Seadrill Chapter 11 details

Seadrill, a publicly traded company that does offshore oil drilling, filed a Chapter 11 arrangement. The salient terms of the pre-packaged deal are:

The chapter 11 plan of reorganization contemplated by the RSA provides the following distributions, assuming general unsecured creditors accept the plan:

• purchasers of the new secured notes will receive 57.5% of the new Seadrill equity, subject to dilution by the primary structuring fee and an employee incentive plan;
• purchasers of the new Seadrill equity will receive 25% of the new Seadrill equity, subject to dilution by the primary structuring fee and an employee incentive plan;
• general unsecured creditors of Seadrill, NADL, and Sevan, which includes Seadrill and NADL bondholders, will receive their pro rata share of 15% of the new Seadrill common stock, subject to dilution by the primary structuring fee and an employee incentive plan, plus certain eligible unsecured creditors will receive the right to participate pro rata in $85 million of the new secured notes and $25 million of the new equity, provided that general unsecured creditors vote to accept the plan; and
• holders of Seadrill common stock will receive 2% of the new Seadrill equity, subject to dilution by the primary structuring fee and an employee incentive plan, provided that general unsecured creditors vote to accept the plan.

This is one of those strange instances where the common stock was trading like something terrible was going to happen, but in relation to its closing price Monday, they received a relatively good “reward” out of this process, 2% of the company (compared to zero if creditors take this to court).

The question is whether the unsecured debtholders will agree to this arrangement – my paper napkin calculation suggests that bondholders will get about 10 cents on the dollar (probably less after the “subject to dilution” is factored in) compared to the trading around the 25 cent level before this announcement.

Their alternative is that if they vote against the deal, the secured creditors will receive everything.

Please read the Pirate Game for how this will turn out and also a lesson on why being an mid-tier creditor in a Chapter 11 arrangement that requires all capital structures to vote in favour of the agreement can be hazardous to your financial health.

I will also note that Teekay Offshore effectively went through a recapitalization, and this leaves Transocean and Diamond Offshore that both in relatively good standing financially.

General comments – furiously conducting research

I have been intensely researching the oil and gas sector, and specifically looking for companies that have decent metrics and enough fortitude to not be operationally taken down due to financial impacts of low commodity prices. I also have been trying to find collateral damage, typical cases of the baby thrown out with the proverbial bathwater.

There are many, many “hits” on my screens which makes the research very slow going. Specifically I want to know about hedging, and financial covenants and their financial structure in general in addition to the usual metrics. Dredging this stuff is very slow going.

There is a lot of high-yield out there which is trading at quite distressed levels, some of which seems very alluring. But high yield of course comes with risk.

A simple example: Do you want to lend your money to Russia for 10 years even though you are compensated with a 13% yield to maturity? I’d actually gamble that their large cap companies (NYSE: RSX is their ETF) would fare better than an investment in their sovereign debt at the moment.

Here’s a more specific example: Do you want to be a HERO? Specifically (Nasdaq: HERO) Hercules Offshore is a third-tier deepwater drilling firm, which is of a lower tier than Seadrill (Nasdaq: SDRL), Diamond Offshore (NYSE: DO), Transocean (NYSE: RIG), etc. All of the drillers have gotten killed over the past couple months simply due to the fact that nobody wants to drill into expensive ocean when you can’t even make money on the shale inland.

In HERO’s case, their equity is trading as if the company is already dead, while the bond market is placing their 2019 debt issue at a yield to maturity of about 28%. So, what is more risky: Investing in Vladimir Putin, or Hercules Offshore?

Seadrill, however, is comparable to Russia – roughly 11.5% yield to maturity on 6 year debt vs. 13% for 10-year Russian debt.