October 30, 2016 - 2:19pm EST by
2016 2017
Price: 1.60 EPS 0 0
Shares Out. (in M): 47 P/E 0 0
Market Cap (in $M): 75 P/FCF 0 0
Net Debt (in $M): 1,372 EBIT 0 0
TEV ($): 1,447 TEV/EBIT 0 0

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  • Offshore Oil and Gas
  • winner


Let’s start with a few caveats;
-I have no strong opinion on the intermediate time-frame price of oil. I’ve read a lot on the topic and
guys make great arguments for any price between $30 and $80. On one extreme, TDW is potentially
worthless, on the other extreme; it’s a 30-bagger. My hunch is that some oil price near the middle of
this range is the correct answer with plenty of volatility along the way, potentially leading to some great
trading spikes in TDW. More importantly, while the oil price leads drilling demand, the OSV industry can
be (and historically has been) very profitable at much lower oil pricesas long as supply and demand
balance out.
-I am not doing a deep dive analysis of TDW. Sorry for you fundy guys. This is a binary outcome and I aim
to prove that TDW is a great lottery ticket to play for a recovery in offshore drilling demand and the
risk of a near-term bankruptcy is greatly overblowngiving you plenty of optionality.
-Offshore Service Vessels (OSVs) are a mediocre business in the best of times. This isn’t a great
compounder of capital or anything.
-There is a not small chance that I’m wrong and TDW goes bankrupt
-With that out of the way, I expect to get a rating between 2 and 3 on this write-up.
Background on the thesis
Over the years, I’ve learned that every time there is a near universal belief that some sizable industry
will cease to exist, the sector usually bounces back (except for when it involves technological change).
More often than not, after an appropriately brutal beat-down has been administered by Mr. Market,
those who are willing to take a chance on survival have been greatly rewarded in these circumstances.
Much like in coal, all you had to do is survive long enough to see the recovery. I feel that the OSV
industry is much like this.
If you were to have a basket of similar situations over time, I think that about 30% of the time, you get a
complete wipe-out, about 30% of the time, you get so diluted that the recovery basically gives you your
money back and 40% of the time, you get a 5-20 bagger. One of these outcomes pertains to TDW
which one?
OSV industry
TDW is the largest global player in the OSV industry with roughly 10% of the total industry’s boats.
Offshore oil production accounts for roughly 30% of the world’s total oil production. For much of the
past few decades, the number of offshore rigs and OSVs increased roughly in tandem. Starting in 2010,
the rate of increase accelerated in both sectors. As more complex rigs were produced, the number of
OSVs needed per rig increased as well, leading to a higher OSV/Rig ratio as the rate of OSV production
increased faster than rig production.
Then, in late 2014, the bottom fell out of the oil market. Rig usage has consistently declined as existing
contracts are not renewed or even cancelled. This has meant that overall demand for OSVs has
collapsed at the same time that a glut of OSVs has come on the market. Based on data from IHS-
Petrodata, as of September 2016, there was a global OSV population of 3,496 and 446 working rigs
leading to an OSV/Rig ratio of 7.84 or somewhere in the mid-6’s if you exclude about 650 older OSVs
(25+ years) that are likely not being used. This compares with a prior ratio in the 3.0-4.0 range for much
of the past few decades. Based on newer rig types that are more OSV intense, the likely range for a
future balancing is the 4-5 range currently.
Like all industries in oversupply, this oversupply in the immediate term, has been met with a sharp
drop in new ordering and the mothballing of older and inefficient vessels. In the medium term, it will
likely be met with consolidation. I don’t want to speculate on what oil price is needed to incentivize an
increase in rig usage, but various experts seem to think that a sustained price level in the $55-$65 range
is necessary for usage to increase, while a consistent price in the low $55 range will lead to a level of
stability based on current rig usages. An increase in usage following the cold-stacking of hundreds of
boats will naturally tighten up the market as there are substantially expenses necessary to take a cold-stacked
boat and make it operational againleading to a slow ramp-up. A balancing at current levels of rig usage
at current priced should eventually balance out OSV economics. OSV operators were very profitable as recently as 15
years ago when oil prices were sporting a 20 handle, as there was a balance between rigs and OSVs,
leading me to believe that it isn’t strictly the price of oil that determines profitability—rather, it is a
balancing of supply and demand.
It should be noted that the overall cost of OSVs in the total cost of offshore drilling is insignificant when
compared to day rates for rigs in the hundreds of thousands. As day rates for drill rigs have dropped
dramatically, the overall cost of offshore drilling has dropped as well. The OSV industry is rather
