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October 9, 2013
Stock Rating Catalyst Category Price Target Price (10/9/13): $35.96 Upside/(Downside): 50% Ticker: RDC Exchange: NYSE Industry: Energy Trading Stats ($USD millions) Market Cap: $4,467 Enterprise Value: $5,699 Price / Book: 0.9x Dividend Yield: 0% Price / 2013E EPS: 17.1x Price / 2014E EPS: 8.7x EV / 2013E EBITDA: 9.1x EV / 2014E EBITDA: 4.7x
Source: Company filings, Wall Street Consensus
Price Performance 52 Week range: $30.05 - $38.65 Analyst Details IB Username: Stilian Morrison Employer: Independent Analyst Job Title: Analyst Analyst Disclosure RDC Position Held: Yes
IB Equity Research
October 9, 2013
Company Overview
Rowan Companies is a major provider of offshore oil and gas contract drilling services internationally and provides its services utilizing a fleet of 31 self-elevating mobile offshore jack-up drilling units. The Companys primary focus is on high specification and premium jack-up rigs, which its customers use for exploratory and development drilling and, in certain areas, well workover operations. Additionally, the Company has four ultra-deepwater drillships under construction, the first of which is scheduled for delivery in December 2013. The Company conducts offshore drilling operations in various markets throughout the world including the U.K. and Norwegian sectors of the North Sea, Middle East, Southeast Asia, the United States Gulf of Mexico (US GOM), Trinidad and Egypt, among others. As of February 21, 2013, its fleet of jack-ups included 6 in the North Sea, 11 in the Middle East, 7 in the United States Gulf of Mexico, 3 in Malaysia, 2 in Trinidad, 1 in Egypt, and 1 in Indonesia.
$46
$43 $40 $37 $34
6.0 5.0
4.0
3.0 2.0
Market Overview
Offshore Drilling Market
E&P spending (both on- and offshore) is invariably tied to prevailing price trends for crude oil and to a lesser extent (especially for offshore) natural gas. The correlation is generally positive, but stickier to the upside. There generally has not been much lag effect either.
IB Equity Research
October 9, 2013
$600
WTI Crude
Offshore drillers compete on price, equipment quality and capability. The determination of competitive niches typically starts with the capability as it relates to water and drill depth as well as a rigs adaptability to particular weather conditions. The North Sea, for instance, is a drill market where mainly high-spec jack-up rigs, capable of absorbing punishing waves from inclement weather, operate. Younger fleet is typically of a higher quality and offers the added engineering redundancy that operators seek from contracted managers in a post-Macondo world. Competing on price will then depend on the contract tenor and the efficiency of the given rig crew as it relates to operational uptime and personnel costs (insurance and other expenses are mostly fixed and relatively di minimus). Capital allocation and intensity are the names of the game here. Todays rigs are generally split between drillships, semi-submersibles, and jack-ups. Drillships are completely independent (i.e. they dont need to be towed to site) and most regularly drill at ultra deepwater (UDW) depths in excess of 7,500 feet. UDW un its total 119 today (including a few semisubmersibles). Together with 176 midwater and deepwater semisubmersibles, they comprise the broader rig category of floaters. Unlike floaters, jack-ups (so named because they can be raised above the ocean surface on their three legs) represent a single equipment category totaling 396 active units, but which can also be bifurcated by their capability for drill depth (above and below 300-350 feet) and environmental tolerance. At todays projected day-rates, these bifurcations impact the payback economics that capital allocators must consider. UDW drillships and High-Spec Jack-ups offer superior economics with estimated EBITDA payback multiples of 5.5x-6.5x the implied values (Source: Pareto Securities; Rig Quarterly; August 22, 2013). The UDW market has operated at or near full capacity for some time now, and utilization is expected to remain robust in the high 90s through 2015-2016 as most newbuilds will enter the market in 2016 and beyond while near-term backlog is already largely contracted. Most of todays newer jack-ups also enjoy 90%+ utilization rates, but there is an observable preference for high-spec rigs that is manifesting out of the need to manage more challenging wellbores. In addition, many of the newbuilds are high-spec rigs that are virtually all contracted to meet open market demand and in turn r eplace an aging fleet. Among todays active jackups, ~55% of the global fleet is more than 30 years old.
