Investing

Seahawk announced earlier this month that they had engaged Simmons & Company International to explore strategic alternatives. “These alternatives could include, but are not limited to, transactions involving a sale of assets, a recapitalization, or a sale or merger of Seahawk.” While there could be many options I want to lay out a proposed capital raising that would raise $54m, be fair to current holders that did not participate and provide current holders with the exclusive right to participate.

The scheme would allocate 5 options and 1 ordinary share for $10.19 to each subscription right. Current holders would be offered this on the basis of .45 subscription rights for each current share. The subscription rights would be tradeable as would the options once issued. The scheme would allow oversubscriptions from current holders in proportion to their subscription rights. If the maximum amount of $54m was not raised then the offer could be extended to non-current holders.

The options would have a strike price of current $20 which would be $17.21 after the capital raising and a 5 year expiry. The share price should not fluctuate immediately after the capital raising because the shares would have been issued at the current price. The new market cap would be 175M (current market cap plus new cash) and there would be 17.2M shares outstanding up from 11.9 today.

The returns from participation are shown below. Note that the “no participation” case does not reflect your ability to sell the rights which will increase your returns (potentially up to $4.50 per right). The participation case does not include the time value of the options which should also increase the participation returns (at-the-money with 3 years remaining would have a time value of $1.40 per option).

$54M would provide about 7 quarters of liquidity at $7M burn per quarter or 5 quarters as $10m. It is quite unlikely that the Q3 experience is going to continue for the next 5 quarters.

Though it’s not very important now, the cash raised from exercising options could be restricted for: repurchasing stock at a discount to book value, repurchasing options at a discount to intrinsic value or a return of capital to shareholders.

Let’s work through the current $20 and current $25 cases.

$20

The market cap indicated by $20 pre-raising is 241M. We add the 54m raised to get 296m. No options would be exercised so there are 17.2M shares outstanding for a share price of $17.21. That would be a 69% upside from current prices after the raising instead of the 96% you would have had in the absence of a raising. Bear in mind that those participants in the capital raising would have at-the-money options which should have some substantial time value (depending on when this occurs).

$25

This case is more complicated because we assume that all options have been exercised (worst case) and the cash is held on the balance sheet. We start with a 356m market cap (current price * 2.5 + cash from raising) and add 459M from option exercise for a market cap of 815M. There are now 44M shares outstanding for a price per share of $18.59. That’s an 82% return for those who did not participate in the capital raising (and did not sell their rights). For those that participated they would make $8.40 from their original shares, $3.78 from their new shares and $3.10 from the options from a total investment of 10.19 (current price) plus 4.58 (.45 * 10.19) for a return of 129%.

So why would you want to participate at $10.19 for 1 ordinary unit and 5 options. Each option is worth around 90c (using an option pricing calculator that includes the impact of dilution) or $4.50 in total for a value of $14.50 per $10 subscription. If you sold the options after issue you would expect to have paid $5.50 for each ordinary share.

This model trades off upside (for those that don’t participate) for a much more certain, lower return; while providing an immediate return for the sold rights (potentially as much as $4.50 per right).

I don’t propose that this is the optimal model but it shows how a capital raising could be structured to be fair, provide substantial upside to those interested in an eventual return to normality and provide the liquidity that HAWK needs right now. Compared to a takeover which would truncate your upside, an underwritten share issue which would greatly dilute your upside or even a discounted rights issue which would reduce the returns to non-participants at all price points (old $20 would return only 30% instead of 69% under this model). It also provides a reasonable baseline to compare future proposals. I’m not suggesting the company should proceed with this model, simply that such a model exists and the challenge for HAWK should be to produce a superior one

posted by Neil  # 6:21 PM 0 comments

Management have continued to innovatively cut costs, sell spare parts and broadly behave in a shareholder friendly manner. There are lots of potential upside surprises and not too many ways things could get worse than Q3.

