AWLCF - Awilco Drilling

[DTEJD1997]

Hey all:

 

Does anybody follow or have any opinion on Awilco Drilling?

 

I think this is a rather interesting situation.  YOu have to be a little careful though as it is a small cap and only has two rigs.  There are other risks too of course.

 

It boils down to this...They are generating a TREMENDOUS amount of free cash flow.  After generating an adequate cash reserve, they are going to dividend out the majority of their cash flow.  They are almost at this level, and dividends should start up this year, perhaps as soon as next quarter.

 

There are lots of caveats here, but it is speculated that the dividend yield could potentially be 20% or so.  If that is correct, I am going to guess that the stock will trade a bit higher than what it currently is at. 

 

So you could be looking at rather substantial income AND a nice capital gain.

 

Any thoughts?

[Radio Free Cash Flow]

Awilco is a huge opportunity. My post on the company is here: http://otcadventures.com/?p=708

 

We do seem to look at the same stuff!

[matts]

How do you guys get comfortable with the (non) diversification risk?

 

One storm/mechanical problem and this stock can be cut in half, no? There are always risks, but this one seems very risky; almost like an option. Do you just mitigate that with a small position size?

 

Would appreciate your thoughts.

 

[ItsAValueTrap]

Historically, the big risks for oil drillers are:

 

1- Fluctuations in rig rates.  For example, the spinoff stock Seahawk Drilling went bankrupt due to low rates.

 

2- Disasters like Deepwater Horizon can affect rig rates.  Because of the incident, regulations went up and it may take a lot longer to get permits to drill.  (Laws and regulations vary from country to country and from state to state of course.)

 

I don't know if that caused demand for some types of rigs to go down.

 

I believe Transocean owned the Deepwater Horizon rig and had a lot of losses associated with the incident.

 

3- Debt magnifies the effect of #1.

 

Or... just read the risk factors.  Overall I think that the tail risk is low.

[ItsAValueTrap]

It might be helpful to look at spot rates for their rigs:

http://www.rigzone.com/data/dayrates/

 

---

The last time I looked at drilling, this is what I thought about the industry.

 

You make money in two ways:

1- Correctly predicting future rig rates (or the price of buying/selling a rig).  Or just buy when rig rates are extremely low because they will likely go up in the future.

 

2- Arbitraging discrepancies in pricing.  The public markets often gets things wrong in pricing these stocks.

 

Atwood Oceanics looks like the only company that generated unusual returns for shareholders.  But their old CEO is gone.  I'm not exactly sure how they made their unusual returns.

 

Dryships/Oceanrig did a lot of #2... but way too much of shareholder money ends up in the CEO's pocket.  If you compare the market cap of these companies compared to the current market value of these rigs, then sometimes there are discrepancies.  They may also have long-term contracts that should be accounted for.

 

3- Overall the drilling industry may not be the greatest industry around.  It is highly cyclical.  There are periods of oversupply which causes everybody to lose a lot of money.  I don't know if the industry makes more during the booms than the busts.  The industry might be close to break-even over the whole boom/bust cycle.  During boom times, the bankers will be busy doing IPOs and secondary offerings for these companies.  That's when you want to avoid the industry.

[DTEJD1997]

Hey all:

 

Yes, there is certainly risk here, and many different flavors of it too!

 

HOWEVER, rates are high, and ARE GOING TO STAY HIGH for the near future, especially in the North Sea.  This could all change in a few years...but what if the cycle stays strong for another couple years after that?

 

There is a possibility that market rates strengthen.  Some people have been talking about "peak oil".  I am not convinced we are there, but we could be...so if that is the case, a LOT more rigs are going to have to be deployed to find the same amount of oil.  There is also growing demand for oil from the 3rd world (China I'm looking at you)!

 

You also could have a potential hedge against the decline of the US dollar.

 

This company only consists of two rigs.  So if one of them has severe problems, the company is going to have BIG problems.

 

Awilco could also have problems with their customers.  If one of them has problems paying the bills, Awilco is going to be in big trouble.

