Seadrill Ltd. - Bankruptcy? Don't Bank On It

| About: Seadrill Limited (SDRL)
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Summary

Seadrill desperately needs to restructure its balance sheet.

Seadrill's 4th quarter earnings were not that bad.

I think the odds are in favor of a successful refinancing.

Offshore drilling company Seadrill Ltd. (NYSE:SDRL) is not in an enviable situation. Bankruptcy risks have obviously grown in light of a crushing sector downturn and billions of dollars in debt that have to be serviced. However, I think there are reasons to be optimistic about Seadrill's ability to restructure its balance sheet, and the company's ultimate recovery.

Seadrill's shares have fallen ~85 percent in the last two years, reflecting the dire developments in the offshore drilling sector including the collapse of crude oil prices in 2014-2016 which fell to their lowest level in more than a decade last year. Plagued by a destabilization of energy prices and a large-scale reduction in investment spending in the energy sector, Seadrill and other offshore drilling companies are having a hard time navigating the downturn. Importantly, the company is under significant pressure to find a financing solution, and restructure its balance sheet. At the end of the December quarter, Seadrill had $8.5 billion of net interest bearing debt sitting on its balance sheet, which is a formidable sum, especially for a company that desperately hopes for a recovery in dayrates. Finding an immediate solution to Seadrill's leverage problem is the most pressing issue of the day, but I think the offshore drilling company will be able to hammer out a deal with its lenders.

The company has already made progress in reducing its debt burden compared to the 4th quarter of last year.

Source: Seadrill

If you look at Seadrill's 4th quarter earnings, you will come to the conclusion that despite the downturn in the offshore drilling market, the company actually reports good results. For instance, Seadrill's 4th quarter EBITDA hit $354 million while its operating income totaled $118 million. That's a lot less than a year ago when Seadrill reported EBITDA of $513 million (a decline of 31 percent Y/Y) and operating income of $223 million (a decline of 47 percent Y/Y), but the company is nonetheless pulling in a decent amount of earnings. In other words, while investors only see the company's big chunk of debt and are paralyzed by a rather weak outlook for the offshore drilling industry, Seadrill still runs a viable business with millions of dollars in profits.

The question now is: Will lenders get on board in order to facilitate a debt restructuring, and allow Seadrill to continue as a going concern? In my opinion, the answer is Yes. Seadrill faces extraordinary market challenges, Yes, but the company is still running a viable business that is throwing off profits. The offshore drilling industry is not going to go away any time soon, oil prices continue to recover, and, most importantly, Seadrill has shown that it can pull a profit even in a difficult market...Which is something rational lenders surely appreciate and will have to consider when making a decision about a financial lifeline.

Your Takeaway

Investors only see Seadrill's heavy debt burden, and are fixated on a poor short term outlook for the offshore drilling industry. However, Seadrill should not be counted out just yet. The company has time until April to hammer out an agreement with its lenders, and I think Seadrill will be able to come up with a solution to restructure its debt. Right now, an investment in Seadrill is of binary nature: Either the company hammers out a debt deal with its creditors (most likely scenario in my opinion), or the company throws in the towel (highly unlikely). As far as I am concerned, Seadrill is a speculative buy.

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Disclosure: I am/we are 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.