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Seadrill At $2b Market Cap

|Includes: DO, ESV, RIG, Seadrill Limited (New) (SDRL)

Seadrill's market cap has fallen from from over $19 billion to now $2 billion due to plunging oil prices and the collapse in offshore drilling activity. Is it a good buy? Well, clearly oil prices need to recover for offshore drilling to pick back up. WTI is at $43.5.

Cost of offshore drilling varies a lot across regions. In fact, drilling rigs that Seadrill provides are part of the COST of oil production. So there's a dichotomy here. If the cost of drilling comes down (as it has and will continue to), Seadrill will experience rate deflation so it might not make a great investment in that scenario. Oil prices need to go up and stay up for a while for oil companies to restart CAPEX to explore and drill for oil. This is a big bet on oil going and staying up.

What do you get for $2b market cap when you buy SDRL?

You get $14.9b of drilling units, $1.5b of newbuilds. Plus about $1.4b in cash. Of course, you also promise to pay back $11.1 billion of debt. The corporate structure makes it messy. $604MM of subsidiaries aren't owned by the parent. So you have to allow for that in the income statement somehow.

But taking the entire family of SDRL, you're paying some $12.5b in EV for $16.4b of drilling units (depreciation included). Ignoring cash, non-controlling interest and investments in associated companies, that's 76% of what the rigs are what management deems they are worth (including depreciation from cost).

Now the point isn't to value Seadrill explicitly, since the rigs are worth what someone is willing to pay for them. And they depreciate. So its a race against time and ultimately the value of the rigs may be significantly below the debt value, in which case the equity is worth zero.

That's the risk here. Depending on how long the downturn lasts, this might be a zero. It's a short, but of course a really risky one at that. As a long, I don't see its merits even as an option on higher oil prices. There are better ways to place that IMO.

UPDATE (5/4/16)

There's a whole industry suffering here. Transocean (55 rigs), Ensco (51), Paragon (38), Seadrill (32), Rowan (31), Diamond (30), Noble (29), Hercules (21), Atwood (10), Pacific Drilling (7).

Oil consumption is huge and these rigs will have utility at some points. Day rates are collapsing right now because there is a severe oversupply in the market. Ironically, the rig companies are reporting better quarterly results due to an influx of termination fees from cancelled contracts. It's unpredictable when day rates will bottom, but these things tend to be prolonged affairs, with several players going bankrupt due to overindebtedness. The strong players (in terms of leverage, rig specifications, contract lengths) tend to survive. If by some miracle the oil market recovers, the highest cost producers likely to perform the best.

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