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23 Mar 1998
MOODY'S UPGRADES FALCON DRILLING'S SENIOR UNS. NOTES TO Ba1 FROM Ba3 AND B1, AND UPGRADES SENIOR SUB NOTES FROM B3 TO Ba3. PROVISIONALLY ASSIGNS Ba1 TO FORTHCOMING $1 BILLION SR. UNS. NTS. OF R&B FALCON
New York, 03-23-98 -- Following review of R&B Falcon Corporation's (RBF) business and financing plan, Moody's Investors Service upgraded to Ba1 Falcon Drilling Company's two issues of 9.750% $110mm and 8.875% of $120mm senior unsecured notes, previously rated Ba3 and B1, respectively. Moody's also upgraded to Ba3 from B3 Falcon's $50mm of 12.5% senior subordinated notes. The outlook is stable.
The Ba1 ratings are also provisionally assigned to a contemplated $1 billion senior unsecured note offering, anticipated to be offered in varying maturities. The notes would fund a tender for all existing public debt, retire substantially all bank debt, and fund capex. Upon completion of the offering, the existing $400mm secured Reading & Bates revolver and the existing $210mm secured Falcon Drilling revolver will be prepaid and canceled. They would be replaced by an unsecured $500mm 5-year R&B Falcon revolver provisionally assigned a Ba1 rating. The new revolver would be undrawn following the offering.
The ratings are supported by Moody's expectation of continued relative strength in the international offshore drilling sector, new RBF's larger more diversified rig fleet resulting in wider participation in currently strong markets as well as spreading risks of potential market weakness geographically or by rig class. The rating is also supported by the fact that 42% of RBF's cash flows during 1998-2000 will be generated under long-term rig contracts.
However, the rating is restrained by RBF's ongoing substantial increases in debt, currently projected to peak at $1.5 billion by year-end 1998 and driven by its heavy capex schedule. Current debt policy signals a target debt structure substantially above investment grade competitors. The sector's extreme capital intensity, its current major capex burdens to offset rig attrition and to build new specialized rig classes, its disproportionate exposure to major worldwide geopolitical and market forces beyond its control, inherent cyclicality, and its difficulty in maintaining pricing power once sector utilization rates fall below 90%, cause Moody's to be sensitive to the comparative degrees of debt each firm employs during the current sector rebuilding and expansion phase. During this phase of growing sector capex commitments, the sector's equity market remains quite weak causing greater reliance by some firms on debt funding. Rig contracts mitigate some but not all the downside exposure of RBF's surge in debt.
In pursuit of lucrative deep water drilling contracts, RBF's expected 1998 debt levels of up to $1.5 billion will fund an aggressive new-build program weighted heavily towards 7 large ticket specialized drill ships for use in the still prototypical, comparatively thin, and still exploration-dominated deep and ultra deep water exploration plays. RBF's 1998 pro-forma debt structure is much higher than its investment grade peers, rendering 1998/99 debt coverages significantly below its peers at the current phase of the up-cycle and that are more vulnerable to reduced coverage in a correction. This vulnerability is tempered to a degree by RBF's contracted cash flows, assuming new build rigs are delivered within the time frame stipulated under the contract terms.
Most of the ultra deep water play largely remains in its early exploration phase. Major oil companies currently place ultra deep exploration projects in a very high priority position and are inducing the drilling sector to build a drill ship fleet sufficiently large to handle the current inventory of priority exploration targets. The major oils typically agree to rig contracts that typically fall substantially short of full payout and, amongst other reasons, the contracts can be canceled if new rig construction and delivery are significantly delayed. While such contracts do provide protection, under certain circumstances they are not irrevocable and could be subject to a degree of "share-the-pain" relationship pressure by major oil customers. Furthermore, as an extremely expensive exploration play, several variables remain to be tested, including exploration success and, therefore, the size of a follow-on deep water development drilling market essential for future full utilization of the growing drill ship fleet. Additionally, in weak price markets it remains uncertain how vulnerable both the major and smaller deep water players' drilling budgets could be to inevitable technological or geological drilling failures and to extended commodity price weakness.
Also, though Moody's believes RBF eventually will reduce debt levels, Moody's notes that RBF's current debt philosophy could induce it to take on additional large new build opportunities if they are backed by new drilling contracts. Continued debt-funded building, even into contracts, would delay Falcon's return to absolute debt levels deemed compatible with investment grade standing in this cyclical sector, until cash flows and earnings accumulate to reduce debt and leverage levels. RBF's major debt-funded investments, in pursuit of a currently lucrative but still-prototypical drilling sector, could ultimately expose the firm to greater business risks if deep water exploration disappoints. The ultra deep plays are still in their early days and the duration, cyclicality, and size of this market has yet to be seen.