 

HOWEVER, I think a lot of those risks will be mitigated with a 20%+ dividend (possibly even a 30% dividend).  Get a couple years of dividends and a lot of risk has been removed.

 

Also let us assume that rates weaken in 3 years.  How far will rates weaken?  Might the dividend go from 30% to 10%?  Does the dividend have to go to zero?

 

These are older rigs, no doubt.  How much life is left in them?  I think that largely depends on market rates in the future.  If there is a demand, they will be used.  The terminal value of these things won't be zero. 

 

Also, I think there is some amount of protection here as both the rigs are working the North Sea, which is a strong demand area.

 

If you had a portfolio of 40 rigs dispersed across the world and held through all economic cycles, your return probably won't be that good.

 

If you hold a concentrated risk in a single market, you might be able to make a go of it, especially if the assets are mispriced (low) to begin with.

 

A good strategy might be to hold this for 12-18 months.  Collect some nice dividends and sell when the "retail" income investors come flooding in and push the price up. 

 

We'll see.  I think it is an interesting opportunity.

 

I would also highly recommend "OTC Adventures" blog.  There are many compelling opportunities that get a good & thoughtful writeup there. 

[ItsAValueTrap]

Also, I think there is some amount of protection here as both the rigs are working the North Sea, which is a strong demand area.

Umm... these rigs are regularly moved around the world.  Many competing rigs are being moved around the world.

 

Secondly, I think that you need to invert.  Not every business out there is a magical fountain of money.  Not every industry out there is wonderful (airlines suck, junior mining is terrible, insurance is marginal, drilling is marginal, etc.).

 

As a sanity check, rank every company in an industry.  Which ones are the best managed?  Which are the worst?  If you can't figure that then you probably should stay away from the industry.  I'll just give you some hints.  The ones with the most debt are probably poorly managed.  The ones where insiders pay themselves too much are bad.

You might also rank them based on the market value of their rigs+contracts.

 

2- Are they actually going to pay out a 20% dividend?  I doubt it, though I could be wrong.

 

Management is probably going to pay out a small dividend to make investors happy.  Then they're going to raise capital anyways (if the shares are overpriced) and go crazy buying up more rigs.

[DTEJD1997]

The rigs can be moved?

 

Yes, but it can take several months and many millions of dollars.  Moving these things from one region to another is not a light undertaking.

 

Not every business is a magical fountain of money?

 

What?  Are you sure about that?  That isn't what my broker told me!

 

This company has only been public for a few years, and the rigs have only been deployed for a bit shorter a time frame than that.  They have contracted rates to established companies.  Assuming the contracts hold, it is fairly easy to see how much money this company will make.  Not a sure thing, but reasonably certain for the next 18 months or so...

 

They have signed contracts for both their rigs for the next 13 months.  One rig is contracted until November 2015 and the other until May 2014.  Both of them have renewal options.  Capacity in the North Sea looks tight well into 2015.

 

In the 4th quarter of 2012, they earned $.76/share.  Multiply that by 4 and you are over $3/share.    There is a strong chance that upcoming 12 months earnings could be somewhat higher than that for a variety of reasons.  So them paying $2.50/share in dividends might easily be possible.

 

Management has stated MANY times that they intend to pay out a vast majority of their free cash flow.  That could change if they see a rig for sale...but I am going to take management at their word.

 

Why would they raise capital at this point?  The shares are probably UNDERVALUED.  They have no need of capital, not now.

 

Sure, they could go crazy buying rigs...a million things could happen.  But if the company stays in a "steady state", this thing is going to throw off a LOT of cash.

 

We'll see what happens...

[Hielko]

Started looking in this name as well.

 

Seems to me that earnings next year could be significnatly higher than $3/share. Whilphoenix was contracted at $290K/day from Oct till the end of Nov before the rate was raised to the current $315K/day. Wilhunter was contracted at $300K/day from Oct to mid Dec, and is currently contracted at $315K/day and this rate will increase to $360K/day in April. Not adjusting for the $3.6 million in bad debt in Q4 also seems quite pessimistic. FCF yield might be closer to 30% in 2013 than 20%.

