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Rating Action:

MOODY'S ASSIGNS Ba1 WITH NEGATIVE OUTLOOK TO R&B FALCON'S PROPOSED SR. UNSECURED NOTES; CONFIRMS OTHER RATINGS

10 Dec 1998
MOODY'S ASSIGNS Ba1 WITH NEGATIVE OUTLOOK TO R&B FALCON'S PROPOSED SR. UNSECURED NOTES; CONFIRMS OTHER RATINGS Moody's Investors Service assigned a Ba1 rating, with negative outlook, to R&B Falcon Corp.'s (FLC) proposed $400 million senior unsecured note offering; the notes will be offered in up to three tranches, in maturities likely to range from four to ten years. Also with a negative outlook, Moody's confirmed FLC's Ba1 rating on $1.1 billion of existing senior unsecured notes (detailed below), its Ba1 rating on an amended $350 million partially secured bank revolver maturing 2002, its Ba2 rating on Cliffs Drillings' senior unsecured notes, and its Ba3 on FLC's remaining senior subordinated notes. The senior implied rating is Ba1with a negative outlook.

The ratings leave little room for material construction, operating, rig contract, or cash flow disappointments, or for debt-funded expansion beyond currently announced plans. The ratings would be pressured if leverage and cash flow targets are not met, or if bank collateral rises materially above the proposed $100 million level. The rating anticipates rising debt and leverage, approximating $2.2 billion on-balance sheet and $2.7 billion on- and off-balance sheet in both 1999/2000. Moody's anticipates 1998 EBITDA/Cash Interest Expense of 4.7x, and falling approximately to 3.8x in 1999 before rising in 2000. The new senior notes provide term funding that was to have been provided by an announced but cancelled trust preferred offering and by one cancelled project financing. The bank facility agreement and note indentures permit substantial further indebtedness. The ratings are presently supported by FLC's large scale, prominence, diversification, asset value coverage, and the prospects for stronger 2000 and 2001 cash flows if new deepwater rigs under construction are delivered into existing term contracts.

As discussed in Moody's press releases/analyses of 4/7/98 and 3/23/98, the original Ba1 ratings anticipated the need to accommodate a combination of innate and substantial operating, contract, construction, sector, and financial risks embedded in FLC's business and funding plans, as well as the potential for additional newbuild rigs. These risks already materialized, resulting in substantial cash flow shortfalls from plan; construction cost overruns, delays, and abandonments; further intensified leverage; and a lengthened period of time FLC will be very highly leveraged (absent substantial equity issuance or strategic action). Still, assuming FLC can now complete its deepwater fleet without further material problems, it delivers those rigs into their existing contracts, it eschews further debt-funded expansion (especially another speculative newbuild), and if shallow water markets firm, FLC believes debt reduction from cash flow could begin in late 2000. Nevertheless, a key caveat remains, namely that term drilling contracts remain subject to cancellation, renegotiation, or relationship pressure by oil companies if those companies can justifiably conclude that rig/rig crew performance, safety, or availability did not meet standards stipulated in the contract.

About 39% of FLC's projected cash flows during 1999-2001 would be generated under term contracts, mostly from deepwater newbuilds. The rating would be at risk if (absent substantial common equity issuance) 1999/2000 cash flows disappoint, FLC takes on additional material on- or off-balance sheet debt for additional newbuilds, FLC debt-funds acquisitions, a material amount of contracted revenue is cancelled or materially renegotiated, and/or if costly construction problems recur. Each could further bloat leverage.

Moody's treats FLC's $531 million share of three important off-balance sheet debt structures (totaling $770 million) as effectively on-balance sheet, strategically important, obligations. These obligations fund three important newbuild rigs to be delivered into three of FLC's most important deepwater contracts, and whose earnings are an important part of FLC's future. These obligations also receive substantial explicit financial support from FLC.

With financial leverage, FLC continues its expansion into the deep water segment, creating what it believes will be its most lucrative business, the deep and ultra-deep water segment. FLC also is consolidating its position in the currently weak shallow water segment with the Cliffs Drilling acquisition. The expansion is partially supported by cash flows from existing businesses (now under sector pressure) but current and visible projected leverage is high for the rating and will rise aggressively into 2000 as deepwater rig capex outpaces cash flows.

