Oct 09 -
-- On Sept. 10, 2012, Transocean Ltd. announced that it had agreed to
sell 38 of its rigs to newly-formed oilfield services company Shelf Drilling
Holdings Ltd. (Shelf Drilling).
-- We are assigning a preliminary 'B' rating to the Cayman Island-based
-- The outlook reflects our expectation of supportive industry conditions
and relatively stable credit metrics.
On Oct. 9, 2012, Standard & Poor's Ratings Services assigned a preliminary 'B'
rating to Cayman Island-based oilfield services company Shelf Drilling
Holdings Ltd. (Shelf Drilling). The outlook is stable.
At the same time, we assigned a preliminary issue rating of 'B+' and a
recovery rating of '2' on the first-lien $75 million term loan facility.
We also assigned our 'B' preliminary issue rating on the $475 million senior
secured notes and our recovery rating of '3.'
The preliminary rating is based on initial information and is subject to the
successful closing of the acquisition. The preliminary rating depends on:
-- The successful implementation of Shelf Drilling's funding structure,
including appropriate commitments from the banks; and
-- Liquidity being assessed as "adequate" under Standard & Poor's
We aim to review the preliminary rating within 90 days.
The ratings on Shelf Drilling reflect our assessment of the business risk
profile as "vulnerable," together with our view that the financial profile is
Our view of Shelf Drilling's financial risk profile is based on its leveraged
cash-flow ratios. We forecast its funds from operations (FFO) to adjusted debt
ratio will be around 13% in 2013 (under our criteria, we treat preferred
equity as debt-like in calculating this ratio.) We consider Shelf Drilling's
free operating cash flow (FOCF) generation to be modest, given its sizable
capital expenditure, leading to modest deleveraging prospects. We assess it as
having adequate liquidity, but a limited cushion if it does not adjust its
capital expenditure in line with actual operating cash flows. Because the
company is to be established as a spin-off, it also lacks audited financial
These risks factors are mitigated by some positive features. The company has
moderate headline leverage (its debt to adjusted EBITDA ratio is around
3.5x-4.0x) and debt ratios are even less leveraged when we exclude the
preferred equity. Additionally, we understand there are no financial
maintenance covenants and the company has little meaningful debt amortization.
The "vulnerable" business risk profile is based on the lack of an established,
operating business track record as a stand-alone entity and the company's
participation in the competitive, fragmented, and capital-intensive oil and
gas service industry. The "jack-up" segment it operates in has historically
been even more volatile. The fleet of 38 rigs is relatively old, with an
average time in service of 31 years. Oilfield service companies depend heavily
on the investment decisions made by exploration and production companies,
which in turn depend on the outlook for cyclical oil prices; as a result, day
rates can be volatile through the cycle. Shelf Drilling's fleet has limited
diversification by depth.
These constraints are partly mitigated by Shelf Drilling's sizable backlog of
contracts, its sound market position as the number three jack-up driller in
the world, its geographical diversification, and its management's significant
We anticipate that Shelf Drilling's liquidity will be "adequate" under our
criteria, reflecting our expectation that cash sources will cover cash needs
by more than 1.2x during the next 15 months. However, we consider that there
is a limited cushion and that a slight adverse variation from our base case in
terms of operational performance or ability to curb capital expenditures would
likely lead to a downward revision to the "less than adequate" category.
Our assessment of sources of liquidity over the coming 15 months, as of Sept.
1, 2012, includes:
-- Cash of about $255 million on hand, although at least $50 million of
this may be tied to operations. In addition, the bulk of the opening cash
balance is understood to be temporary, intended to be used to fund the
exceptionally high working capital outflow in the first year; and
-- FFO of $160 million-$180 million to Dec. 31, 2013.
Our assessment of liquidity needs includes:
-- Scheduled debt maturities of less than $1 million a year;
-- Capital spending dedicated to maintenance purposes of close to $86
million, excluding the investment needed to restart the stacked rigs, for
upgrade, or to prepare contracts to which management has not committed and
therefore can be cut if the market conditions are not favorable.
-- One-off working capital outflow of about $180 million, because
Transocean will collect and retain its existing receivables after the sale
closes (offset by the high initial cash balance).
We consider it positive that Shelf Drilling will not have any financial
maintenance covenants under its senior term loan.
The preliminary issue rating on the first-lien $75 million term loan facility
is 'B+'. The recovery rating on the term loan is '2', indicating our
expectation of substantial recovery (70%-90%) in the event of a payment
default. The preliminary issue rating on the $475 million senior secured notes
is 'B'. The recovery rating on the senior secured notes is '3', indicating our
expectation of meaningful (50%-70%) recovery in the event of a payment default.
