Ocean Rig - 2017 Financial Projections And Comments

| About: Ocean Rig (ORIG)

Summary

The financial results for 2016, before extraordinary charges, were largely as expected.

The company made a significant writedown on the value of its modern assets. This doesn't affect cash flows or debt covenants, but could boost undiluted 2017 EPS to $3/share.

For the year 2017, the net debt/EBITDA ratio will remain below 4.5, which is likely to be bank debt covenant compliant.

As expected, and as in past quarters, the company mentioned restructuring talk with Chapter 11 as the last option should all negotiations fail.

Chapter 11 isn't probable in the foreseeable future, but share dilution should be taken into account.

With the global oil supply/demand balance expected to show a significant deficit in the second half of 2017, oil prices should move up to a new level and the upstream offshore market should start to recover. Offshore drillers are late-cycle stocks. Past cycles indicate that the activity bottom is reached 18 months after the oil price bottom. Share prices usually bottom in between.

In 2014, the break even costs for offshore oil were said to be $10/b to $20/b lower than U.S. shale oil. Since then, the costs of U.S. shale oil have come down significantly, but according to a recent Rystad study, the oil costs of new offshore projects have at least matched that cost decline. Without a significant recovery of upstream offshore activity, global oil supply will not be able to match demand in a few years.

On the floater supply side, I think that scrapping will continue to exceed new arrivals. The year 2018 will be the financially most difficult year for offshore drillers, but upstream offshore activity will most likely show a clear uptrend, lifting the spirits and the stock prices.

In that context, in previous Seeking Alpha articles, I had recommended Ocean Rig (NASDAQ:ORIG) with its modern fleet as a long-term investment for patient investors. So far, the company's financial results have been in line or exceeded my projections, but that has become associated with recurring unpredictable management actions causing strong stock price volatility. For that reason, I think that the stock currently is more a trading vehicle than a long term investment.

The projected Ocean Rig financial numbers for 2017 are summarized in the table below.

1000 $

2017

Revenues ex deferrals

953975

Total Direct and Onshore Rig Costs ex deferrals

226108

G&A

75000

Maintenance

15000

Tax

62000

Depreciation

115000

Interest Costs

201405

Other costs

15000

Total Cost

694513

Cash Earnings from Operations

259462

Cash flow from Operations

374462

EBITDA

637867

Cash year-end

405323

Debt repayments cash

701000

Upgrades-Spares-surveys

40000

Net debt (total liabilities-current assets)

2769815

Net debt 2 (interest bearing debt-cash)

2716677

Net debt/EBITDA

4.259002

Shares out (tsd)

83000

Per share

Cash EPS ($) from operations

3.126048

The revenues include a $25M arbitration settlement and the Athena termination fee, supposed to be cash flow neutral.

The calculated net debt/EBITDA ratio is around 4.3 for 2017. Covenant compliance is often calculated on the basis of the past a 4 quarters, which implies that, even without renegotiating the covenants, the company could remain covenant compliant during the year. Covenant renegotiations have become the norm in the offshore drilling sector. SDRL and PACD are now allowed net debt/EBITDA ratios of 6.5. According to SEC filings, ATW got a bank covenant suspension until the middle of 2018 and SDRL asks in its restructuring proposal for a 3 year bank debt covenant holiday. Banks have shown a lot of flexibility in this regard. Contrary to SDRL and PACD, ORIG's issue is covenant compliance in 2018, not debt refinancing.

The volume of ORIG's recent writedowns of its modern floaters is extraordinary, not matched by competitors and certainly not required by accounting rules as there is currently no established market value for such floaters. The writedowns do not affect the company's fundamentals, but will result in higher earnings numbers in the future.

For 2017, my model currently assumes that ORIG repays the 2017 bonds with 100% cash. The previous scenario included a gain of $100M from assumed ongoing repurchases. A $170M debt repayment for the Apollo is also included. By the middle of 2018, Apollo will be debt free.

The resulting projected cash at the end of 2017 is $400M now. Cash flow from operations should be around $375M in 2017, all based on current contracts. Because of reduced depreciation charges, EPS (before any dilution) for 2017 is calculated with $3/share. The current quarter EPS should be around $1/share.

ORIG management has a more negative market outlook than its competitors. Cold stacking half the modern fleet is completely out of the norm. That preserves cash in the short term but either results in lost revenue opportunities when the market recovers or requires premature high reactivation costs. But the company will get two additional new class 7 ships after 2017 for which final payment is delayed by 5 years.

Management's actions are difficult to understand. Recurrently creating strong fear among investors and, as a consequence, decimating the stock price is not an intelligent strategy if equity for debt swaps are intended. Making radical write downs of the assets is not a plausible strategy if the assets are intended to secure debt. Paying 100% for bonds at maturity when they could have been bought at half price seems odd.

CEO George Economou has nothing to gain from Chapter 11. Share dilution is a much more likely scenario. I am quite sure that management intends to have a higher cash level at the end of 2017 than projected here. The company could have achieved that by continuing buying back the 2017 bonds. A further repurchase of bonds for 200M at a 50% discount would have boosted year end cash by $100M compared to the number in my table. With the amount of bonds under control, most likely exceeding the consensus threshold, the company could than have offered the remaining bondholders a cash + shares or cash + shares + semi-subs deal that could have boosted year-end cash to $600M.

A variant of that scenario could still be played out, if somebody associated with the company had acquired the mentioned bond volume. In that case, a shares for debt swap deal risks to be significantly more dilutive for existing shareholders. Such a shares-for-debt option seems to be facilitated by the bond covenants, which specify that the bonds are secured by the company's shares (not by the company), besides the 2 semi-subs. Anyway, it's very likely that ORIG intends to keep a high cash level by limiting the cash part of the 2017 bond repurchase.

A resulting net debt level of around $2.5B is close to DO's level. With DO owning 7 modern floaters and several revamped 40 year old semi-subs compared to ORIG's 9 + 2 modern ships + 2 harsh environment semi-subs.

Based on current contracts, the ships belonging to the 2 bank facilities will generate enough cash to pay for debt obligations until maturities in 2020 and 2021, but cash flow is unevenly shared. The banks behind the facility with negative cash flow will certainly require a better cushion. ORIG could try to satisfy that by forking over cash and assets not burdened with debt like the Paros and the Apollo (free by mid-2018). The results of the SDRL restructuring will be instructive in that regard.

Disclosure: I am/we are long ORIG.

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.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

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