Monday, 17 April 2017

NADL: An 11th Hour Buyout Target?

Some life was breathed into North Atlantic Drilling Limited (NADL) last week when the company announced 10-year contract awards totaling $1.4 billion with ConocoPhillips (COP). The market reacted very positively with the stock price rising 270% from $0.74 to $2.70 on April 11 the day of the announcement, and hitting as high as $3.89 the next day. The stock has pulled back to $2.10 on Thursday and it may be an opportune time for an entry point around $2 pre-market Monday for those who like a volatile, news-based stock with a small float and a lot of upside potential in an industry that looks to be in recovery. According to Yahoo Finance the float is only 7 million shares (24 million total outstanding) with 1 million short so it's still a prime short squeeze target.

NADL is not without its risks. It wouldn't be trading this cheap if it didn't. It is a subsidiary owned by Seadrill Limited (SDRL) which is coming under fire for a need to restructure its massive $10 billion debt amid the struggling the offshore oil rig business. SDRL had warned the investing public earlier this month that a restructuring may be needed that will result in little value left to shareholders, while also announcing the positive news that the window for negotiation has been extended its creditors. As a subsidiary of SDRL, NADL may be dragged into this. NADL has $2 billion of a credit facility that was due June 30, 2017 but has since been extended to September 14, 2017 as part of the larger extension granted to SDRL. You just need to check a multi-year chart on either NADL or SDRL to know what the market thinks of the situation for these stocks. But with great risks comes great potential rewards. The $50 million market cap for NADL looks like a bargain to us given the new contract with COP. Perhaps it will also look like a bargain to those companies looking to expand their offshore oil drilling businesses by acquiring NADL at a discount.

Offshore oil drilling has been impacted greatly in the last few years thanks to the drop in oil prices and political pressure to reduce this activity. While oil prices have rebounded slightly into the $50's for 2017, U.S. President Donald Trump is preparing executive orders to increase offshore oil drilling, including moves to open the Atlantic coast to offshore drilling for the first time in more than 30 years. It's expected moves like these that may have helped to persuade COP to make such a large 10 year commitment with NADL in the first place. Prior to the contract announcement, NADL reported that its backlog was $300 million. This $1.4 billion contract will result in more than a 5-fold increase to that number. As part of the deal, $58 million of existing backlog is extinguished, so adding $1.4 billion to $242 million results in backlog of $1.64 billion.

A lot of this revenue is expected to be in the outer years so it may have little impact on near-term financials. However, NADL is trading at a deep discount even after the most recent rise in price thanks to the contract announcement. The EV/EBITDA multiple is only 7.5 which is quite low given the newly announced backlog. NADL's EBITDA is $310 million according to Yahoo Finance. Enterprise value (EV) includes a company's debt. NADL's enterprise value is $2.33 billion versus a market cap of only around $50 million. Needless to say, this company's stock is going to be highly volatile especially if a buyout does come at the 11th hour.

NADL actually has pretty good operating cash flow, reported to be $129 million in 2016 despite being in an industry under pressure. NADL showed a net loss only because of very heavy depreciation amounts for its rigs.

There is a rumor that Transocean (RIG) plans to purchase West Rigela project worth $568 million which is 23% owned by NADL. If such rumors are true and if there is a continued increase in offshore drilling activity, NADL as a whole may become a buyout target at the 11th hour. It would make sense for SDRL to try to sell its stake in NADL as part of a greater effort to stay afloat in its own right.

If NADL was to be sold for an EV/EBITDA multiple of 9, that would lead to a $2.7 billion dollar valuation. Subtracting the $2.3 billion in net debt that would leave $400 million left for shareholders, around $16.50 per share. This is just an illustration of the extreme upside potential for NADL if the offshore drilling industry improves over the next several months. The actual valuation could be higher or lower. What about SDRL itself? Well we think NADL has much more upside. $2 billion in debt is a lot easier to work around than over $10 billion in debt. So we believe NADL makes the better trade based on its move last week and the direct impact that the deal with COP will have on NADL's financials. If you buy in and the stock runs a lot and you have profits, don't forget to take some off the table. Do your own research and judge for yourself if NADL is appropriate for your risk tolerance. But we think the $2's are a good entry point for us.

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Disclosure: We are long NADL

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