Post-Restructuring Seadrill Will Be Highly Levered

| About: Seadrill Limited (SDRL)


SDRL lenders will forbear contractual payments but will not cut debt balances.

Lenders will also take (virtually) all of SDRL's equity as a price of forbearance.

If optimistic contracting and dayrate targets are not met, lenders will restructure again in 202x.

Since Seadrill (NYSE:SDRL) released the status of restructuring negotiations between the Company and Bondholders. As the conflicting proposals demonstrate, the two sides are far apart. The implications for shareholders were discussed in " Seadrill Restructuring To Leave Shareholders With Penny Stock." In the article, "Seadrill Bankruptcy Primer," the reasons shareholders will receive (next to) nothing were discussed in the context on capital structure, and how equity holders rank behind unsecured debt, which ranks behind secured debt.

Despite the above articles, and those from other authors, many readers (and authors) are missing the point of the restructuring. There is a misconception that the purpose of the restructuring is to provide SDRL with a clean balance sheet, and a competitive business advantage, by having the company's secured lenders and bondholders write-off some of their loans. No, that is simply wrong. The purpose of a restructuring is driven by the borrower's inability to satisfy its obligations, and hence the collective lenders seek to create an environment with the greatest certainty that they will be repaid. An important concept to understand is when the ability of a firm to meet its obligations is in doubt, the company enters the "zone of insolvency." Once this occurs, management has a fiduciary obligation to work in the interests of the lenders (not the shareholders). So, as SDRL is indeed operating in the zone of insolvency, a restructuring will be structured to provide the greatest opportunity for lenders to recover the amounts owed to them (individually and collectively).

As lenders have the contractual right to foreclose if SDRL defaults, they, not management, can basically dictate what they require to "forbear" from exercising their rights and remedies in a default situation. The agreement between the lenders and the borrower is known as a forbearance agreement.

Both SDRL and Bondholders (and presumably senior lenders) agree that time provides an opportunity, though not an assurance, that obligations can be repaid. This calculus is based on maximizing lender value, not shareholder value. And not industry value. This is where many readers (and writers) are incorrect in their assertions that the proposed deals are "bad." Bad perhaps for future shareholders, but shareholders do not have a seat at the table. Appropriate for lenders.

Source: Seadrill

Perhaps contracting demand and dayrates will recover to a sufficient level that lenders will be paid in full under the SDRL, or another, repayment schedule. And if, by deferring payments, SDRL is able to generate enough value to satisfy lenders, great (for the lenders). If not, the lenders will, next decade, again force a restructuring of the Company. And, if demand and dayrates recover, it is the lenders who will benefit as they receive virtually all the Company's equity as the price for agreeing to forbear. And, if contracting demand and dayrates due to not recover to a sufficient level to satisfy obligations to lenders, a second restructuring will be required in 202X. And it will again be the lenders who will receive a new slug of equity, rendering the equity from the first restructuring near worthless (the lenders will, if possible, sold their equity to new shareholders, leaving these investors to, again, suffer losses).


The bottom line is any SDRL restructuring will be solely for the benefit of the lenders. The lenders are not incented to exchange debt for equity and will not do so. The lenders will agree to forbear and delay payments in exchange for retaining all rights and remedies and taking (virtually) all SDRL's equity. The lenders have no incentive to create a SDRL with a clean, low-leverage balance sheet (at their expense). If the market recovers, the lenders will get repaid, and the returns from new equity will more than compensate for payment delays. If the market does not sufficiently recover, there will be a second restructuring next decade. Lenders only care about lenders (and if you were a lender, you would feel the same way).

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.

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