indifferent if the deep-water offshore day rate is $700k or $100k as long as the rig is getting used. I
suspect that as drill rates drop, more companies will start to drill againeven if oil bounces around at
the current level of $50 as the economics start to work againleading to an increase in OSV usage.
Additionally, while it’s hard to quantify, there has been a marked increase in global permits issued for
offshore wind generation. The construction and maintenance of these facilities will need OSVsthough
it is hard to quantify the magnitude of demand and is likely irrelevant to this thesis as the build-out
won’t ramp up for a few years.
For most of the period from 2008 to 2014, the shares traded between $40 and $60 giving TDW a market
cap of $2b to $3b. As recently as the year ended March 2016, TDW had $253m of OCF down from
$358m of OCF in the year ended March 2015 before maintenance expense and which is mostly included
in OCF. TDW has one of the newest fleets in the industry (average age of 249 newer vessels out of 266 is
8.1 years). As of June 2016 their fleet and other capital assets have a purchase cost of $4.696 billion and
a fully depreciated value of $3.475 billion after over $150 million in impairments over the past few
quarters. The net tangible book value is $1.852 billion or $39.35 per share compared with a current share price of $1.60.
Key components of Balance Sheet As of June 2016 ($ millions)
Cash 669
Receivables 202
Supplies + Current Assets 69
Total Current Assets 940
Net Properties & Equipment 3475
Other Assets 84
Total Assets 4499
Accounts Payable 54
Accrued Expenses 72
Due to affiliate 197
Accrued liability losses 3
Current portion of debt 2041
Other Current 64
Deferred Income Tax 42
Other Liabilities and Deferred Credits 174
Total Liabilities 2647
Net Book 1852
Net Book Per Share $39.35 
I think that the June 2016 quarter likely represents near-trough economics for the industry and TDW
was roughly break even on an OCF basis if you subtract increased costs for debt negotiations and
interest expense for the $600m revolver draw-down. I suspect there were also a lot of costs recognized
during the quarter related to the dramatic down-sizing that was undertaken and these costs will trail off
as the company has now right-sized to its new utilization structure.
Anecdotally, the industry seems to have stabilized around here to slightly lower than June as more
vessels are cold-stacked offsetting fewer rigs, leading to consistent or slightly better utilization at lower
day rates (or at least, that’s what I can tell from various industry publications). However, I wouldn’t be
surprised if things continue to slip slightly further south over the next few quarters. Fortunately, the
rally in oil from the $20s to around $50 has seemed to stabilize rig usage somewhatthough at much
lower day rates.
It is worth noting that bankruptcies in an industry like dry bulk or cargo shipping only move the boat
from one set of hands to another. I bet you that with a few hours of phone calls, I could get any boat
contracted with an operator who will get me a crew, cargoes, etc. That’s why bankruptcies in shipping
don’t help supply. OSVs are about safety record, service quality, utilization, etc. related to much more
expensive sets of equipment like a drill rig. Therefore, there is real franchise value and knowhow for
someone like TDW who is the industry’s largest player. A round of industry bankruptcies will only help
TDW as you cannot simply take a boat and crew it and operate it like you can in dry-bulk or cargo. If a
smaller player fails, the boats will get cold-stacked and overall supply will drop as there isn’t much
demand to buy new ones today, when everyone already has too many boats.
If oil can find an equilibrium around here ($50/bbl) to slightly higher, the industry should bottom in the
near-term as rigs will stop coming out of the market, making TDW highly undervalued on a book value
basis at book of $39.35 (assuming it can survive that long). Metrics like cash flow seem less relevant as
there is no cash flow at the bottom in a highly cyclical industry like OSVs. Even assuming a cyclical
recovery to .2x book gets you roughly a 5-bagger from here.
This isn’t like a drill rig that borrowed money based on one day rate and now is insolvent because
those day rates are impossible without $100 oil. All you need is for demand to stabilize at an equilibrium
that allows OSVs to earn some return on capital. For a point of reference, 15 years ago, the OSV industry
was very profitable at a time when oil sported a 20’s handle.
Debt Negotiations
On Friday, October 21st, after the close, TDW put out a PR that sent the shares down by roughly half on
the following Monday. I think the market has completely misinterpreted this PR. For some back-story,
the company is in violation of its covenants related to EBITDA coverage ratios. They have $669m of cash
and $2.041 billion of debt as of June 2016 for net debt of $1.327 billion after drawing down $600m on
the revolver in March before the covenant breach. They have paid their interest on time and have no
near-term maturities. Normally, in a situation like this, the company begs forgiveness, pays a fee along