 

 

[Packer16]

These appear to be fixed-up older rigs.  How did you get comfortable that they will not be obsolete in 5 years and you only get your money back.  I saw on the OTC adventures website that these have a 20 year remaining life but could find no source for rationale. 

 

Packer

[Hielko]

I'm not comfortable with anything yet... but 20 year remaining life is simply based on the company estimate. It sounds reasonable to me, although maintenance expenses are probably going up after a couple of years.

[Packer16]

Based upon the latest balance sheet it appears that they have an expected remaining useful life of 15.5 years.

 

Packer

[DTEJD1997]

Hey all:

 

I think the remaining life of these rigs will LARGELY depend on market demand.

 

As long as they are maintained properly and receive retrofits every dozen years or so, their life can be quite long.  I read that there are still some rigs in the Gulf of Mexico that have been operating since the 50's!  Not to say these will last those long...but it is not impossible.

 

HOWEVER, is it worth it to make the maintenance & retrofits?  At this point in time, YES, no doubt about it.

 

What will the situation be in 5 years?  Hard to say...

 

The thing about this investment is that the near term cash flows are going to be SO STRONG that it indicates it is mis-priced.

 

As long as there is no catastrophe, cash flow is going to be EXTREMELY strong in the next 24 months...

 

We will see.

[HJ]

As long as the company is committed to pay out the earnings from the currently very tight market, I think this is fine.  Diamond Offshore has a bunch of rigs working in the North Sea that were built in the 70's and 80's, and rated water depth is only  1500 feet.  They believe those were some of  the highest return on capital rigs in the industry.  North Sea market also operates with a very specific set of regulations.  It's not that easy to retrofit a GOM rig and move into that market. 

 

If they start talking about wanting to start a new build cap ex program, that's when this becomes more questionable.  But if you are just buying the current assets, and getting half of your money back within the first 2-3 years, how bad can it be?

[matjone]

Thanks for posting this and thanks to otcadventures blog for the writeup. 

 

I thought I'd do a quick look at enterprise values, fleets and revenues on a few companies.

 

diamond: 30 semi-subs, 7 jack-ups, and 1 drill ships.  4 drillships and 2 semisubs under construction.  2.9 B ttm revenue, 9.8 B EV.

 

noble: 14 semi-subs, 43 jack-ups, 9 drill ships.  Also 5 drillships & 6 jackups under construction. 3.7 B ttm revenue, 14.8 B EV. 

 

Awilco: 2 semisubs.  Dayrates for both of them together for the next year look like they are going to be around 690k/day based on otcadventures writeup.  I am not sure what would be a reasonable amount of days to figure these are utilized.  I don't know if you should use 100%.  Maybe 80%?  That would be around 200 M revenue.  EV 521 M based on otcadventures writeup.

 

The majority of most of these companies' vessels can drill in water deeper than 1200 feet.  Obviously the shallow water stuff isn't where the big finds are happening, but there must be some left in shallow water or people would't be building and buying jack ups.

 

One thing that caught my eye - Awilco's operating margin last quarter was 53%.  Is this a little higher than might be expected long term?  The other companies seem to do a  worse than that.

 

I'm googling around and see if there have been any recent sales of semi-sub rigs that are comparable to these two.  I'm having trouble finding anything that's a good comparison, but Noble just sold the lewis dugger jack up for 61m and was getting a dayrate of 83k/day for it.  I imagine a semi-sub goes for a higher price/dayrate ratio than a jack up - that would put these two at at least 506 M.

[Hielko]

They had ~95% utilization in Q3 & Q4 last year. I think you should expect something a lot lower in Q1 this year since that was the winter season. Maybe high 80's?

 

I've also tried to get a better grip on the asset value of the two rigs. What I noticed is that Transocean took a ~300 million impairment on the two vessels in 2009 (oil hit a price below $40 then) and that they were sold for $195 million (at a loss of $15 million) early 2010. So these rigs used to have a book value around $500 million before the GFC and before being upgraded in 2011.

