Songa Offshore SONG NO
April 23, 2008 - 12:04pm EST by
johnv928
2008 2009
Price: 76.50 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 2,100 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

Songa Offshore (“Songa”) is a Norway-listed company which operates four “mid-water” offshore drilling rigs and one drill ship in each of Australia, the North Sea, and Western Africa. Songa has a total enterprise value (“TEV”) of $2.1 billion and is expected to generate 2009 revenue and EBITDA of $643 million and $442 million, respectively. We believe Songa has over 100% upside because: (i) Songa is likely to start paying 100% of earnings as a structured ordinary dividend which will re-value Songa on dividend yield (current stock price at ~18% yield on 2009 dividend), (ii) operating risk is declining as the company secures high-priced contracts, and (iii) Songa is guided by an exceptional management team and anchor investor with a track record of returning cash to shareholders.

  • Robust Mid-water Offshore Market: The table below shows historical and projected supply of rigs in three segments of the offshore drilling market. Jackup and deep-water supply is projected to increase by 62% and 29%, respectively, from 2006 to 2009. Supply of mid-water rigs, Songa’s segment, will remain flat. Meanwhile, ODS-Petrodata estimates mid-water demand will outstrip supply by 15 rigs in June 2008.

















2006 - 2009


2003
2004
2005
2006
2007
2008
2009
CAGR

















Jackups
332
335
358
359
370
395
420
5.4%
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 Australia. 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.
  • Below Market Contracts: Songa was founded by Arne Blystad, a Norwegian investor, who initially recruited managers from Transocean and Frontline to acquire, refurbish, and operate mid-water rigs ahead of an anticipated tightening in the market. Between April 2005 and May 2006, Songa acquired and signed initial contracts for the Venus, Mercur, Saturn and Dee rigs. Trym was acquired in December 2006. Relevant data on the rigs is shown below.



Drill


Day Rate ($000)
EBITDA
Rig
Depth (feet)
Availability
2008
2009
2008
2009













Saturn
3,750
Q4 2009
403
403
103
99
Venus
1,500
Q3 2008
248
400
48
91
Mercur
1,500
Q1 2009
331
400
78
91
Dee
1,800
Q1 2011
42 (1) 425
14
105
Trym
1,200
Q1 2009
50 (1) 313
17
67








Corporate Expense:
(12)
(12)













(1) Bareboat contracts under which the customer assumes operating costs.
249
441

Songa has contracts (including options) [1] 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.

  • Rational Management focused on Return of Capital: Management is typically a significant risk in any offshore driller investment. Most managers overspend on “gold-plated” newbuild projects, maintain low contract coverage so as to retain a “call option” on further increases in day rates, and retain too much cash. Songa is unique because Arne Blystad, who owns 22% of the company, and the management team, which owns 7%, have a track record of rational capital allocation. Blystad is a reputable Norwegian investor with success in a number of shipping-related sectors, including chemical tankers, dry bulkers and crude tankers. Tom Jebsen, Songa’s CFO, was previously the CFO of Frontline, a Norwegian shipping company that pioneered large ordinary dividend payouts for shipping companies. The team has already demonstrated its financial acumen with Songa by: (i) acquiring assets cheaply ahead of a significant tightening in the mid-water segment, (ii) circumventing a restriction on share repurchases under the bond indenture by executing total return swaps on 5 million shares (8% of the float) when the stock was trading poorly, (iii) redeeming a bond to give the company financial flexibility to pay ordinary dividends, and (iv) re-domiciling the company from Norway to Cyprus to lower the tax rate and facilitate quarterly dividends. We believe management is poised to return significant capital in 2008. We are especially pleased because management’s recent actions suggest they are focused on returning cash via ordinary dividends as opposed to share repurchases or special dividends, maximizing value for shareholders.
  • Yield-Based Valuation: Songa currently trades at 5.4x 2009 P/E and a 22% 2009 free cash yield. This compares with multiples of 9x P/E for comparable companies in the United States and Norway, implying a 40% discount. Songa’s current discount is primarily due to investor impatience with the delayed launch of rigs and relatively low contract coverage in 2009 and 2010. The following table shows our financial projections.



2008
2009
2010
Revenue
365
660
690
% Contract Coverage 98%
80%
60%
EBITDA
249
441
462
Net Income 115
286
313
EPS (NOK)
5.70
14.17
15.51
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[2], 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[3]. 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.


[1] All options are likely to be exercised as they are “in the money” compared to current market rates.

[2] 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%.

[3] 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.


Catalyst

- New contracts
- Return of capital
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    Description

    Songa Offshore (“Songa”) is a Norway-listed company which operates four “mid-water” offshore drilling rigs and one drill ship in each of Australia, the North Sea, and Western Africa. Songa has a total enterprise value (“TEV”) of $2.1 billion and is expected to generate 2009 revenue and EBITDA of $643 million and $442 million, respectively. We believe Songa has over 100% upside because: (i) Songa is likely to start paying 100% of earnings as a structured ordinary dividend which will re-value Songa on dividend yield (current stock price at ~18% yield on 2009 dividend), (ii) operating risk is declining as the company secures high-priced contracts, and (iii) Songa is guided by an exceptional management team and anchor investor with a track record of returning cash to shareholders.

















    2006 - 2009


    2003
    2004
    2005
    2006
    2007
    2008
    2009
    CAGR

















    Jackups
    332
    335
    358
    359
    370
    395
    420
    5.4%
    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 Australia. 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.



    Drill


    Day Rate ($000)
    EBITDA
    Rig
    Depth (feet)
    Availability
    2008
    2009
    2008
    2009













    Saturn
    3,750
    Q4 2009
    403
    403
    103
    99
    Venus
    1,500
    Q3 2008
    248
    400
    48
    91
    Mercur
    1,500
    Q1 2009
    331
    400
    78
    91
    Dee
    1,800
    Q1 2011
    42 (1) 425
    14
    105
    Trym
    1,200
    Q1 2009
    50 (1) 313
    17
    67








    Corporate Expense:
    (12)
    (12)













    (1) Bareboat contracts under which the customer assumes operating costs.
    249
    441

    Songa has contracts (including options) [1] 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.



    2008
    2009
    2010
    Revenue
    365
    660
    690
    % Contract Coverage 98%
    80%
    60%
    EBITDA
    249
    441
    462
    Net Income 115
    286
    313
    EPS (NOK)
    5.70
    14.17
    15.51
    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[2], 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[3]. 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.


    [1] All options are likely to be exercised as they are “in the money” compared to current market rates.

    [2] 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%.

    [3] 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.


    Catalyst

    - New contracts
    - Return of capital
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