with a higher interest rate and gets an amendment that allows it to march on with life for long enough
to see if industry conditions get better or worse.
TDW is in a funny situation as there is no senior lender. In this case, there are 8 separate lenders who
are all pari-passu for seniority and none is secured. This means that an amendment requires all lenders
to sign on. On TDW’s side, they want relaxed covenants for an extended period of time and the ability to
keep some cash from the revolver drawdown while returning the restbasically they want to set things
up so that there isn’t a BK in the future. On the lender side, they want various fees, increases in interest
rates, changes in maturities and most importantly security over TDW’s vessels in case they decide to
push for a CH 11 sometime in the future.
The PR specifically said the following, which seems to have spooked shareholders;
The company has previously reported that progress was being made in its negotiations with its
principal lenders and noteholders to obtain the covenant relief sought; however, recent industry data,
including data regarding projected levels of offshore drilling activity, a primary driver of activity within
the offshore service vessel (OSV) industry, has led the company to conclude that important debt
terms will require further negotiation. While the company will continue to work toward amendments to
its various debt arrangements that will be acceptable to all parties, there is a possibility that the
lenders, noteholders and the company will not be able to negotiate new debt terms that are
acceptable to all parties, in which case the company will have to consider other options, including a
possible reorganization under Chapter 11 of the federal bankruptcy laws.
I take this to mean that they are going to continue to talk and the worst case is that there is no
agreement on November 11 and they get another grace period to keep talking. TDW wasn’t happy with
the terms offered and wanted something more. The talk of a BK is just something the lawyers put in to
cover everyone’s legal risk. This was subsequently confirmed from speaking with management.
If the lenders wanted to push a CH 11, they would have done it already as they’ve now had 4 extensions
of the grace period. The lenders are mostly made up of banks and insurance companies (it is all PP debt
and doesn’t trade much). These aren’t the type who want to take over an OSV company and operate
itnor do they want to liquidate it into an amazingly soft market for boats. If they were to stack the
fleet, the value would deteriorate rapidly. The best outcome from them is to have a roughly break-even
(from a cash standpoint) OSV company that continues to plod onwards while keeping all debts current
so that the banks don’t need to take any impairments on their balance shsets.
In many ways, the lenders are stuck and a BK is the worst case scenario for them. A BK also has negative
consequences for TDW when bidding for new business or even continuing their existing business and
some contracts likely have cross-default provisions where the rig operators can break contracts
following a BK, further hitting cash flow. Finally, since the lenders are unsecured, they get lumped into
the bucket with all other creditors. While payables and whatnot aren’t extreme, the lenders want a
senior position if this becomes a BK in the future—they don’t want to go in unsecured. The best scenario
for lenders is a higher interest rate, some fees, and lots of collateral coverage. I think they’re actually
pretty close in the discussions and year-end is coming up, which may force the hand of some lenders as
they don’t want impairments on their books. The issue is that with so many parties to the negotiations,
it’s hard to get everyone to agree at the same time—however, I really don’t think anyone wants a
bankruptcy unless things get much worse as no one gains anything from it.
In the end, this may very well end up as a BK, but with a current market cap of $75 million, the downside
is likely limited on the day of a filing as many currently BK energy companies trade with similar market
caps even after the BK filing. Even in a BK, I suspect that there’s recovery for shareholders, as we’ve seen
with Hercules (HEROQ) and likely Paragon (PGNPQ). 37% of the float of TDW is short, so any sort of good
news (successful amendment of covenant breach, increase in oil prices, change in rig utilization, etc.)
could lead to an explosive recovery in the shares. I suspect that this is a situation with 30-50% downside
on the day it goes BK (if it goes BK) and potentially 10-fold or more upside in the next 18 months if oil
can creep up a few dollars from here. As I said at the beginning, a good basket of these types of
situations will over time reward an investor if they can avoid the wipe-outs. From speaking with
management, I get the impression that they want the company to survive until the industry revives and
will do whatever is needed to avoid a BK. In essence, Mr. Market is already valuing this as a BK, when it’s
far from there currently.


I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.


Recovery in demand for OSV services

Debt settlement agreement

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