After disclosing that bankruptcy was on the table, shares of the offshore driller have fallen to penny-stock territory. The question investors must answer is whether they're willing to lose everything on the chance that doesn't happen.
Discussions with the banks, potential new money investors, the advisors to the ad hoc committee of bondholders and Hemen Holdings Ltd. continue. Given timing, however, it will be challenging for the Company to finalize a fully consensual agreement before 30 April 2017 ... In the event a consensual restructuring agreement is not concluded or an agreement to an extension is not reached, we are also preparing various contingency plans, including potential schemes of arrangement or chapter 11 proceedings.
That's what Seadrill LTD (NYSE:SDRL) did on February 28, sending its stock price down by one-third within days, and putting it on the cusp of falling below $1 per share as recently as March 7. And the reality is, shareholders who have sold in the past 10 days have exited for good reason. There's significant risk of permanent capital losses for anyone who continues to hold Seadrill stock.
Owning Seadrill feels a lot like this today. Image source: Getty Images.
But that doesn't mean there's zero chance of this stock recovering. If Seadrill's management can work out a deal with debtholders to refinance some debt, pay off some with stock, and extend the maturities on the rest out a few years, today's stock price could be an absolute steal of a deal. Let's take a closer look at the situation, the upside, and the very real risks to holding Seadrill stock right now.
For more than a year, Seadrill's management has done an incredible job of managing an ugly balance sheet. The company has used a combination of getting creditors to extend debt maturities, paying off other debt, and negotiating with shipbuilders to delay delivery of newbuild vessels to avoid further capital spending.
While these efforts have improved the balance sheet and bought the company time, it could prove to have been too little, too late.
As you can see in the table above, current debt -- that is, debt due within 12 months -- is a staggering $3.2 billion. The company also has another $1.5 billion in other current liabilities. Combined, that's nearly $5 billion in cash outlays Seadrill is obligated to pay in the next year, while its order backlog is only $2.5 billion, most of which is contracted over the next 14 months.
That's a massive shortfall of projected cash inflows to deal with its short-term obligations. And it's compounded by an offshore drilling environment that has shown very little sign that producers are ready to start spending before the end of 2017.
Data source: Seadrill SEC filing.
The company has $1.3 billion in cash, but it must retain much of that cash to simply ride out the rest of 2017, with much of its vessel fleet off-contract, and zero appetite for new work from producers.
In other words, the company could default on its debt as soon as April, and it could be forced to file for bankruptcy protection if its noteholders don't agree to further extensions.
Seadrill management has touted the young age and high specifications of its vessel fleet as competitive advantages for years. And while this should prove to be true over the long term, it has little value today, with offshore oil and gas producers showing little interest in ramping up drilling activity. This is why Seadrill's massive debt has proven to be a bigger short-term risk than its high-quality fleet has proved to be a strength.
SDRL Price to Book Value data by YCharts.
In short, the market expects common shareholders will be completely wiped out. And while it is a distinct possibility, it's not a definite. It's also not a definite (though it would be far more likely) that, even if the company files for Chapter 11 restructuring, common shareholders would be wiped out.
And there are some real similarities between Ultra's and Seadrill's situation, too. Both companies own wonderful assets with very real long-term value -- Seadrill in its vessel fleet and Ultra in its wonderful natural gas holdings -- and both companies were caught with very significant debt maturities at the absolutely worst possible time in the market cycle.
Put it all together, and you have a company with industry-leading assets, facing the worst-case scenario with debt maturities at the bottom of its industry's cycle. If its debt holders come to recognize the opportunity this creates to keep the company intact and exchange that debt for an equity stake, shareholders at this price would likely do incredibly well.
Still, I wouldn't bet on it with a single dollar I wasn't ready to lose. At this point, it's too close to call what will happen.