Investing

It’s important to understand how the risk-reward profile of HAWK is modified as they take on debt. In their quarterly call they indicated a strong preference for adding debt and adding rigs.

I’ve considered three scenarios.

1. HAWK retains their current leverage and uses asset sales to pay for operations. These asset sales will be at scrap values, around $7M per rig.

2. HAWK takes on 110M of debt and 50M of new assets. These new assets are 3M cash flow positive each quarter after interest. All of HAWKs rigs, new and old are security for this debt. It replaces the existing credit line. This amount of debt is below the scrap value of existing rigs + new asset value.

3. Hawk takes on $150M of debt and 50M of new assets. Similarly,  these new assets are 3M cash flow positive each quarter after interest. All of HAWKs rigs, new and old are security for this debt. It replaces the existing credit line. This amount of debt is about the liquidation value of current rigs and new rigs, net of liabilities.

The “good case” is where HAWK continues their current cash burn, as modified in the scenarios above, until a point in time when rig market values return to December 2008 levels.

By taking on debt instead of scrapping rigs a large potential return is maintained at the expense of the time in which that return can occur.

The company values under each scenario are shown below assuming a return to December 2008 values in that period. The value added and subtracted by debt are shown along with the 40M residual value under case 2.

The degree to which debt will be a good or bad idea will depend on the covenants, the total debt load and the purpose for which they can use that debt. To the extent that HAWK can take on 150M of debt with few covenants (because their security is money good) and for general working capital, then I don’t mind the risk reward trade-off. To the extent that HAWK take on less than the maximum debt then there will be a residual value in the event of a bankruptcy. That residual value could easily be half of the current share price which will not be available if HAWK is allowed to liquidate their last rig (in reality their last few rigs because they have liabilities if not long term debt). With debt You sacrifice the last 1.5 years of potential turnaround for up to 3 times your upside.

posted by Neil  # 4:11 AM 4 comments

Hercules offshore has had similar, albeit much smaller, tax issues with Mexico. In March 2007 HERO received a tax assessment from the Mexican government for the 2004 tax year. The Mexican government then commenced an audit for 2005. This related to deductions and remittance of withholding tax for these deductions. HERO reserved 17M for the tax assessment and posted a bond for 13.2M. They settled for 10.8M. HAWK’s total assessment is for 93M plus $5M as a result of indemnifying PRIDE. Furthermore HAWK believes that the Mexican authorities could level a further 100M using the same methodology for other tax years. HAWK is being much more aggressive than HERO, especially as they have essentially no assets in Mexico. In this quarter HAWK have reduced their future exposure to the Mexican tax issue by 10M out of the 93M. It seems unlikely that HAWK will get any meaningful work in Mexico after likely walking away from their tax liability. However, demand in the Mexican GOM will divert vessels from the US GOM, tightening supply there.

There is a fantastic analysis of the tax issue at http://greenbackd.com/2010/08/10/guest-post-seahawk-drilling-inc-nasdaqhawk-and-the-hacienda . The possibility that paying the IRS ends up paying the Mexican authorities rather than HAWK is at least intriguing.

The tax issues relate to work for PEMEX. They are a major source of revenues for the Mexican government and the only way they are even going to sustain current, much lower, production is through substantial capital investment. There are currently about 50 rigs marketed and 70 or so including cold stacked in the US GOM. Demand was for about 90 from 2002-05. Maybe 70 since 2005 until the drop off in early 09. The commodity jackup demand has been almost constant at around 55 until early 09. As premium rigs abandon the GOM, never to return then demand will be met by commodity rigs or rates that are sufficiently high to lure the premium rigs back. If demand for commodity rigs stays at 55 with 10 of the 70 supplied off to PEMEX then HAWK will be running 18 rigs. If there is small additional demand from the lost premium rigs then HAWK easily gets to 100% utilization. That assumes HERO can bring their cold stacked rigs back online. Some of them apparently require a lot of Capex. 

I have heard concern that PEMEX will lay off their jackup rigs and look to upgrade. The truth is that there are only 2 matt supported jackups in Mexican GOM so worst case they are a few percent addition to the US GOM commodity fleet. To the extent that PEMEX can add matt supported jackups then they’ll be getting more bang for their E&P buck.

On a different note I had a discussion on seekingalpha regarding the suitability of HAWK’s rigs and whether or not they would be the last to get contracts because their rigs were less desirable.

Comparison of HAWK and HERO GOM Fleet:

• Across the portfolio HAWK’s rigs are newer (inclusive of upgrades)
• Across the portfolio HAWK’s rigs can work in deeper water
• HERO has 3 rigs that outclass any of HAWK’s. HAWK has no independent leg rigs. Aside from those three the rest the other 39 rigs are evenly matched
• Stack Ranking Depth, age and capability HAWK comes out substantially ahead as shown below. (This multiplies the rank of Type,Upgrade, Legs and Drill)

posted by Neil  # 10:10 AM 0 comments

Having listened to the Hercules Offshore (HERO) and Seahawk (HAWK) quarterly calls there is some interesting information on the current state of offshore and potential minor changes to the HAWK thesis both positive and negative. This should be ready in conjunction with my original analysis on HAWK .