[ItsAValueTrap]

The Company owns two semi submersible drilling rigs, WilHunter and WilPhoenix, currently operating on the UK sector of the North Sea. The rigs were acquired from Transocean in January 2010 at an aggregate price of USD 205 million which was, in combination with working capital of USD 10 million, financed by seller’s credit of USD 165 million and equity of USD 50 million.

 

At the time the rigs were acquired from Transocean, the WilPhoenix required a significant overhaul and both WilPhoenix and WilHunter were due for a classification renewal. In addition, a programme of rig enhancement and upgrade was also established, initially for the WilPhoenix and latterly for the WilHunter. The rigs were subsequently sent to the Polish shipyard Remontowa to commence the project work. The aggregate cost for upgrading, maintenance and classification is estimated to be approximately USD 94 million for both rigs. This amount was part financed by a USD 65 million private placement of equity in October 2010, as well as by a USD 17.5 million private placement of equity in June 2011.

http://www.oslobors.no/obnewsletter/download/961ffa8dd773c86da97be747b9ea03f8/file/file/Awilco%20Drilling%20newsletter.pdf

 

Bought for US$205M, $94M was added to refurbish the rigs.  That totals $299M.  (You could also add interest / opportunity cost to that 299M.)

 

I suspect that the current market price for these rigs is a lot higher.

[SharperDingaan]

You might want to consider why TransOcean sold these particular rigs, & not something else.

 

Just maybe ... TransOcean didn't think they could keep the rigs in service long enough to earn their minimum WACC? Hence to get the rigs, Awilco may have overpaid for them.

 

Just maybe ... Awilco did nothing more than luck out? They bought the rigs just as the market turned, & got their rates & utilization because they were the only ones with available rigs? It does occasionally happen, as Ari Onassis found out in the tanker trade.

 

Just maybe ... Awilco's CF is also being boosted by cutbacks in maintenance?, because they expect to resell/scrap these rigs as soon as the cycle starts to turn again?

 

They may well be able to hype themselves higher over the near term ... but one has to think that one may well make more, & do it more reliably, by progressively betting against them. Even Ari couldn't avoid  the pullback, & it eventually crippled him.

 

If you inverted; you would be looking at longer term investments in the Repsol's of the world, & have rig exposure at much less risk. Is this really worth that additional risk?

 

 

[Hielko]

To answer one of the maybe's... Transocean was forced to sell because of antitrust concerns after a merger (they had 65% of the UK market or something like that).

[DTEJD1997]

RIG was forced to sell these two rigs because of anti-trust concerns.

 

MAYBE Awilco got a GREAT DEAL on these because of government actions (forced sale)?

 

MAYBE Awilco has "lucked out" and is in a strong area/position?

 

It is my understanding that one of the rigs is not even drilling for oil.  They are capping dead/spent wells and doing maintenance work on the seabed.  It is my further understanding that drilling standards in the North Sea are extremely strict.  So oil field owners/operators will have to spend for this type of thing.

 

I think Awilco will make TONS & TONS of money for the next 24 months or so.  Beyond that?  50/50, who is to say?  I don't think anybody will know what will happen then.

 

HOWEVER, so what if rates go down?  These things are not going to be worthless, even if they are scrapped.  I doubt they will be scrapped after two years though....There is an argument to be made that ocean drilling is going to be a big thing for the foreseeable future, as the world needs more oil.  Eventually that might change, and holding this for 10+ years might not be the best thing...but the next few years could be very lucrative.

 

If this makes $3-$4/share in NET EARNINGS is this stock going to trade for 4X earnings?  I very much doubt that....

 

Will it trade for 12X earnings?  I doubt that too. 

 

I think this might trade for 7X, 8X, 9X earnings of $3.50/share.

 

We will see...

[Packer16]

If Transocean had a choice of what to sell, they probably sold their highest cost/oldest rigs.  If that is the case, does anyone know enough about these rigs to know if they are lemons or hidden diamonds.  I don't know but maybe someone here with more O&G experience would know.

 

Packer

[ItsAValueTrap]

I'd look at the private market value of these rigs and the drilling contracts.  If there is a large difference between the public and private market values, then there will be an arbitrage opportunity that you don't want to be on the wrong side of.

