Ocean Rig (
) Trades 50% Below Book Value
By Dan Shainberg (email@example.com)
OceanRig is an international deep and ultra-deep-water (UDW)
independent driller and a subsidiary of DryShips (
). ORIG's strong operating performance is being overshadowed by the
overhang of poor performance at its largest shareholder and parent
company. Due to the trough in the highly cyclical shipping
industry, the parent company cannot easily attain traditional
funding. Overall financial performance of the company is extremely
poor and voyage revenues have come down by about 40% over the past
year. It is a "forced-seller" on a stock with limited float but
excellent high-quality assets, contracted/visible growth and clear
ORIG's backlog stands at $5.1bn over three years with a healthy
balance sheet and significant contracted free cash flow and growth
visibility. ORIG's stock is simply "technically" pressured, down
over 20% from $17.55/sh on 2/11/13 to $14.05/sh currently, as DRYS
announced its third non-dilutive offering of ORIG stock to generate
Due to this forced selling of ORIG stock amidst an illiquid
public float, ORIG is currently valued at an incredible opportunity
for investors: ~50% below its $22/sh book/appraisal/replacement
value and at a sizable 185% below its forward fair Cash Flow based
valuation of $40/sh. Besides the technical selling, the company is
in transition, recently increasing term debt by $1.35bn to fund the
final payments for its three new rigs under contracts set to begin
throughout 2013. While the leverage should rise, the considerable
Free Cash Flow ((
)) through 2013 and 2014 should pay off this new debt, leaving the
company with a similar level of net debt but materially higher
EBITDA and FCF. EBITDA and FCF are set to explode from $294mm and
$90mm in 2012 to $900mm and $630mm in 2014. Leverage should drop as
well from 8x LTM to a very reasonable 3x LTM (and 2.5x fwd) in
ORIG owns and operates six drilling units including two drilling
rigs, the Leiv Eiriksson and Eirik Raude, and 4 drill-ships, the
Corcovado, Olympia, Poseidon and Mykonos. All six units are
constructed for the UDW and harsh environments. In addition, they
have 3 UDW drillships under construction, capable to work in 12k
feet water depth and scheduled to begin operating under new
contracts in 2013.
WHY IS ORIG ON SALE?
1) The technical ownership structure of ORIG's stock is creating
a significant overhang. DRYS still owns 57% of ORIG's stock even
after this latest March offering of 7.5mm shares. ORIG shares fell
hard, over 20%, after DRYS announced it is increasing its sale
(2/2013) from 5mm to 7.5mm shares.
Further, DRYS pledged some of ORIG's shares to cover for any
covenant breaches and had cross-default and cross-acceleration
clauses in ORIG's credit agreements creating a linkage with its
parent. In April 2012, ORIG amended its agreements to eliminate all
cross-default and cross-acceleration clauses with its parent,
although the pledged shares may still warrant the overhang as some
investors may be concerned about a short-term forced selling
The recent non-dilutive DRYS offering was upsized by 50% from
5mm shares to 7.5mm shares, further pressuring the limited float.
As an illiquid, majority-controlled stub, ORIG has very limited
analyst coverage and few investors aware of the story.
2) Q4'12 earnings were slightly disappointing. There were an
unexpected 130 total days of downtime for the Eirik Raude and Leiv
Eiriksson and 10 days of downtime for the Ocean Rig Mykonos in
Brazil. Further, it experienced a $44mm expense related to the
class survey for Eirik Raude.
The stock price is currently $14.05/sh. A fair value estimate is
$20-$22/sh simply based off of their NAV, representing 40-50%
upside to current asset value.
Assuming they remain a traditional corporation and institute a
reasonable dividend this year (per guidance), it should trade in
line with Pacific Drilling (
), its closest peer in terms of rig depth, age, and asset quality.
PACD does not have a dividend, so using its 7.5x fwd EBITDA
multiple is certainly conservative. At 7.5x fwd EBITDA of $950mm in
2014, ORIG should have an Enterprise Value over $7bn and a Market
Capitalization of ~$4.3bn, or $33.00/sh stock price representing
nearly a 2.5x return.
Should it successfully convert to an MLP and/or institute a
strong recurring dividend per its guidance, it should trade in line
with Seadrill (
), it's only publicly traded MLP comp with a 9% dividend yield.
Given projected Free Cash Flow from operations of $650-$700mm by
2014 (net of maintenance capex), ORIG should certainly be able to
commit to a comparable dividend payout. SDRL trades at 8.5x Fwd
EBITDA. Using this multiple, ORIG should have an Enterprise Value
over $8bn and a Market Capitalization of ~$5bn, or $40.00/sh stock
price representing nearly a 3x return.