Interesting

• Across US GOM there are 47-48 marketed jackups, 32-33 are contracted and of those 9 are waiting on permits. 19 have contracts that expire by the end of September. Operators will need to secure new permits before the jackups will be contracted.
• Before the freeze HAWK had 90% utilization of their marketed rigs.
• There are +/- 70 jackups uncontracted in international markets and 20 more on order. Though international E&P is expected to increase over the second half. Remember that this only impacts HAWK to the extent that rigs would be moved back in to the GOM because of the lack of demand elsewhere. There is no reason to think that will occur as the economics remain poor and the matt supported jackups all-in costs are cheaper (because the rigs themselves are old and not worth much compared to newer, more flexible rigs)
• HERO have sold another retired rig for scrap for 4.8M (the Hercules 155 a 150m rig).
• Rigs are costing about 8-10k per day while idle. Compared to 4-5k per day for cold stacked rigs. The primary cost for cold stacked rigs is insurance.
• There are two new permit requirements out of the Bureau of Ocean Energy Management relating to shallow GOM. Notice to leasees 05 (NTL 05) and NTL 06. Meeting NTL 05 has been relatively easy and is mostly the responsibility of the rig owners. It’s primarily around blowout preventers. Most of the HAWK rigs were already compliant. They are all compliant now, even the cold stacked ones would only need minor work if any. NTL 06 is much less clear and is the responsibility of the operator. There have been a few permits issued that met NTL 06 but they were for wells with few liquids. The BOEM is still trying to figure out what compliance with NTL 06 really means.
• Rates are much better than last year and day rates are not likely to come down from these levels. The issue is not supply and demand (economic) but permit driven. Neither HAWK nor HERO is likely to take a contract below current levels. There is not likely to be a double dip in rig rates. There is also a belief (though I'm not sure of the foundation) that natural gas prices will improve.
• Insurance rates for the next 12 months have been set and are (only) about 10% higher.
• There is no additional news on the Mexican tax issues
• Valuations for jackups have come down a little more since the first half of the year. This isn’t scrap value but orderly sales.
• To be cash flow neutral HAWK would need 9-10 rigs at 90% utilization.
• HAWK’s cash burn is about 10M per quarter but will be effected by, as yet unknown, repair costs on Seahawk 3000 which is about to go into dry dock for repairs.
• HAWK’s current revolver is drawn by 6.4M.
• There was no new news on the Mexican Tax dispute.

Changes the HAWK thesis positively

• PEMEX has requested a 54% increase in their 2011 budget. The PEMEX capital process is subject to the vagaries of the Mexican political system so there is a great chance that between the request and the allocation the amounts will change. This is similar to the story told for 2010 which did not amount to much. There are 26 Jackups in the Mexican GOM. 13 are scheduled to come off contract in 2011. 28 to 35 rigs in Mexican GOM has remained constant throughout the cycle. The headline number is an additional 21 rigs if the CAPEX is allocated as requested. HERO would not be surprised if there were 35-38 rigs operating (net addition on 8-10) there by this time next year. Though PEMEX may not request matt supported rigs, whatever they request is likely to leave US GOM, further reducing supply in US GOM.
• The combination of additional demand from PEMEX, scrapping of GOM rigs and rigs leaving the GOM is going to be very bullish, one day!
• HERO and HAWK will not sell their rigs to potential competitors in the GOM. It makes selling them for scrap or repurposing them as accommodation units, mobile production units etc. HAWK are exploring selling cold stacked rigs as mobile production units. That said if there is a cash squeeze anything is possible
• The pace of permits has improved in the last few weeks. If this momentum continues then the silver lining is the demand once the backlog of permits is cleared.

Changes the HAWK thesis negatively

• HAWK is looking to add one or more packages of 2-3 IC rigs from outside the GOM that will be immediately cash flow accretive. Ideally in West Africa, Middle East, Far East or India. HAWK is one of the only potential buyers for jackup rigs world wide at the moment. For example, any acquisitions for HERO would need to be 100% equity financed as they have no room to take on further debt.
• On their conference call HAWK was asked if they would sell rigs to buy back shares. After all why purchase someone else’s rigs when you can buy back your own greatly discounted rigs. The CEO said they want to diversify their sources of cash and that the float is already too small. I was very disappointed with this answer. Concerns about Randy Stilley (HAWK CEO) are magnified by this response. It is clear that he is not going to be a great capital allocator and is more interested in building HAWK into an empire than guaranteeing low risk returns to shareholders. The only way for them to add rigs is to take on additional debt which means they will look more like HERO where Randy originally came from (and oversaw a potentially equity killing expansion program). In his defence he has taken his compensation as stock for the rest of the year. This isn’t enough of a reason to get out of HAWK but it makes me more likely to get out in the low 20s. Also it is possible they will come up with a way to finance the additional rigs without taking the liability at the company level (i.e. a non-recourse loan) in which case, depending on how much equity they need to use, I’ll be proved wrong.

posted by Neil  # 2:47 AM 0 comments