I’m surprised at how much money they’ve spent on the Seahawk 3000 but from a liquidity point of view it makes sense.

The Mexican tax issues continue with no clarity as to the eventual outcome, though HAWK continues to insist that they don’t expect a payout.

The Strategic review was triggered by a deterioration in management expectations since July. There is going to be a liquidity problem in the first half of 2011 and they want to explore alternatives now. They had previously “hoped” to be cash flow neutral by the end of 2010. I never shared management’s optimism though the review creates additional potential upside surprises (albeit with the potential to lock in a smaller, definite, upside such as a sale in the mid-teens)

Below are my notes from the call organized by topic.

Upcoming work

• Seahawk 3000 on contract by 1st week December 55-60k per day for 6 months.
• They think could have 8-9 rigs working by the end of the year.
• 6 rigs under contract, 3 idle, 11 cold stack not including the Seahawk 3000
• “Customers haven't been able to drill in 2010. Could you see a bonanza next year to catch up?”
  • That depends on permits. If he could see how many permits issue next year then would know drilling activity. If get back to normal you would think it wouldn't take long to get back to fully utilized rigs.
• US Nat Gas prices have been weak with increased drilling on land. Workovers and re-entry drilling should create increased shallow water demand if permits were issued in a timely fashion. As permitting process improves they expect demand to improve regardless of gas prices. Especially the plugging and abandonment of wells.
• PEMEX will issue tenders for 20 jackups starting in 2011 in addition to 4 short term. 10 for incremental rigs and will likely relax the 10 year age restrictions. Some of these will likely come from us GOM. PEMEX may not require matt supported rigs but Seahawk should still benefit from the supply / demand environment.
• “Randy are you seeing opportunities throughout the world for matt rigs outside GOM?”
  • Not a whole lot. There could be some opportunities but they'll be in the same place. East coast India needs a matt rig. For the most part by the time you factor the mobilization costs it's hard to be competitive.

Idle Iron

• 3500 wells and 650 platforms. Should lead to additional demand over next 3 years.
• Applies to wells out of service for 5 years. If there are platforms with no producing wells then the platforms have to be decommissioned along with the pipelines.
• From Oct 20th Operators had 120 days to submit plans to BOEM. 3 years to complete the work. P&A work over and above normal and platform decommissioning.
• “How can this be done with 44 rigs given around 4k wells and platforms?”
  • Typical P&A job is 1wk - 10 days.
  • Platform may or may not use a rig can use a lift boat.
• “Are any recent contracts for P&A?”
  • P&A is still in the future.
  • Probably 2Q next year at the earliest.
  • 2Q & 3Q most active due to weather.
  • The work will be planned out over the 3 years. Actual decommissioning only during 6 months but P&A all year.
• “Is the cost of P&A same as drilling a well?”
  • No, some P&A few hundred thousand to 1M. Per day cost is the same.
• “3500 wells need to be plugged, over 3 years. 1200 wells per year. 7-10 days to do the work. 1 rig could do 35 wells in a year. Is that correct?”
  • 10 days on outside. Figure on 7 days. Could probably do 52 per year.
  • Until they see the plans they won't know how many will require rigs and how many won't require rigs.
  • There are other ways, temporary plugs can be done with wireline units. Permanent plug require rigs. Once the plans are submitted they'll know the real demand for the rigs. Much clearer picture early next year.
• (HERO talked about the incremental demand for their liftboats from this work on their call)