The recovery rating on the term loan will be primarily supported, as soon as
the security is affected, by a first-lien security on at least 27 rigs and
pledges of the equity of five restricted subsidiaries owning five of the
company's 11 remaining rigs. The above-mentioned security will be required to
be put in place within 90 days following the closing of the acquisition. The
recovery rating on the senior secured notes is supported by a second-lien
ranking on the same security package. However, it is constrained at the '3'
level by substantial jurisdictional risk, as the rigs are located in many
different jurisdictions through Africa, Asia, and the Middle East, and by the
notes' contractual subordination to first ranking debt.
The 38 rigs are located in 12 different countries worldwide, primarily in
Saudi Arabia, India, Egypt, and Thailand. We anticipate that enforcing these
assets in case of a default could be challenging. The documentation for the
credit facility allows for, in addition to the existing $75 million prior
ranking term loan, an incremental term facility of $50 million that is subject
to 3.25x total net leverage ratio, and additional second-lien debt that is
subject to a 2.0x fixed-charge coverage ratio and 2.0x secured leverage ratio.
The senior secured notes documentation includes restricted payments covenants,
which provide restrictions on dividend payments that cannot exceed an income
basket of 50% of consolidated net income, which starts to accumulate from the
first quarter of the issuance of bonds.
In assigning recovery ratings according to our criteria, Standard & Poor's
simulates a payment default scenario that incorporates a borrower's
fundamental business risk and the financial risk inherent in the capital
structure. We consider that the key risk Shelf Drilling faces concerns its
ability to secure contracts on the rigs as existing ones expire. Furthermore,
we believe the company has exposure to volatility in market rates as contracts
come up for renewal, and has limited flexibility to reduce underlying
operating costs without taking rigs out of operation. Given that most of the
rigs are at least 30 years old, we expect relatively high maintenance capex.
We assume these pressures would depress Shelf Drilling's utilization and day
rates, revenue, and profitability, and lead to a payment default in 2014.
We believe Shelf Drilling would remain a going concern because of its good
market position in the jack-up drilling rigs business pro forma the
acquisition, its distinct operating activities, and the contract-based nature
of its drilling activities, which provides short- to medium-term earnings
visibility. Still, we have used a discrete asset valuation methodology to
estimate the value of the company, given that we believe the company has an
extensive asset base, and this method provides insight as to the company's
likely value at default. We have estimated the stressed enterprise value of
the company at default by stressing its assets at different levels according
to their estimated value post-default. Given the volatility of the industry
and the fleet age of these rigs (on average 30 years), we have estimated a
stressed enterprise value of $618 million for Shelf Drilling at the point
where the company would default.
From the gross enterprise value we deducted administrative costs and 50% of
pension costs as priority liabilities. The net stressed enterprise value would
be sufficient to provide substantial recovery (70%-90%) for the first-lien
term loans of $129 million (which includes the incremental facility and six
months prepetition interests), and meaningful recovery (50%-70%) for the
second-lien senior secured notes of $496 million (including six months'
prepetition interest). Numerically the coverage is high, but because of the
jurisdictional risk and less than full asset security, we keep the recovery
rating on the term loan at '2' and senior secured notes at '3'.
The stable outlook reflects our expectation that industry conditions are
becoming firmer after two weak years. Slightly higher day rates should allow
Shelf Drilling to stabilize EBITDA, which has declined in recent years. We
anticipate that the oil price will remain supportive for operators overall,
despite the uncertain global environment. On a pro forma basis, we view a
sustainable adjusted ratio of FFO to debt (including preferred equity) of
15%-20% as commensurate with the current ratings. We would expect this ratio
to be 10%-15% at bottom of the cycle and above 20% at top of the cycle.
We could raise the ratings in the medium term, once Shelf Drilling has built
an operating track record. If management can successfully contain costs,
especially if Shelf Drilling can lock in higher average day-rates as the
market strengthens, FFO to debt could rise sustainably to the "significant"
category, that is, between 20% and 30%. Raising the ratings would also depend
on the new owners pursuing supportive financial policies.
We could lower the ratings if we see FFO to debt of 12% or below on a
sustainable basis or if day-rates or utilization levels fall. This could occur
because new rigs are competing with Shelf Drilling's older rigs. That said,
Shelf Drilling currently has an adequate contract line-up for the next 12-18
months. Falling day-rates remain a key risk factor, given the sensitivity of
Shelf Drilling's cash flows and perceived limited liquidity cushion.
Related Criteria And Research
All articles listed below are available on RatingsDirect on the Global Credit
Portal, unless otherwise stated.
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
-- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18,
-- Methodology And Assumptions: Liquidity Descriptors For Global
Corporate Issuers, Sept. 28, 2011
-- Hybrid Capital Handbook: September 2008 Edition, Sept. 15, 2008
-- Key Credit Factors: Global Criteria For Rating Oilfield Services And
Equipment Companies, July 30, 2012
New Preliminary Rating
Shelf Drilling Holdings Ltd.
Corporate Credit Rating B/Stable/--
Senior Secured B+
Recovery Rating 2
Senior Secured B
Recovery Rating 3