Additional uncertainties for sustained drill ship utilization rates include: the current absence of a significant development drilling market in ultra deep waters and the deep water development drilling market's dependence on exploration successes yet to occur, the fact that some oil companies have historically preferred not to use drill ships for development drilling (preferring semi-submersibles), the inherent exposure to pressure by major oil customers to renegotiate contracts should exploration priorities change in a weak price environment, and the risk that one of several speculative drill ship building programs may get off the ground. Thus, Moody's believes investment grade standing will be postponed until RBF's performance and financial and investment policies bring it closer into line with its peers.
Current very weak crude prices are not likely to impact 1998 sector fundamentals though failure to correct back to historic mean real prices could impact some 1999 exploration drilling programs and/or the psychology of rig markets. And weak prices, assuming they correct in due course, could be fortuitous for the rig sector by forestalling the emergence of excessive optimism and overbuilding by major rig operators and by making it more difficult for independent builders of speculative new-build rigs to raise funding.
RBF's merger impacts favorably on industry structure and strengthens the combined firm's competitive and cost positions within that industry. The merger also diversifies the number of drilling markets the firm will participate in and intensifies the firm's participation in some of the strongest drilling markets. The new company will eventually operate 116 rigs with strong positions in shallow and deep water and transition zone markets in the Gulf of Mexico and worldwide.
The company's component of shallow water and non-premium rigs provide diversification but may be more vulnerable in a period of weak crude or natural gas prices. The firm's large mat supported jack-up rig fleet is ideally suited for Gulf of Mexico bottoms but is not competitive with independent leg jack-ups in most other offshore jack-up markets (where the firm's 9 independent leg jack-ups compete). An exception may be RBF's barge rigs which the producing sector needs to participate in the strong transition zone play. Additionally, Moody's observes that the U.S. Gulf of Mexico jack-up rig fleet competes in a market where short-term contracts are the norm.
Current day rate strength is supported by strong rig demand and supply forces arising from the intersection in 1996/97 of 15 years of global rig attrition, sustained growth in hydrocarbon consumption, continued shrinkage in proven but undeveloped reserves relative to deliverability requirements, and oil company's needs to exhibit volume growth to the equity markets. Day rates are further strengthened by simultaneous tightness in all global offshore markets and in virtually all rig classes. Moody's observes a higher risk of emerging weakness in markets, including the shallow Gulf of Mexico, the longer crude prices remain weak. Key to a return to more favorable crude market psychology is some sign that Venezuela and Saudi Arabia will avoid their current collision course of continuing to maintain full production to sustain their market shares. Until this week, Saudi Arabia and especially Venezuela have remained adamant that they will maintain and or grow production to protect their market shares. Earlier this week, Venezuela signaled it may be prepared to cooperate in some fashion.
RBF believes, 1998 EBITDA will grow substantially beyond $600mm, up from a normalized $442mm in 1997. Total debt will grow from $827mm on 12/31/97 to approximately $1.5 billion by 12/31/98 since $1.1 billion of 1998 capex and almost $100mm of projected interest expense will substantially exceed EBITDA. Actual 12/31/97 debt of $827mm was up from $522mm on 3/31/97 and was supported by $442mm of 1997 combined EBITDA (excluding $66mm of merger expenses) and $740mm of net worth. EBIT and net income for 1997 were $359mm and $164mm, respectively, before merger and asset disposal costs. The company took a significant write down in 4Q97 on disposal of its E&P business. Equity market capitalization approximates $4 billion.
Total Debt/Total Capital was 54% on 12/31/97 and will rise significantly in 1998 unless earnings gains keep pace with increasing debt levels. Considering current sector strength and earnings from an expanded rig fleet, it is plausible that Total Debt/Total Capital could rise to only 57% to 60% by 12/31/98 in spite of a 1998 surge in debt. Gross Debt/EBITDA was 1.9x on 12/31/97 and will increase to at least 2.2x to 2.4x, depending on 1998 EBITDA growth.
Pro-forma EBITDA/Cash Interest Expense in 1997 was 5.6x and, assuming RBF realizes EBITDA gains, this may be in the 6.5x to 7x range in 1998. Using pro-forma 1997 EBITDA and forecasted 1998 interest expense, EBITDA/Interest Expense would fall between 4.5x and 5x. EBIT covered 1997 interest expense 5.6x.
Reading & Bates and Falcon Drilling are both headquartered in Houston, Texas.
No Related Data.
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