On 02/07/11, Ensco PLC (NYSE: ESV) announced a definitive merger agreement to acquire Pride International (NYSE: PDE) for $7.3bn in cash and stock. Consolidation in the offshore drilling & services sector has been expected after the Macondo well incident in the Gulf of Mexico as oil E&P companies will require a higher duty of care for their exploration activities to conform to new drilling regulatory requirements.
Under the terms of the merger agreement, PDE stockholders will receive 0.4778 newly-issued shares of ESV plus $15.60 in cash for each share of PDE common stock. The implied offer price represents a premium of 21% to PDE's closing share price as of the close on 02/04/11 and a premium of 25% to the one month volume weighted average closing price of PDE. Upon closing, and reflecting the issuance of new ESV shares, ESV and PDE shareholders will own an estimated 62% and 38%, respectively, of the combined company. The deal values PDE at ~17.4x 2010E EBITDA, which is a pretty rich multiple considering most precedent offshore drilling transactions have been 8-10x EBITDA.
The transaction will create the second largest offshore driller in the world with 74 rigs spanning all of the strategic, high-growth markets around the globe. The combined company will have 21 ultra-deep-water and deep-water rigs, forming the second largest/youngest fleet able to drill in water depths of 4,500 feet or greater. In addition, the combined company will have more active jackup rigs than any other driller. Mid-water rigs will represent 8% of the combined fleet.
ESV is acquiring PDE to gain a foothold in the rapidly growing Brazil and West Africa off-shore markets. ESV signed its first contract to lease a rig in Brazil last week and currently has no presence in West Africa. Under the terms of the proposed transaction, ESV’s Brazilian rig count will climb to 10, with five more in West Africa.
ESV expects the combined company to realize annual pre-tax expense synergies of at least $50 million for full year 2012 and beyond. The combination is projected by ESV management to be immediately accretive to ESV earnings and cash flow per share before synergies.
In May 2010, ESV lost a bidding contest for Scorpion Offshore Ltd, a Bermuda based offshore driller, to Seadrill Limited (NYSE: SDRL). ESV attempted to buy a 19% stake in Scorpion as a first step toward an eventual takeover of Scorpion, but was outbid by SDRL and missed out on Scorpions’ low-priced deep-water assets.
Although the definitive merger agreement was unanimously approved by PDE's Board of Directors, SDRL has yet to indicate its view on the proposed transaction. SDRL, based in Norway and currently the second largest offshore driller, owns ~9.4% of PDE as a result of its failed 2008 attempt to acquire all of PDE. While SDRL does not have any direct representation on the PDE Board, historically, it has been quite vocal on its perspective of the correct course of action for PDE, such as the spin-off of Seahawk Drilling (NASDAQ: HAWK), the company's mat-supported jack-up business located in the Gulf of Mexico. In December 2010, SDRL was reportedly again in talks to acquire the remainder of PDE, but an agreement on price could not be reached.
Because the merger agreement termination fee is only $260mm, or less than 3.6% of the implied transaction equity value, SDRL could purse the following strategies:
- Support the transaction and utilize cash portion of the merger consideration to help fund SDRL’s aggressive rig construction program. Based on SDRL’s cost-basis for its 9.4% in PDE, it stands to reap a ~$125mm profit, a ~23% IRR, if the ESV transaction closes successfully.
- Advocate against the proposed transaction and hold out for a higher price. In 2008, PDE traded above $47/share when SDRL has pursing it.
- Top ESV’s offer and once again attempt to acquire PDE. Because of SDRL’s CAPEX obligations for its ongoing rig construction program, it may be limited in the amount of cash it could include in an acquisition offer. However, many would argue SDRL stock is a more attractive acquisition currency relative to ESV because of SDRL’s current asset base and future growth trajectory.
Disclosure: Absaroka currently holds no position in ESV or PDE