($ in billions)
$500
($/bbl)
IB Equity Research
October 9, 2013
Floater Utilization by Water Depth
IB Equity Research
October 9, 2013
2007-2013E RDC EBITDA Bridge
$1,200
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$800
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Management is now contemplating the option to extend the window for committing to a fifth drillship that would likely cost around $750MM (if exercised) and require additional financing beyond the current debt stack. Yields on the existing debt are attractive at 4.5% such that funding the commitment for this I-grade credit should not be a problem if undertaken. My sense from conversations with the Company is that this decision will not be seriously considered until the fourth drillship is first contracted. Furthermore, the decision itself is not viewed as mutually exclusive of an option to reinstate the Companys dividend, which last ran to the tune of $0.60/share (1.7% yield today) in 2008 and would cost just over $70MM.
IB Equity Research
October 9, 2013
Valuation
Overview
We believe it is most appropriate to value the Company by the pro forma asset quality that represents the source of the earnings transformation and market bifurcations in rig classes. Based on the comps (see appendix), the implied market values assigned to the UDW fleet of various drillers ranges from $650$860MM, with pure play drillers at the low end due to their credit-specific issues of stress (e.g. Ocean Rig). We know that Rowan is spending $750MM per vessel with 75% of that fleet already contracted and worth roughly $400MM per year in guaranteed EBITDA for the 3-year terms (barring a major disruption that leads to downtime or repairs). Yet, the market implied value per drillship is currently $638k, less than the levels of highly levered drillers like ORIG. The story is the same for the core high-spec fleet: a deep NAV discount on the market that is inconsistent with the fleet quality. On a forward multiples basis, the upside is less meaningful, but still substantial. We believe this is indicative of the relatively uncertain earnings environment past 2015 during which most UDW and jack-up newbuilds in the pipeline are estimated to come to market. A lot of this backlog remains uncommitted and subject to deferral/dismissal and there is a cycle of replacement stock that has to be worked through for aged rigs. Nevertheless, we ascribe meaningful weight to the multiples used. The DCF is largely an imprecise black box due to the timing of Rowans capital cycle, but we nonetheless ascribe some weighting to determine our target estimate of $54/share.
Multiples
EBITDA 1,207 6.0x $ 7,242 1,006 (2,000) (238) $ 6,010 124.212 $ Net Inc $ 514 12.0x
Net A
2015E Metric Multiple Implied TEV Cash Long-term Debt Underfunded Pension Implied Equity Diluted Shares O/s
$ 6,173 124.212
Implied Price/Share
48.39 $ 49.70
IB Equity Research
October 9, 2013
$ 99.67 $ 61.95 $ 79.48 $ 94.83 $ 94.05 $ 92.14 $ 99.67 $ 98.00 $ 90.54 $ 86.08 $ 83.72 $ 82.35 $ 8.90 $ 4.16 $ 4.38 $ 4.04 $ 2.75 $ 3.45 $ 3.68 $ 3.94 $ 4.14 $ 4.27 $ 4.38 $ 4.51
$ $ $ $ $ $
$ $ $ $ $ $
$ $ $ $ $ $
$ $ $ $ $ $
209 129 117 122 128 142 928 11 939 718 431 45.9%
$ $ $ $ $ $
$ $ $ $ $ $
$ $ $ $ $ $
$ $ $ $ $ $
$ $ $ $ $ $
$ $ $ $ $ $
$ $ $ $ $ $
$ $ $ $ $ $
1,209 2 $ 1,211
1,029 14 $ 1,043
1,000 18 $ 1,018 $
1,474 37 $ 1,511
1,530 35 $ 1,565
1,767 37 $ 1,803
2,461 37 $ 2,498
2,550 37 $ 2,587
2,466 37 $ 2,502
2,466 37 $ 2,503
731 60.4%
639 61.2%
601 59.0%
704 46.6%
754 48.2%
910 50.4%
