When the market is in a panic mode, strange things happen. The recent proposal by Ensco Rowan (ESV) shareholder Luminus Management has good chances to win the title of "weirdest shareholder proposal of the year". In all likelihood, many investors and traders who are reading these words have already seen it: Luminus proposes to borrow $2.5 billion to pay a special dividend to shareholders (the proposal itself and the accompanying presentation can be found at this website).
The proposal - theory
Luminus Management is disappointed with the stock's recent performance and has the following idea (a full quote follows):
- Raise $2.5 billion of priority guaranteed debt and safeguard the company's ability to issue additional structurally senior debt.
- Safeguard future financial flexibility (on both a junior and senior priority guaranteed basis).
- Fund a $2.5 billion special dividend.
- Better incentivize management to continue to pursue this value creation plan and at the very least re-value employee equity and option grants.
Current Ensco Rowan market capitalization is roughly $1.5 billion. If we assume that it can raise $2.5 billion of debt and then distribute it as a special dividend, anyone who purchased the shares below $12.5 is bailed out plus will retain the shares as a free option on the company's survival with a capital structure that includes an additional $2.5 billion of debt. In practice, the stock will surely rise much higher under such a scenario due to short covering and the fact that Ensco Rowan's equity won't be immediately priced at zero after the company has paid the dividend.
The proposal - practice
Luminus Management believes that Ensco Rowan can raise up to $4.5 billion of debt:
Source: Luminus Management presentation
However, this is where theory meets practice: who in his right mind will lend Ensco Rowan $2.5 billion that will be paid as a dividend rather than invested into the company's future? The market is currently expressing material concerns about the whole industry's chances to survive with the current capital structure. I believe that these concerns are premature, and that the industry's fundamentals are improving, although at a slower-than-expected pace. However, market sentiment plays a major role in financing. Luminus Management itself believes that 9% is an appropriate interest rate for debt. Adding $225 million of annual interest payments at times of poor dayrates and cash flow challenges is a pure suicide. There is simply no way how this proposal can be accepted, as well as there's no way to raise several billion dollars from creditors just to pay a dividend.
Is it a PR stunt?
We live in the era of information overload, and publicity tactics increasingly involve saying or doing outrageous things. Could it be that Luminus Management simply views Ensco Rowan shares as undervalued and wants to attract attention of more investors? This looks like a plausible theory, but I think it's a bad move. At times of market panic, such proposal does not highlight value in Ensco Rowan shares - it highlights Luminus Management's panic over an underwater position.
What about the stock?
Ensco Rowan shares lost half of their value since early May without any change in the fundamental catalysts. I continue to believe that such a punishment is undeserved, at least at this point - as I've shown in my articles on offshore drilling fundamentals (here, here and here), the situation is improving rather than deteriorating. From a practical point of view, it makes sense to try a speculative position when the stock exits the tight downside channel - but proper risk management and position sizing is a must. Offshore drilling industry is highly speculative and provides material volatility, so anyone willing to enter into long-term positions should be aware of all risks and prepare for a rollercoaster ride for the next years.
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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in ESV over 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.
Additional disclosure: I may trade any of the above-mentioned stocks.