S&P: Oilfield Services Company Shelf Drilling Downgraded To 'CCC'; On Watch Neg On High Probability Of An Exchange Offer
At the same time, we lowered our issue rating on Shelf Drilling's first-lien US$200 million revolving credit facility (RCF) to 'CCC+' from 'B+', our issue rating on Shelf Drilling's US$475 million senior secured notes to 'CCC' from 'B', and our rating on the US$350 million term loan facility issued by Shelf Drilling Midco Ltd. to 'CC' from 'CCC+'.
The recovery rating on the first-lien US$200 million RCF is unchanged at '2' with recovery prospects in the higher half of the 70%-90% range. The recovery rating on the US$475 million senior secured notes is unchanged at '3' with recovery prospects in the lower half of the 50%-70% range. The recovery rating on the US$350 million term loan facility issued by Shelf Drilling Midco is unchanged at '6' with recovery prospects in the zero-10% range.
All the issue ratings were placed on CreditWatch with negative implications.
The three-notch downgrade reflects our view that there is a high probability that Shelf Drilling will perform an exchange offer, although there is still uncertainty on the outcome of such negotiations. This follows the company's announcement that it is currently negotiating with certain significant debtholders regarding its capital structure. We would most likely treat this as a distressed exchange offer, since we view market conditions as challenging and we forecast Shelf Drilling's EBITDA will continue to fall in 2016-2017. This will most likely strain the company's ability to refinance its sizable debt maturing in 2018, in our view. We think that low oil prices will continue to materially affect Shelf Drilling's ability to maintain utilization and day rates, extend or renew contracts, and sign new contracts on favorable terms.
The company also announced that it had made an upstream dividend payment of US$100 million to the parent company, Shelf Drilling Ltd. We view this negatively because this unforeseen decision to upstream liquidity could jeopardize paying debtholders on time. Because the parent is not a guarantor of the term loan, the dividend renders this cash inaccessible to debtholders at this time. As a result, we have revised our management and governance assessment on Shelf Drilling to weak from fair. We note that this dividend payment could prompt the decision to pay in kind (PIK) the interest due on its term loan in September (about US$18 million). Under the terms of this facility, if the average daily balance of Shelf Drilling Midco's consolidated unrestricted cash continues to be less than US$100 million for the next 30 days, Shelf Drilling Midco has the right to pay the interest in kind. While we would not view such in-kind payment as a default, we do not think it boosts Shelf Drilling's ability and willingness to pay its subsequent obligations on time. We note that immediately following the dividend, the unrestricted cash of Shelf Drilling Midco and its restricted subsidiaries was approximately US$65 million.
We recognize that Shelf Drilling has visibility on 2016 revenues. However, the active fleet under contract has already declined to 28 vessels, as three vessels are now cold stacked (shut down and stored in a harbor, shipyard, or designated offshore area) and another six are off contract. The company's backlog decreased to US$2.0 billion on June 30, 2016, down from US$2.3 billion on Dec. 31, 2015 (US$3.2 billion in 2014). Moreover, we expect average day rates to decrease further in the coming few quarters, and note that day rates on new contracts in 2016 were much below the average day rates of the entire fleet.
Our assessment of Shelf Drilling's financial risk profile as highly leveraged reflects our forecast that leverage will increase markedly in 2016-2017 to at least 8x, and that discretionary cash flows (DCF) will be negative on average in 2015-2016.
Our assessment of Shelf Drilling's business risk profile as weak reflects its participation in the competitive, fragmented, and capital-intensive oil and gas drilling industry, its limited business diversification, with shallow-water (jack-up) drilling activities only and little diversification by depth, and a relatively old fleet, the average of which is 35 years. Cash flows in the jack-up segment can be volatile, and we perceive heightened pressure, as companies are exposed to both contract risk and the risk of oversupply. Shelf Drilling's diversified geographies of operation (and its focus outside the U. S. including in the Arabian Gulf, which we view as positive), supports the business risk profile, as does our perception of its strong relationships with a diversified customer base, its sound market position and strategic focus as the No. 2 jack-up driller in the world, its focus on production activities as opposed to exploration (which is more vulnerable to cuts, in our view), and its management's significant industry experience.
The CreditWatch reflects our view that there is a high likelihood of an exchange offer to restructure Shelf Drilling's capital structure in the next few months or quarters, and that we would likely see this as tantamount to a default according to our definition. However, we would most likely not view a PIK interest payment in September 2016 as a default. This also factors in our view of persisting challenging market conditions, weakening EBITDA and backlog, and our more pessimistic view on contract cancelations and renewals.
We aim to resolve the CreditWatch shortly after any exchange offer is made, or otherwise in the next 90 days.
We could lower the rating on Shelf Drilling by at least one notch and to as low as 'D' if we believe that an exchange offer is almost certain in the near term.
We could affirm the rating and assign a negative outlook if we see the possibility of an exchange offer as remote in the short term. In case of an unforeseen transaction in which the debtholders did not obtain less than the original promise, we could potentially raise our rating most likely by one notch, depending on the new capital structure.