62 66 79 88 100 114 125 128 669 $ 573 $ 522 $ 343 $ 541 $ 589 $ 629 $ 782 55.2% 54.9% 51.3% 36.5% 38.8% 39.0% 40.2% 43.4% (366) 303 $ (167) 406 $ (89) (296) 433 $ 47 $ (350) 191 $ (333) 257 $ (399) 230 $
(400) 382 $
(400) 807 $
(400) 836 $
(400) 696 $
IB Equity Research
October 9, 2013
$ $ $ $
$ $ $ $
5% 24% 60%
6%
0.9x $
638 $
(1) Source: Rig Quarterly ; Pareto Securites (2) Includes newbuilds in the pipeline. Other rigs are excluded as they are either zero or a di minimus part of mix for all drillers Note: Fred Olsen financials translated at USD/NOK rate of 6.11
Risk Factors
Oversupply
The visibility for utilization begins to blur somewhat once one looks past 2016 to a host of newbuild rigs that remain uncontracted in some cases. Contract terms have come down from 5 to 3 years and it seems prudent to expect that day-rates will begin to decline among UDW and premium jack-ups. Rowan does have the advantage of playing in defensible regions like North Sea and recent steps taken to reduce operating downtime provide a greater cushion against potential declines in utilization and day-rates.
Commodity
Crude is back to its annual 2008 highs and there is no question that E&P spending is experiencing resultant euphoria. There is, however, some historical precedent for oil and gas spending to show resilience to macroeconomic pressures as evidenced by a 15% decline in the face of a 48% decline in crude during 2009.
Geopolitical
Rowans leading customer is Saudi Aramco (29% of revenue) and the Company has a heavy Middle Eastern presence in some potentially volatile areas. In the event of disruption, some rigs may be mobilized to safer regions with open demand and all units in the fleet are adequately insured for loss or damage with a $25MM deductible.
Operational
Rowans jack-up fleet is the second youngest in the industry (behind Seadrill) and its new drillships are equipped with the latest in redundancy engineering (two seven-ram blowout preventers) to mitigate the risk of a Macondo-like incident.
IB Equity Research
October 9, 2013
Conclusion
Rowan is priced at a discount to the inflection point that it currently faces in asset and earnings quality. Its conservative investment grade capital structure supports execution of a transformative fleet capex program that will bring the Company into the lucrative UDW drillship market. There are no hard-hitting catalysts beyond the discernible ship deployments and the market has stood pat as a result. However, the focus on earnings has obscured the quality of the pro forma asset base. Other competitors are being credited for their more aggressive budgets, but we prefer our drillers to be conservative in their capital budgeting, particularly with todays inverted oil futures curve. We prefer to get in here early rather than be late to the party.
IB Equity Research
October 9, 2013
Appendix: DCF
DCF Valuation
Oct-13 10yr Tsry Beta ERP WACC Perpetuity growth rate Terminal multiple LTM EBITDA EBIT*(1-tax) Depreciation Stock comp Capex NWC/Other UFCF Discount Factor Sum PV UFCF $ 15 Perpet Terminal Rate Multiple $ 8,226 $ 8,272 8.0x (0.3%) $ 6,079 $ 6,113 2.7% 0.75 5.8% 6.0% (0.3%) 8.0x $ $ 629 $ 782 $ 1,207 $ 1,236 $ 1,096 $ 1,034 Dec-13 Dec-14 Dec-15 Dec-16 Dec-17 Dec-18
137 $ 349 $ 609 $ 631 $ 525 $ 479 133 320 400 400 400 400 19 37 37 37 37 37 (931) (1,521) (850) (400) (400) (400) 32 (65) (126) (17) 16 (0) $ (611) $ (880) $ 71 $ 652 $ 578 $ 516 0.9869 0.9315 0.8791 0.8296 0.7830 0.7390
Average Terminal Value Impl. terminal multiple/perpet rate PV Terminal Value Implied TEV Cash Long-term Debt Underfunded Pension Implied Equity Diluted Shares Outstanding Implied Price/Share $ $ 6,096