 

HOWEVER, so what if rates go down?  These things are not going to be worthless, even if they are scrapped.  I doubt they will be scrapped after two years though....There is an argument to be made that ocean drilling is going to be a big thing for the foreseeable future, as the world needs more oil.  Eventually that might change, and holding this for 10+ years might not be the best thing...but the next few years could be very lucrative.

Take a look at Seahawk's history.  Too much debt + lower rates spelled their death.

 

I don't think that Awilco has enough debt to push them into bankruptcy if rates were to fall a lot. 

 

If that is the case, does anyone know enough about these rigs to know if they are lemons or hidden diamonds.

Over time, maintenance/operating costs of the rig will go up.

 

Eventually there will be a point where the rig isn't cash flow positive.  So then you can idle the rig or sell it for scrap metal (Awilco's financials puts residual value at $15M).  These are all *estimates*.  The ultimate lifespan of the rig depends on drilling rates (and prices of scrap metal).

[Myth465]

You might want to consider why TransOcean sold these particular rigs, & not something else.

 

Just maybe ... TransOcean didn't think they could keep the rigs in service long enough to earn their minimum WACC? Hence to get the rigs, Awilco may have overpaid for them.

 

Just maybe ... Awilco did nothing more than luck out? They bought the rigs just as the market turned, & got their rates & utilization because they were the only ones with available rigs? It does occasionally happen, as Ari Onassis found out in the tanker trade.

 

Just maybe ... Awilco's CF is also being boosted by cutbacks in maintenance?, because they expect to resell/scrap these rigs as soon as the cycle starts to turn again?

 

They may well be able to hype themselves higher over the near term ... but one has to think that one may well make more, & do it more reliably, by progressively betting against them. Even Ari couldn't avoid  the pullback, & it eventually crippled him.

 

If you inverted; you would be looking at longer term investments in the Repsol's of the world, & have rig exposure at much less risk. Is this really worth that additional risk?

 

Sharper has some good points. I would have sold some crappy rigs, and not top assets.

Also scrap value isnt worth anything in the Drilling Business. Ask Hercules and Seahawk about it.

 

Its interesting but there are alot of ways to lose inmo.

[Olmsted]

I think Awilco will make TONS & TONS of money for the next 24 months or so.  Beyond that?  50/50, who is to say?  I don't think anybody will know what will happen then.

 

I agree.  I don't think the thesis depends on the long-term economics of the North Sea, whether these rigs last 10 or 20 years, or the price of oil in 5 years.  These are contracted for 1-2 years, we know how much Awilco will make in this time (barring an accident), and provided management isn't lying we know about how much we'll get in a dividend.  If we get that dividend, a yield hog will pay more for it than the share price now.  Can't an investment be just that simple sometimes?

 

To make money here, you don't have to Buffett and buy this company and hold it forever.  We have the luxury of buying now and hopefully selling it to someone else for more.  Just look at some of the crappy royalty trusts out there that are going to stop cashflowing in a couple years - they still get bid up based on the dividend.  This situation is at least as good. 

[Myth465]

I think Awilco will make TONS & TONS of money for the next 24 months or so.  Beyond that?  50/50, who is to say?  I don't think anybody will know what will happen then.

 

I agree.  I don't think the thesis depends on the long-term economics of the North Sea, whether these rigs last 10 or 20 years, or the price of oil in 5 years.  These are contracted for 1-2 years, we know how much Awilco will make in this time (barring an accident), and provided management isn't lying we know about how much we'll get in a dividend.  If we get that dividend, a yield hog will pay more for it than the share price now.  Can't an investment be just that simple sometimes?

 

To make money here, you don't have to Buffett and buy this company and hold it forever.  We have the luxury of buying now and hopefully selling it to someone else for more.  Just look at some of the crappy royalty trusts out there that are going to stop cashflowing in a couple years - they still get bid up based on the dividend.  This situation is at least as good.

 

Very good counter argument, this was my thesis with ROIC and it worked out well.

Its also why I find myself drawn to this thread. With 2 rigs though not alot of room for error, downtime or any major accident by any major rig company would pretty much kill / maim the company in the short term.