AWLCF - Awilco Drilling

[oddballstocks]

Great discussion here, thanks all. One thing I have been pondering about for a while is why it is common practice to adjust for risk by means of the discount rate? I.e. it seems to be acceptable to say: well, I use a 10% discount rate for most stuff but Awilco is risky so I use a 15% discount rate. But isn't that a very arbitrary approach to estimate risk?

 

Wouldn't it be much clearer to work out a few scenarios and explicitly assign probabilities to them? I.e.:

 

70% chance of things working out (using the standard discount rate)

25% chance of lower rates (using standard discount rate but lowering expected cashflow)

5% change of disaster (equity is worth 0).

 

and take the weighted average of these scenarios. This way you force yourself to make explicit assumptions about the risks you are incurring, instead of stuffing everything away in an arbitrary discount rate.

 

I think that's an excellent way to look at it.  As to why people do it other ways? I'm guessing because b-school encourages a discount rate change for 'risk'.  Your method is how I've seen people in the business world approach this problem, I've never heard anyone say "why not adjust the discount rate." it's always "what are the chances this won't work verses it works? Is it worth doing?"

[shhughes1116]

Just thought these were some interesting numbers:

 

Since August 19th (ex-div day), ~5,250,000 shares have traded on the pink sheets.  There are ~30 million shares outstanding, of which about half are owned by the controlling shareholders.  So the free float is ~15,000,000 shares, of which I thought most traded on the Oslo exchange.  So I must say I am absolutely amazed by the volume, relative to the size of the free float, and given it traded on the pink sheets with relatively low volume in the past.  Out of curiosity, does anyone know if your broker(s) will allow you to borrow shares and sell short?   

 

Also a couple pieces of news which bode well for rig operators:

1.  PEMEX signed a contract with SLB to install the infrastructure to support deep water drilling (http://www.upstreamonline.com/live/1379980/OneSubsea-wins-Lakach-prize).  The depth of this field requires midwater and/or deepwater drilling rigs.  This may soak up some of the impending supply of deepwater rigs coming into the market in 2015 and 2016.   

2.  The decline in Brazilian offshore drilling is partly the result of domestic energy policies by the current Brazilian President, which prevent Petrobras from developing these fields profitably.  Current polling suggests that Rousseff is going to lose to a more business-friendly candidate (http://blogs.barrons.com/emergingmarketsdaily/2014/10/13/brazil-rallies-neves-endorsed-supported-by-new-poll/?mod=BOL_hp_blog_stw).  A change in domestic energy policy may yield more offshore drilling in Brazil.   

3.  In addition to #2, domestic policies implemented by Rousseff have required Petrobras to operate more and more domestically-built drilling rigs.  Because of this policy, Petrobras is contracting fewer and fewer non-domestically-built rigs.  This may also change if a more business-friendly president is elected in Brazil. 

 

 

 

 

 

 

[Picasso]

I tried to borrow 30k shares to sell short but was denied.

 

I probably need to try shorting AWDR.NO instead.

[yadayada]

What about Lamprell? It looks cheaper to be honest, with the net cash position. Less shaky competitive position

 

AWLCF and Lamprell are totally different businesses. Lamprell is a rig maker.

yeah but similar multiples. Seems Lamprell is more durable if your bullish about oil.

[shhughes1116]

@ Picasso - Recently? 

[Picasso]

@ Picasso - Recently?

 

At the time of my last post.

[shhughes1116]

If you don't mind me asking, what is your target price? 

 

I certainly agree that Awilco was a bit overvalued at $25, but I figured folks would be covering their short positions at this price.  Going short at ~$14.50 implies (imho) that the rigs won't operate until the end of their useful life, or that rig day rates will fall well below the 2009 lows seen in the North Sea. 

[Picasso]

Oh I'm not shorting the stock, just been following the story for a while.  I thought it was pretty representative of the idea that there are very few bargains out there when investors are piling into a deep sea driller with a couple rigs to earn maybe 15%.  But that's my opinion and I haven't redone my cash flow estimates for about six months but I assume the prospects look worse today.

 

I just tried to get the short borrow but was unable to do so.

[Hielko]

Great discussion here, thanks all. One thing I have been pondering about for a while is why it is common practice to adjust for risk by means of the discount rate? I.e. it seems to be acceptable to say: well, I use a 10% discount rate for most stuff but Awilco is risky so I use a 15% discount rate. But isn't that a very arbitrary approach to estimate risk?

