadrill, but when purely focusing on today's small transaction, there's actually very little to complain about.
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