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Tuesday, August 17, 2010
Seahawk (HAWK) Debt, Risk and Reward
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.
| Case | Period until HAWK goes bankrupt | Value if recovery occurs just before bankruptcy | Value if recovery at 8 Quarters | Value if recovery at 16 Quarters | Residual Value | Notes |
| Case 1 (no debt) | 23 Quarters | $200M (16.90) | $562M | $320M | $0 | Hawk keeps selling rigs until they have no rigs left to sell or liabilities exceed net assets |
| Case 2 (Medium Debt) | 13 Quarters | $706M (59.60) | $734M | $40M | $40M | HAWK is liquidated by lenders but the liquidation yields more cash than the lenders had security because HAWK did not take on the absolute maximum amount of debt. |
| Case 3 (Maximum Debt) | 18 Quarters | $671M | $734M | $680M | $0 | HAWK is liquidated by lenders and there is no residual because HAWK borrowed against the full, scrap, value of the rigs. |
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.
* His voice made it seem like management is definitely going to buy rigs internationally.
* Getting a new credit facility for more working capital
* Might sell some rigs that they think will not see service for a while
* Look for more gaps between service for the rigs since customers are afraid to commit before getting the permits
Seems like nothing said what very different from what we knew before. It basically comes down to the permitting process and when that will smooth out.
They have a few rigs that require substantial capex to restart so they would be good candidates. Hopefully they don't sell any of the better rigs as they'll be able to earn in one year what you'll get for scrap!
Taking on debt is a foregone conclusion. We just have to decide how that effects our thesis. My view is that the risk reward is similar. More risk and more reward versus no debt. I certainly don't think it's an awful idea plus management have enough skin in the game through restricted stock to help guide them away from awful decisions.
In my latest post I explain why I don't think this is really 1/3 of book and that I suspect this is indicative of the value of their average rig supporting a much higher share price.
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Analyses are prepared from sources and data believed to be reliable, but no representation is made as to their accuracy or completeness. I am not paid by covered companies. Strategies or ideas are presented for informational purposes and should not be used as a basis for any financial decisions.
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