|Shares Out. (in M):||0||P/E|
|Market Cap (in $M):||2,100||P/FCF|
|Net Debt (in $M):||0||EBIT||0||0|
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Songa Offshore (“Songa”) is a Norway-listed company which operates four
“mid-water” offshore drilling rigs and one drill ship in each of
|2006 - 2009|
|Midwater (<3,000 ft)||68||73||85||91||90||92||93||0.7%|
|Deepwater (>3,000 ft)||79||80||94||101||105||112||130||8.8%|
From the demand perspective, the backlog for mid-water rigs has increased significantly in recent years. In January 2005, the average mid-water rig was booked for approximately 200 days. By January 2006, this had increased to 400 days, and by August 2007, the backlog was 600 days. The tight market has resulted in drastic day rate increases. In 2006 mid-water day rates ranged from $200,000 to $250,000. In late 2007, rates rose to a range of $350,000 to $435,000 and were at the upper end of that range in tight markets like the North Sea and
. With newbuild costs up 25% since 2005, limited rig building capacity, and customers’ use of a $40 per barrel oil price assumption in their project approval process, we believe mid-water drilling will remain robust for the next few years. Australia
|Drill||Day Rate ($000)||EBITDA|
|(1) Bareboat contracts under which the customer assumes operating costs.||249||441|
Songa has contracts (including options)  on its rigs for 98%, 45%, and 20% of 2008, 2009, and 2010, respectively. Initially, management aggressively sought contracts in 2009 and 2010 but was hindered by launch delays of one to eight months on three rigs. The silver lining is that mid-water day rates have continued to increase (approximately 80% since the beginning of 2006). Having achieved utilization rates in the mid-90% range on its recently launched rigs, the company is poised to sign contracts for 2009 and 2010 at higher rates relative to 2008. The previous table shows significant day rate improvements for all rigs in 2009. With operating leverage, the higher day rates in 2009 translate into an 80% and 100% increase in EBITDA and free cash flow, respectively.
|% Contract Coverage||98%||80%||60%|
|Free Cash Flow||175||345||372|
|Net Debt / EBITDA||2.1||1.1||1.0|
Songa could achieve 2009 and 2010 contract coverage of 80% and 60%, respectively, as contracts are signed for Venus, Trym, and Mercur. Based on $442 million of EBITDA in 2009, the company will be levered at only 1.1x net debt to EBITDA. Assuming the company pays out 100% of net income (less than 85% of free cash flow) as an ordinary dividend, the market could value the company at a yield of 8% to 10%. While there are no direct yield-based comparables in the offshore drilling sector, we believe these yield assumptions are reasonable relative to yields in the shipping industry which are approximately of 10% despite the fact that the “Dry Bulk Index” of day rates has increased 3x since January 2006 (tanker rates have been stable over the same period). High cash dividends clearly enhance valuations, resulting in 10x EBITDA multiples for highly cyclical businesses. Relative to shipping, we believe 8% to 10% yields for Songa are reasonable. These yields imply a price of NOK 142 to NOK 177 assuming a 2009 ordinary dividend of NOK 14.17.We believe Songa provides a unique capital return opportunity in a business with robust end markets, and a management team and anchor shareholder who are highly aligned with shareholders. It is also worth noting that Songa has significantly underperformed comparable offshore drillers since 2006, despite having higher leverage. Since 12/31/06, Songa has returned 16% versus 83% for Transocean and 53% for Noble Corp. In US dollar terms, Songa has performed better (+36%) but it still a laggard relative to the sector. We believe the next 9-12 months are a unique inflection point for the company as it differentiates itself from peers by securing high contract coverage and aggressively returning capital.
 All options are likely to be exercised as they are “in the money” compared to current market rates.
 While some drillers have returned significant cash to shareholders, they have not returned it in the form of a structured ordinary dividend. Offshore drillers such as Transocean, Noble, GlobalSantaFe, Diamond Offshore, Ensco, Pride, and Rowan all have ordinary payout ratios of less than 15%.
 In a 4/17/07 note, Merrill Lynch estimates offshore drillers would trade at ordinary dividend yields of 8.5%. In a 4/2/07 report, Morgan Stanley estimates offshore drillers would be valued at ordinary yields of less than 9%.DISCLAIMER: This does not constitute a recommendation to buy or sell this stock. We own shares of the company and we may buy or sell shares at any time. Any projections are our estimates, and should not be relied upon.
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