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TEXT-S&P rates Pacific Drilling corporate credit 'B'
November 12, 2012 / 3:50 PM / 5 years ago

TEXT-S&P rates Pacific Drilling corporate credit 'B'

Overview
     -- Luxembourg-based Pacific Drilling S.A. plans to issue $500
million of senior secured notes due 2017 through its subsidiary, Pacific
Drilling V Ltd. 
(PD5).
     -- We are assigning our 'B' corporate credit rating to Pacific Drilling. 
We are assigning a 'B+' rating to Pacific Drilling V Ltd.'s proposed senior 
secured notes.
     -- The stable outlook reflects our expectation that the senior secured 
notes issue, along with a planned $1 billion credit facility, will fund the 
bulk of costs related to ongoing construction of additional ultra-deepwater 
drillships over the next two years.

Rating Action
On Nov. 12, 2012, Standard & Poor's Ratings Services assigned its 'B' 
long-term corporate credit rating to Luxembourg-based Pacific Drilling S.A. 
The outlook is stable.

We also assigned our 'B+' issue-level rating to subsidiary PD5's planned $500 
million senior secured notes due 2017. The recovery rating on the senior 
secured notes is '2', which indicates our expectations of substantial 
(70%-90%) recovery in the event of a payment default. Pacific Drilling will 
use proceeds of the senior secured notes to fund the construction of 
ultra-deepwater drillships.

Rationale
Our 'B' rating on Pacific Drilling reflects the company's "weak" business risk 
profile as a start-up oil and gas contract driller, and its "highly leveraged" 
financial risk profile.

In assessing Pacific Drilling's business risk profile, we believe the company 
is disadvantaged by:
     -- Its lack of an extended track record:, it has only booked revenues 
since the second half of 2011;
     -- Its narrow asset base: all of its rigs are ultra-deepwater drillships, 
and only four drillships are currently operational;
     -- Its narrow customer base of only three customers. All of them are 
investment-grade global energy companies, however, with solid competitive 
positions in their upstream operations;
     -- Its high degree of exposure to country risk in Nigeria and Brazil;
     -- Its exposure to the operating risks of the ultra-deepwater drillship 
sector, including potential startup problems related to its new drillships, 
and liability exposure in the event of a spill (notwithstanding the 
protections afforded by indemnification agreements and insurance coverage);
     -- The potential that currently favorable supply/demand dynamics in the 
ultra-deepwater drillship segment could ultimately lead to the development of 
excess production capacity industrywide; and,
     -- A lack of transparency with respect to the financial condition of 
Pacific Drilling's founder and majority shareholder, privately held Quantum 
Pacific Group (unrated), and Quantum Pacific Group's long-range strategy with 
respect to its stake in Pacific Drilling.

On the other hand, we believe that Pacific Drilling's business risk profile 
benefits from:
     -- The depth of industry experience among its top management group; 
     -- Currently positive fundamentals of the ultra-deepwater drillship 
sector, including secular growth in demand and limited new capacity, which 
support favorable day rate trends and high capacity utilization industrywide;
     -- The advantages afforded by Pacific Drilling's highly modern fleet, 
which is concentrated in ultra-deepwater drilling,  the contract drilling 
subsector with the most favorable near-term prospects presently; and, 
     -- Pacific Drilling's demonstrated ability to secure customer contracts 
and drillship construction contracts on relatively favorable terms compared 
with market norms.
 
In assessing Pacific Drilling's financial risk profile, we accounted for our 
expectation that credit protection measures will be very weak for at least the 
next two years. From 2012-2014, we expect negative free cash flow (that is, 
net cash provided by operating activities less cash flow used in investing 
activities) to total about $2 billion, assuming that there are incremental 
capital expenditures and debt-raising actions in 2013-2014 related to 
construction of additional drillships beyond those currently in operation or 
under construction. Based on our assumptions, definitions and adjustment 
methodology, we would expect gross debt-to-EBITDA to be very high at more than 
8x in 2013, and debt-to-EBIDA could well be over 6x in 2014. Given these 
expectations, we believe that prefunding its investment requirements with the 
$500 million senior secured notes issuance and planning to establish a $1 
billion credit facility would be supportive from a ratings perspective.