FLC's financial flexibility could further decline. FLC now estimates peak debt lasting into late 2000/early 2001 before expected new deepwater revenues can make a dent in debt levels. Excluding over $500 million of off-balance sheet debt, Total Debt/Cash Flow may range from a very low 0.15x to 0.20x in 1999 to a still aggressive 0.25x to 0.35x in year 2000. Amongst other operating improvements, the higher coverage ratios would require domestic jack-up rates to rise 100% from current very low levels and deepwater rigs to be completed on-time and delivered into existing contracts.

Regarding off-balance sheet debt, two synthetic leases and one project financing each fund newbuild deepwater rigs strategically important to FLC, and each financing required the direct financial and implicit support of FLC. The fundings include FLC's 100% share of a $250 million project financing of the RBS8M fifth generation semi-submersible newbuild, its 60% share of the $260 million Deepwater Frontier synthetic lease, and its 50% share of the $258 million Deepwater Pathfinder synthetic lease. The synthetic leases take out construction funding. FLC provides residual value guarantees totaling $190 million on its portions of the synthetic leases, provides an indemnity of a $250 million surety bond during construction of the RBS8M, and it is strategically important to FLC that debt service is covered on all three financings.

Given the nature of the contract drilling business and the current extended period of oil price uncertainty, Moody's is sensitive to the degrees to which each contract drilling firm becomes financially extended while funding expansion. The sector's extreme capital intensity, its vulnerability to its customers' exposure to petroleum prices; its lack of pricing power when segment rig utilization rates fall towards or below approximately 90%, and its exposure to global forces beyond its control cause most competitors to avoid high leverage.

Also, current shallow water uncertainty and, importantly, deepwater rig supply and demand dynamics in the 2002-2005 period, add risk to the pace at which FLC can de-lever with internal funds during the post-2001 time frame. More completed deepwater rigs will be available and some will already be off contract, yet the vital emergence of growth in deepwater development drilling demand remains dependent on scale exploration success largely yet to be seen. In the meantime, the sector's equity market remains weak, causing greater reliance on debt funding and extending length of time FLC is highly leveraged.

The important deepwater contracts mitigate some but not all the downside risk of FLC's high leverage. However, these contracts are not irrevocable, are not full-payout, require FLC to meet minimum performance standards, and their economics could erode if FLC experiences further construction cost overruns/delays. Additionally, these contracts tend to be with major oil firms with great market power, and could face a degree of "share-the-pain" relationship pressure from a major oil if sector conditions worsen or priorities change. Much of the deep and virtually all of the ultra-deep water play remains in its early exploration phase. The growing attraction of potential Saudi and Kuwaiti projects could eventually internally compete with an oil major's own deepwater activity for drilling capex, having the potential to impact higher risk/higher cost deepwater activity.

FLC's component of shallow water barge and jack-up fleet, and its non-premium semi-submersibles provide substantial diversification but are more vulnerable in a downturn. Additionally, thirteen jack-ups currently under contract to Global Marine's turnkey drilling business at attractive dayrates will come off contract during 1999.

FLC's leverage bridges to either sector equity and rig market recoveries and/or strengthened 2000/2001 cash flows. Moody's anticipates FLC's 12/31/98 on-balance sheet short and long-term debt will exceed $2.2 billion, with net debt approximating $1.8 billion. Combined on- and off-balance sheet net debt would reach or exceed $2.75 billion in 1999 through 2000. Moody's expects capex to exceed cash flow through most of 2000 before flipping to a potential debt reduction mode from cash flow in late 2000. EBITDA/Cash Interest Expense declined to 3.6x in 3Q98 and may decline further in 1999. Combined debt will also climb faster than cash flows since new deepwater contract revenues will probably be offset by further weakening of shallow water cash flow as 13 jack-ups come off contract with Global Marine. On-balance sheet Total Debt/Total Capital had risen to 64% by 9/30/98, with Total Gross Debt and Total Net Debt to Total Capital approximating 63% and 52%, respectively, on 12/31/98. Net Debt/Capital will subsequently rise as note proceeds are consumed in the building program.

Specifically, with negative outlook, Moody's confirmed the Ba1 ratings on FLC's $250 million of 6.5% notes due 2003, $350 million of 6.75% notes due 2005, $250 million of 6.95% notes due 2008, and $250 million of 7.375% notes due 2018. Moody's also confirmed the Ba1 rating on FLC's $500 million senior unsecured bank revolver maturing 2003, the Ba2 rating on Cliffs Drilling's $200 million of 10.25% senior unsecured notes due 2003, and the Ba3 rating on Falcon Drilling's remaining $17 million of senior subordinated notes.

R&B Falcon Corporation is headquartered in Houston, Texas.

No Related Data.
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