 

Wouldn't it be much clearer to work out a few scenarios and explicitly assign probabilities to them? I.e.:

 

70% chance of things working out (using the standard discount rate)

25% chance of lower rates (using standard discount rate but lowering expected cashflow)

5% change of disaster (equity is worth 0).

 

and take the weighted average of these scenarios. This way you force yourself to make explicit assumptions about the risks you are incurring, instead of stuffing everything away in an arbitrary discount rate.

That's not a good idea because an idea with a 100% probability of being worth $100/share is a better idea than one that has a 50% probability of being worth $0/share and $200/share IF this represents systematic risk (idiosyncratic risk can be diversified). The higher discount rate accounts for the variability in the outcomes that is correlated with the big fundamental risk factors.

 

In the Awilco case: you do 'deserve' to be compensated for risk related to oil prices, day rates and other large economic influences. But you don't deserve a higher return because it is a two rig company because that is company specific risk that you can diversify away (in theory).

[writser]

Good point, hadn't thought about that. But how do you arrive at a correct risk-adjusted discount rate? Wouldn't a scenario-based approach still be better than an arbitrary 'let's use 15% instead of 10%' approach?

[Hielko]

Good point, hadn't thought about that. But how do you arrive at a correct risk-adjusted discount rate? Wouldn't a scenario-based approach still be better than an arbitrary 'let's use 15% instead of 10%' approach?

No because the scenario based approach is not a substitute. You still need that 'arbitrary' higher discount rate in every single scenario. With the scenario based approach you can capture more precisely what the expected value is, but it doesn't capture how risky it is.

 

And every single valuation method at some point encounters estimates that you can describe as arbitrary if you want to critique it. It's not like you have to randomly go for 15% because 10% is too low, and I certainly haven't said anything about what the correct rate is. But you can do better than just a random guess to figure out an appropriate discount rate.

[writser]

Good point, hadn't thought about that. But how do you arrive at a correct risk-adjusted discount rate? Wouldn't a scenario-based approach still be better than an arbitrary 'let's use 15% instead of 10%' approach?

No because the scenario based approach is not a substitute. You still need that 'arbitrary' higher discount rate in every single scenario. With the scenario based approach you can capture more precisely what the expected value is, but it doesn't capture how risky it is.

 

And every single valuation method at some point encounters estimates that you can describe as arbitrary if you want to critique it. It's not like you have to randomly go for 15% because 10% is too low, and I certainly haven't said anything about what the correct rate is. But you can do better than just a random guess to figure out an appropriate discount rate.

 

That was exactly my point. How?

[shhughes1116]

Some related news....

 

Transocean Leader - Awarded a four year contract in an undisclosed location at a dayrate of $335,000 for the first three years and at an indexed rate for the fourth year ($478 million estimated backlog). The rig's prior dayrate was $400,000.

 

Most recent (current?) location is in the North Sea, off the coast of Norway.  Rig just received AoC from Norwegian authorities about 10 days ago, so likely still operating for Statoil. 

[siddharth18]

Some related news....

 

Transocean Leader - Awarded a four year contract in an undisclosed location at a dayrate of $335,000 for the first three years and at an indexed rate for the fourth year ($478 million estimated backlog). The rig's prior dayrate was $400,000.

 

Most recent (current?) location is in the North Sea, off the coast of Norway.  Rig just received AoC from Norwegian authorities about 10 days ago, so likely still operating for Statoil. 

 

What was the year (in which the $400K dayrate) was agreed to?

 

I'm not familiar with the nitty-gritty specs of the rigs but looks like Transocean Leader is a 4th Gen Rig (compared to 3rd Gen WilHunter + WilPhoenix). This means a water depth of 4500 ft for Leader compared to 1200-1500 feet for Awilco's rigs.

 

But assuming that the day-rate drop was solely due to the recent oil price drop/softness it seems about a 20% day-rate drop.

[Tim Eriksen]

Some related news....

 

Transocean Leader - Awarded a four year contract in an undisclosed location at a dayrate of $335,000 for the first three years and at an indexed rate for the fourth year ($478 million estimated backlog). The rig's prior dayrate was $400,000.

 

Most recent (current?) location is in the North Sea, off the coast of Norway.  Rig just received AoC from Norwegian authorities about 10 days ago, so likely still operating for Statoil. 