We believe that Pacific Drilling's cash flow dynamics could improve markedly 
beyond the next two years, as the company places three additional drillships 
into operation and investment requirements subside. We recognize management's 
stated intention to target debt-to-debt plus equity of approximately 30%, 
compared with a peak level that could approximate 50%. However, we perceive 
the pace of future leverage reduction to be highly uncertain. Further new 
drillship development could slow the pace of deleveraging considerably.
Liquidity
We view Pacific Drilling's liquidity as "adequate," as this term is defined 
under our criteria. Notwithstanding our expectation of substantial negative 
free cash flow over the next two years, we assume that the company will 
prefund near-term investment requirements on relatively favorable terms 
through the two planned financings. In our broad consideration of Pacific 
Drilling's financial flexibility, we take account of the company's 
demonstrated ability to tap the capital markets for debt and equity funding. 
We also account for the potential that if, contrary to our current 
expectations, Pacific Drilling were to experience temporary liquidity 
problems, that Quantum Pacific Group could possibly extend extraordinary 
financial support, given its continuing large investment in Pacific Drilling. 
On the other hand, financial flexibility is limited by the fact that virtually 
all of Pacific Drilling's assets are encumbered. Also, financial covenants 
under different borrowing agreements could be problematic under certain 
adverse scenarios. Moreover, the average tenor of Pacific Drilling's term debt 
is relatively short, and there are substantial debt amortization requirements.
Recovery analysis
The issue rating on the $500 million senior secured notes is 'B+'. The 
recovery rating on the notes is '2', indicating our expectation of substantial 
(70%-90%) recovery in the event of a payment default. 

Pacific Drilling's British Virgin Island-based subsidiary, PD5, is the issuer 
of the notes. The recovery rating on the secured notes will be primarily 
supported by a pledge of the stock of PD5, a first priority security interest 
in the Khamsin drillship, once it is delivered and until the construction is 
complete, assignment of all of the issuer's rights under the Samsung 
construction contract. The secured notes are also supported by an unsecured 
parent guarantee at the Pacific Drilling level. 

Our simulated default scenario assumes a default in 2014 following a cyclical 
downturn, coupled with operating difficulties, start-up delays, or other 
disruptions that cause Pacific Drilling's vessels to experience downtime, 
which reduces cash flows for the idled vessels. We value the drillships at 70% 
of the $630 million expected cost of the recent drillships. Furthermore, we 
have assumed bankruptcy enforcement costs of 15% to reflect delays and 
increased costs that might result from the company's exposure to multiple 
jurisdictions in terms of the company's operations, creditors and the 
deployment of the company's assets. Nevertheless, actual enforcement costs 
could well be higher given the concentrated asset base (one drillship) 
comprising the collateral and the jurisdictional and legal complications that 
could arise in seizing the vessel.

Under our analysis, the value of the collateral (approximately $375 million 
relating to the Khamsin drillship) represents slightly more than 70% of the 
$520 million (principal plus six months' interest) that we estimate would be 
due to the secured noteholders. Pacific Drilling's unsecured guarantee may 
represent an additional source of recovery for secured noteholders; to the 
extent Pacific Drilling's subsidiaries (other than PD5) have residual value 
after satisfaction of their respective debt obligations. The value at Pacific 
Drilling would be shared on a pari passu basis by the residual claims relating 
to the secured notes along with the other debt and guarantee related claims at 
Pacific Drilling. We expect approximately $445 million of value (includes $70 
million from Pacific Drilling's guarantee) would be available to satisfy the 
claims relating to the senior secured notes, suggesting a recovery that is 
close to the high end of the 70%-90% range.
Outlook
We believe a stable rating outlook is warranted, given our expectation that 
there is less than a one in three chance of either an upgrade or downgrade 
occurring within the one-year time frame-the period our outlook considers. 
Still, if we come to expect that Pacific Drilling will achieve and maintain 
debt-to-EBITDA of less than 4x --possibly through a combination of 
successfully starting up its new drillships and demonstrating moderation in 
its growth trajectory--we could consider an upgrade. Conversely, if we come to 
expect that debt-to-EBITDA would remain at more than 5x beyond the next two 
years, we could consider a downgrade.

Related Criteria And Research
     -- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
     -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
     -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008

Ratings List

New Rating; Outlook Action

Pacific Drilling S.A.
 Corporate credit            B/Stable

Pacific Drilling V Ltd.
 Senior secured              B+
  Recovery rating            2
 

Complete ratings information is available to subscribers of RatingsDirect on 
the Global Credit Portal at www.globalcreditportal.com. All ratings affected 
by this rating action can be found on Standard & Poor's public Web site at 
www.standardandpoors.com. Use the Ratings search box located in the left 
column.

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