Costs & liquidity

• Only 1 idle rig is fully crewed the others are not
• “What is the contingency on the 2505?”
  • Contingent on award of drilling contract. Not awarded until early Feb at the latest.
• “Are you looking to stack 1-2 more rigs?”
  • The idle rigs are not crewed so it's not so much of an issue.
• “Are you seeing some reasonable pricing gains?”
  • Some modest gains or at least holding their own.
  • On P&A potential, are operators starting to move? Right now operators are submitting plans. Won't get plans in until early next year. Then 3 years from then.
• In 3rd Q sold some surplus equipment for 900k and received gain on sale of 750k.
• 4Q rig utilization is unpredictable expect 3-7 rigs, operating costs excluding SG&A, Depreciation and Repair costs : 23-25M including $2M of shore based expense.
• “Prepaid expenses and accrued current liabilities, what are the major components?” -
  • Prepaids - some of the usual stuff, insurance etc. Any of this one time - no it's ordinary. Not unusual.
  • On the accrued expenses and liabilities- some of the repair work on Seahawk 3000, rest of that is ordinary stuff. How much of 46 is repair work, 7m.
• Impairment analysis, no reason for additional write-downs unless they sell more rigs for less than book.
• Repair of Seahawk 3000 $7m in Q4.
• Operating costs 22-26k per day of working rigs.
• Cold stack 2k-3.5k per day per rig as a result of cluster stacking scheme.
• 4Q SG&A $8m-$9m (similar) 2.4M non cash stock comp.
• HAWK balance sheet currently has 41.4M cash , net work 11.4M
• 14.5M payable to pride. Will not pay pride until resolve counter claims.
• Drew down $11.5M revolving credit for Seahawk 3000.
• Actual cash burn $18m.
• Forecast $25M cash burn for 4Q includes $15M paid out for Seahawk 3000. Cash burn assuming current run rates on the current contracts.

Permits and overall industry

• Across the GOM 31 contracted rigs of 44 marketed fleet. Only 27 working due to permit delays.
• 13 new well permits since April 20th. Not optimistic that they’ll get to 15 per month until mid to end next year.
• “What is the permitting process like now?”
  • Has improved somewhat.
  • Normally picks up in 4Q.
  • BOEM is trying to add 200 additional staff.
  • Process is now more time consuming than previous approach. Right now optimistic about the direction. By 1Q 2011 should be back to more normal activity.
• Shallow issuance improved in October and they hope to see that continue over coming months
• Most permits issued so far have been workovers and re-entry drilling that did not need to comply with NTL 06
• It seems that a tiered risk format may be implemented for shallow gas wells in the near future to be followed by a similar process for shallow oil wells at a later date. This change would increase permit issuance.
  • More detail on tiered risk approach. Generally the approach is to classify wells in tiers of risk, shallow, gas only, area , lower pressure, previously drilled, going to be a low risk well. As you go up, higher pressures, more productive zones, more liquids then higher risk.

Strategic Alternatives

• They recently issued a press release on strategic alternatives. They want to maximize shareholder value. They Continue to believe their strategy is sound and international opportunities are attractive. Everything is on the table not limited to sale assets, sale, merger, recap. Do not plan to disclose developments until board approves a transaction.
  • “Why not ride it out as this sounds like the bottom?”
    • Still a very uncertain environment. Can't guarantee that the permit process will improve quickly.
    • Also have certain liquidity needs that need to address early next year. Prudent to look at alternatives right now to better position the company for the future.
  • “Strategic alternatives. What happened that got management to look in to this versus in July/August when that wasn't the plan. What changed in thinking?”
    • In summer still more optimistic that the regulatory environment would not be as difficult. In early summer they thought it might get back to early 2010 levels and return to cash positive by end of year.
    • It doesn't look like that now. More of a near term issue from a cash point of view. Still optimistic long term domestically. Still like opportunities internationally.
  • “International strategy - update on those conversation?”
    • A number of rigs looking at acquiring are working rigs with contracts attached. Its more important for a qualified drilling contractor as a buyer as they have contracts.

Mexican Tax

• 46M unsecured credit from Pride used to replace surety bonds. HAWK is defending their tax position.
• Received an unfavourable ruling on USD $21M.
• HAWK believes court did not take in to consideration key expert testimony and have appealed.

posted by Neil  # 12:03 AM 0 comments