To illustrate the dislocation in ORIG's valuation, ORIG is
currently trading at a pro forma EV / 2014 EBITDA of 4.9x and EV /
2015 EBITDA of 4.1x vs. peers PACD and SDRL @ 7.5x and 8.5x fwd
Large-cap peers such as Transocean (RIG), Ensco (ESV), Noble
(NE) have much older rigs with higher maintenance capex, weaker
technology and thus softer market dayrates. Those companies trade @
10-15% fwd FCF Yields. PACD and SDRL trade @ 19% and 14%,
respectively. Yet ORIG trades at a significant discount with a 35%
and 42% pro forma 2014 and 2015 FCF Yield, respectively. Further,
these FCF Yields should rise assuming it successfully converts to
the MLP structure which can lower its cash taxes.
ORIG is trading at a Price / NAV of only 66% vs. large-cap peers
that generally trade @ 100-130% of book value. "Vantage (VTG) is
the only other comp trading at a discount to NAV" (Clarkson
ORIG's implied value / rig = "$600mm, yet replicating the assets
today would cost ~$850mm/ rig" (
per CEO Q4'12
). The construction cost & appraised value / rig = $730mm (per
company) for a book value / share of > $22/sh, so the current
discount to book value > 40%. "Current assets would cost $8.8bn
to generate the fleet today given the market newbuild cost for the
current fleet is $850mm / rig" (Q4'12 call and 2/16/13 investor
presentation). The Total Appraised Value of their 10 Rigs is
~$7.3bn (p. 26 of investor presentation).
Its pro forma 2014 P/E = 5.0x and 4.0x 2015. Large-cap peers
trade @ 8.5x fwd P/E; SDRL @ 9.7x.
1) Strong Growth Visibility:
ORIG increased its backlog from $1.6bn in 2011 to $5.1bn in
2012. Its ramp-up of FCF in 2013 and 2014 is under contracts that
are already signed with very high creditworthy customers such as
Total (TOT), Exxon (XOM) Chevron (CVX), Eni (E), Conoco (COP), etc.
It is fully contracted for 2013 with 90% contracted for 2014 and
65% in 2015. It recently established three long-term contracts for
the new rigs: Leiv Eriksson, Olympia, Athena & Mylos.
2) Significant FCF:
EBITDA is set to rise from the three newbuilds entering
contracts in 2013. Given they occur throughout H2'13, their
contributions to 2013 EBITDA growth are not indicative of a full
year of operations. The fleet is set to generate $900-$950mm EBITDA
in 2014 vs. LTM EBITDA < $300mm. Even assuming some FCF leakage
for refinancing its notes under the early call provisions, ORIG
should be able to generate a minimum of $600mm of Free Cash Flow
after all maintenance capex requirements in 2014. Including their
new contract for the Apollo, they should hit $750-$800mm in
3) DRYS Overhang and Forced Selling:
OceanRig is a publicly traded subsidiary of DryShips. DRYS is in
a depressed industry cycle, experiencing difficulty attracting
traditional funding. The financial performance of DRYS is extremely
poor with voyage revenues (-40%) year-over-year. The IPO of ORIG
(12/2010) helped DRYS' liquidity profile, yet ORIG's strong growth
has been overshadowed by the poor performance of its parent.
DRYS sold 7.5mm shares in 2/2012, reducing their ownership from
65% to 59% because it needed to raise more cash to repay its
newbuild commitments and debt maturities. "Selling our ORIG shares
was not a preferred action especially at today's pricing level. We
continue to be bullish about the prospects for ORIG. Based on
current charter rates, we estimate we will need to raise a few
hundred million through '14." ORIG is "comfortable that there won't
be any more DRYS selling in 2013." (CEO ORIG Q4'12 call)
Dryships already reduced its exposure to ORIG from a 73%
ownership position to 59% in 2012 and 57% as of 3/2013. While it
still has majority control, as it sell its stake, the public float
should rise from only 35% currently and allow for inclusion into
indexes and ETF holdings. An eventual DRYS exit would increase
analyst coverage, new investor interest, and remove the ownership
overhang. Larger mutual funds and hedge funds should be able to
allocate capital to this position once the float rises.
4) Distribution / Dividend:
ORIG is not just a stock trading well below its asset value and
fair multiple of free cash flow, but it also has a significant
distribution catalyst. It should be able to institute a recurring
dividend and/or convert its corporate structure to an MLP this
year. Its strong contracts create visibility and reduce earnings
risk, allowing for a distribution policy. This would likely attract
a new set of investors.
According to the CEO: "Cash distributions are a high priority;
it could be paid in a recurring dividend or as a distribution
through an MLP conversion. The dividend will be paid as soon as
possible; it is likely a late 2013 event. The only reason for a
dividend delay would be an operational surprise. The dividend is a
very high priority for management."
5) Refinancing & Deleveraging:
The financing risk for the three new-builds is now behind it
after it closed on a new $1.35bn Jan 2013 bank loan offering.
The "opportunity remains to refi our 9.5% notes callable 2014.
