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20 Nov 1998
MOODY'S CONFIRMS R&B FALCON'S Ba1 SR. UNSECURED NOTE & BANK RATINGS, AND Ba3 SR. SUB. RATING; UPGRADES CLIFFS DRILLING'S SR. UNSECURED NOTES TO Ba2; OUTLOOK NEGATIVE
New York, November 20, 1998 -- Moody's Investors Service confirmed R&B Falcon Corp.'s (FLC) Ba1 rating on $1.1 billion of senior unsecured notes and provisionally assigned a (P)"ba3" rating to an announced but yet-to-be-filed $300 million trust preferred shelf. The senior implied rating is Ba1. The ratings leave little room for further material construction or operating disappointments, or debt-funded expansion beyond announced plans. The rating anticipates rising debt and leverage, approximating $2.1 billion on-balance sheet and $2.6 billion on- and off-balance sheet in both 1999/2000, with some reduction in debt service coverage through 1999. The ratings outlook is reduced to negative from stable.
As discussed in Moody's press releases/analyses of 4/7/98 and 3/23/98, the Ba1 ratings anticipated the need to accommodate a combination of innate and substantial operating, construction, sector, and financial risks embedded in FLC's business and funding plans, as well as the potential for additional newbuild rigs. These risks 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, Moody's believes debt reduction from cash flow could begin in late 2000.
Thus, the ratings are currently supported by FLC's large scale, prominence, diversification, solid asset value coverage, and the anticipation of stronger 2000 and 2001 cash flows from new deepwater rigs (now in construction) delivered into term contracts. 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, and/or if costly construction problems recur. Each would 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.
The risks Moody's built into the original Ba1 materialized and continue and FLC's financial flexibility at the assigned ratings could further progressively decline. FLC now estimates peak debt lasting into late 2000/early 2001 (exceeding $2.6 billion of on- and off-balance sheet, $2.1 billion of on-balance sheet debt, and a substantial anticipated trust preferred offering), before expected new deepwater revenues make a dent in debt levels. Excluding over $500 million of off-balance sheet debt and trust preferreds, 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 RBS8 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 surety bond during construction of the RBS8, 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 commodity 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 do mitigate some but not all the downside risk of FLC's high leverage.
Though vital, these contracts are not irrevocable, 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 much 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 from completed deepwater rigs on contract. Moody's anticipates FLC's 12/31/98 on-balance sheet short and long-term debt t exceed $1.8 billion, rising to approximately $2.1 billion in 1999 and 2000. Substantial additional funding beyond that is required and will apparently be provided by a possible trust preferred offering in 4Q98. Combined on- and off-balance sheet debt, plus preferreds, 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 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. And debt, both on- and off-balance sheet, will climb faster than cash flows as new deepwater contract revenues likely will face further weakening of shallow water cash flow, especially as the 13 jack-ups come off contract with Global Marine. On-balance sheet Total Debt/Total Capital had risen to 64% by 9/30/98.
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. Moody's also upgraded to Ba2 Cliffs Drilling's $200 million of 10.25% senior unsecured notes due 2003, and confirmed the Ba3 rating on Falcon Drillings remaining $17 million of senior subordinated notes. A fully-drawn $150 million bank facility funding construction of the Millennium, a newbuild drillship, is not rated.
Thus, Moody's believes investment grade standing for FLC awaits performance, and financial and investment policies, that bring it closer in line with its peers. Investment grade standing would not occur before major deleveraging and strengthening of debt coverage.
R&B Falcon Corporation is headquartered in Houston, Texas.
No Related Data.
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