 

What was the year (in which the $400K dayrate) was agreed to?

 

I'm not familiar with the nitty-gritty specs of the rigs but looks like Transocean Leader is a 4th Gen Rig (compared to 3rd Gen WilHunter + WilPhoenix). This means a water depth of 4500 ft for Leader compared to 1200-1500 feet for Awilco's rigs.

 

But assuming that the day-rate drop was solely due to the recent oil price drop/softness it seems about a 20% day-rate drop.

 

Looks like the old three year deal with the 400k day rate was agreed to in February 2011

[shhughes1116]

Yes, capable of deeper operations than Awilco's rigs.  However, currently operating in 900-1000 ft depths, similar to Awilco's rigs.  Similar BOP equipment as well. 

 

I expected a steeper concession on day rates for Transocean given the length of the contract, but a 16.25% decrease for a 4 year contract is not too bad given the current expectations for rigs.  Maybe has something to do with the recent re-certification by the Norwegian government...  Interesting to note that one of Diamond Offshore's midwater rigs recently had its contract cancelled by Statoil due to non-compliance with Norwegian requirements.     

[shhughes1116]

Forgot to mention...rig age is similar to Awilco's rigs.

[Gamecock-YT]

From the Broyhill Letter:

 

Given the amount of cash we have on hand today, our investors should be hoping for the market to fall, as panicked

sellers give us the opportunity to invest at lower prices, which ultimately drive future returns. We recognize that this is

counterintuitive and may mean short-term losses in those positions we currently hold, but those losses should be less

than those suffered by the overall market, and more than offset by gains from additional purchases. The examples below

should give you a sense of the opportunities we see today, as a result of recent volatility:

 

The collapse in energy prices has wreaked havoc on the oil sector, which has dropped 20% since the summer.

Many stocks in the industry have fallen much further. A recent investment in a Norwegian drilling company

has effectively been cut in half in recent months due to uncertainty around Scottish Independence and the

speculative unwind in commodity-related businesses. In the short-term, we are likely to see continued volatility

in the shares. In exchange for accepting this volatility, we receive the majority of the company’s cash flow in

the form of dividends, which approximate a 30% yield today. The founder owns about half of the shares

outstanding and the company’s rigs were last valued in excess of the total market capitalization.

 

Sounds like Awilco...

[Palantir]

I don't understand the thesis for this investment. Day rates have been steadily rising for the past few years, however, oil prices have been falling for the last year. The major players in this space are spinning off their old rigs, and that's what is left for investors to buy, and that too in an industry renowned for being risky and levered to commodity prices.....I just don't see why this is attractive.

[SwedishValue]

If you base your decisions solely on quality, then it is obviously not a buy. If you at all use price as a factor for investment decisions, a ~25-30% expected cash yield on assets depreciating at less than 10% could potentially compensate for the less than Coca Cola quality.

[Palantir]

Then why aren't majors buying them up instead of spinning them off?

[ukvalueinvestment]

I know very little of this situation, but I do recall that Awilco was spun off for a very specific non financial reason.  Does anyone remember?

[yadayada]

if your buying this you basicly say that you break even if rates plummet after 4 years. So to make decent money on it, you need thm continue for 5-10 years at elevated dayrates.

 

I guess there is a float element in here though. Youc an reinvest the dividend. But im not so sure there is much added value in that. Since it is not exactly a risk free float.

[Libs]

I don't understand the thesis for this investment. Day rates have been steadily rising for the past few years, however, oil prices have been falling for the last year. The major players in this space are spinning off their old rigs, and that's what is left for investors to buy, and that too in an industry renowned for being risky and levered to commodity prices.....I just don't see why this is attractive.

 

I bought some this week. Their existing contracts should produce $6-7 in dividends over the next six quarters. That's half the $14 price right there.

 

If oil rebounds or even stays at these levels, I think they will get new contracts.

 

That's how I see it. Speculative but a good bet.

 

 

[Hielko]

I know very little of this situation, but I do recall that Awilco was spun off for a very specific non financial reason.  Does anyone remember?

Transocean had to divest the rigs after a big acquisition due to regulatory concerns (too much market share in UK)

 

For those interested, did a little DCF model to check how the current price compares to intrinsic value: http://alphavulture.com/2014/10/17/awilco-drilling-back-to-square-one/