Our first goal is to reduce debt and then we can pay a dividend. We
expect leverage < 4x LTM by the end of 2014. We have no debt
maturities prior to 2016. Our low net debt per rig which should
drop to $350mm by 2016 would allow for very attractive
ORIG has 9.5% Notes due 4/2016 that are callable 4/27/14 @
104.5. Assuming a very reasonable rate, it could easily save at
least $10mm in annual interest expense. It also has 6.5% Notes due
10/2017 that are callable 10/1/15 @ 103.25. While a bit further
out, it could save another $5mm in interest expense annually with
this refinancing. Should it convert to an MLP structure, the
interest savings would mostly flow through to a similar level of
increased Free Cash Flow given the minor offset of higher taxes
given the tax benefits of the MLP structure.
6) MLP Corporate Conversion:
"We have thought about converting the corporate structure to
unlock the discount in our valuation. But our Deutsche Bank credit
facility needs to be amended first; we are working on this. We will
get our refi completed in 2013; the goal is for an MLP structure in
2013." (Q4'12 conference call)
"Each rig generates ~$100mm in EBITDA so an MLP vehicle would
add 1-2x or $1.50/sh per rig." (Credit Suisse research analyst
An MLP structure could also improve its tax rates.
1) Healthy Balance Sheet:
While it appears that ORIG is highly levered, its latest
financial statements really should be adjusted materially for the
new events. It refi'd its Eriksson / Erik-Raude credit facility
into a new $1.35bn facility which covers 2013 new-builds and
eliminated all Dryships credit risk "by removing all cross-default
and cross-acceleration clauses on 4/2012". According to the
DRYS Q4 2012 conference call
, "We do not have any access whatsoever to ORIG's financial
resources" (CEO of DRYS, 3/7/13).
2) Strong Insider Ownership:
CEO owns > 5mm ORIG shares worth ~$74mm, aligning interest
with public shareholders.
3) Asset Quality:
ORIG has one of the most premium fleets in the publicly traded
space along with Vantage and Pacific Drilling. It has 100% exposure
to deep and UDW as well as one of the youngest fleets with an
average age of 2.7 years. This materially improves contracted
dayrates and reduces maintenance capex requirements. While the deep
and UDW outlook remains bright, there is clearly a dislocation
between new, young and technologically advanced rigs and older
4) Recent Contract Wins:
The Erik Laude rig secured a new contract with Exxon for a
$120mm backlog starting at the end of March 2013.
The Leive Erikson is in dry-dock working on upgrades, but set to
start drilling operations under a new three-year contract beginning
ORIG received a new contract offshore West Africa with Lukoil
(LUKOF.PK) adding $217mm to its backlog and a new three-year
contract with a "major oil company" @ $633k dayrate for the Apollo
rig starting in Jan 2015.
Its three newbuilds Mylos, Skyros and Athena have new contracts
for July, October and November of 2013, respectively.
Petrobras (PBR) has asked contractors for pricing of extensions
for rigs set to complete current charters in 2015, including the
Corcovado and the Mykonos.
(Paraphrased per ORIG's CEO on their Q4'12 conference call): The
UDW market should support sustainably high dayrates through 2016.
Offshore drilling activity set to increase 61% by 2015 to $200bn
spend globally, and spending is set to double from $50bn in 2011 to
$90bn by 2015. There were 52 UDW discoveries in 2012 in 14
countries vs. 37 discoveries in 2011. These discoveries should lead
into substantial UDW drilling demand for many years. Deep and UDW
drilling will remain attractive as long as the oil price outlook
remains above the UDW cost of drilling, between $30/bbl and
$70/bbl. Further, oil companies prefer long-term offshore oil
contracts vs. onshore which are more short-term.
The offshore drilling fleet is currently very old, over 30 years
average age, and they are technologically stale. The market should
keep supply capacity with very limited shipyard building spots
available. The past year proves that the market can easily absorb
25 new UDW assets / year. The three-year Erik Laude contract signed
to start in Jan 2015 is an indication of how tight the market
2012 was best year on record for UDW oil exploration with 36
discoveries >4k ft, 18 >7k, 9 > 8k. (Noble Corp)
Leiv Eriksson: Drills in Falklands which is in a remote,
higher-cost region with harsh weather.
Operational: Downtime, rig maintenance, labor, acceptance
testing delays, mobilization delays.
Industry Cycle: Guiding to no issues over next two-three years,
given limited newbuild capacity and high demand.
Regulatory: GoM type permitting slowdowns, etc and new
regulations that may increase operating costs.
Dryships Selling: "Comfortable that there won't be any more DRYS
selling in 2013" (Q4'12 call). There could be more selling from
DRYS or if bankers take their pledged ORIG shares and
I am long [[ORIG]]. I wrote this article myself, and it expresses
my own opinions. I am not receiving compensation for it. I have no
business relationship with any company whose stock is mentioned in
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