Hercules Offshore, Inc. (HERO)
May 21, 2013 2:05 pm ET
Executives
Son P. Vann - Vice President of Investor Relations & Planning
Unknown Analyst
Let's get started here. Our next presentation will be from Hercules Offshore, and today, we have Son Vann, Vice President of Investor Relations and Planning here today. Son joined Hercules Offshore in June 2010 and appointed to Vice President, Investor Relations and Planning In March of 2012. Along with heading up Investor Relations, he's involved in various financing and strategic planning aspects of the company's M&A and capital markets initiatives. And the Gulf of Mexico jackup market has been surprisingly strong, so this a good time for his presentation. With that, I'll turn it over to Son.
Son P. Vann - Vice President of Investor Relations & Planning
Thanks, Paul, and I want to thank UBS for inviting Hercules Offshore to their conference and I also want to thank you guys for listening in on Hercules Offshore. I know there's another conference going on right now or another presentation going on right now, but I appreciate your attendance here.
Before I start, let me just remind everyone that I will be making some forward-looking statements from time to time, and these statements are [indiscernible] with risks, so please refer to our SEC filings for a more robust discussions of those risks.
So today, I'll be talking to you about Hercules Offshore, give you a general overview, go into deeper dive of our core segments, talk about a few strategic opportunities, and hopefully, we'll have some time for Q&A.
So Hercules Offshore, we are a global provider of jackup rigs and liftboats. We're probably best known as the leading provider of jackups within U.S. Gulf of Mexico where we have 19 marketed rigs. There's roughly about 50% of the market share in the Gulf of Mexico. We also have an international footprint in West Africa where we have 2 rigs, 3 rigs in the Middle East and 1 rig in the Southeast Asian market.
We're also the largest liftboat provider, with the largest market share in the U.S. Gulf of Mexico, largest market share in West Africa, and we have a growing presence in the Middle East with 3 vessels there.
Our operational expertise really spans most of the shallow water regions in the world. And with our 32% ownership investment in Discovery Offshore, it's very possible that we'll expand our operational expertise to the North Sea.
Now, to talk about our 2012 report card when it's May of 2013 might sound a little bit outdated but I think it's important to talk about what we've done in 2012 because that really keys up what we need to do in 2013. So what are some of the things that happened in 2012? Well, probably the biggest thing is our core market, the U.S. Gulf of Mexico jackup space really took off in 2012. Leading-edge rates has about gone up a lot 60% year-over-year. That momentum continues to carry forward into 2013. Backlog basically doubled. We began 2012 with approximately 4 months of backlog per rig. Today, it's roughly about 8 months and we see that trending very similar to where we're at today. Even utilization kind of improved year-over-year by about 10.5 basis points.
In terms of our balance sheet, we refinanced about $500 million of term debt about this time last year. The important part about that is that it really opened up a lot of flexibility for us in terms of getting additional investments in place, and we'll talk about some of those investments that we've done since our financing.
Fleet optimization, we're always in the market for opportunities for kind of tuck-in acquisitions. We were able to get the Ocean Columbia last year, and we've since placed that rig on long-term contract with Saudi Aramco at about $117,000 a day. We also sold several cold-stacked and kind of what we call unproductive assets, generated about $73 million there. The important part about these assets sales is not only does it kind of prune non-core assets but we were able to redirect those proceeds to more attractive investment opportunities. And we also kind of moved around some assets to markets that were more attractively priced.
So in 2013, some of the strategic objectives that we need to do in 2013 aren't too dissimilar sort of from what we need to do on an ongoing basis but that's really to kind of optimize our fleet both externally and internally. Externally, we're always, again, in the market to look for kind of tuck-in acquisitions either on the jackup side or the liftboat side. Internally, we have the opportunities to reactivate rigs in the U.S. Gulf of Mexico. And also we're always looking for opportunities to pare down the other remaining cold-stacked fleet that we have, as well as assets that are not quite core to our long-term prospects.
Balance sheet, just like your health, there's always room for improvement there. With 2013, we have $300 million of senior notes that are callable in October. More likely than not, we'll look to refinance that. Based on where the current market is, I mean, we could probably be looking at about somewhere between a 400-or-so basis points improvement from the coupon rate to where the current rate is right now, so looking forward to that. We also, with the improvement in our underlying business, we got a credit-rating upgrade earlier this year from Moody's. We got one last year from S&P. We're currently rated, corporate rating is around a B, so always opportunities there to improve that as well.
And the biggest thing this year that's probably on our plate is the management of Discovery Offshore. Discovery Offshore, for those that are not too familiar, we own 32% of this entity. Entity is -- has 2 rigs, high-spec rigs under construction. The first rig was recently completed, second rig will be completed in October. We still need to get contracts for both the rigs as well as secure long-term financing for that.
Now going back to kind of our optimization of our fleet. We've done a couple of transactions this year in terms of the M&A market that we're really excited about. The first transaction is the acquisition of Ben Avon which we named to the Hercules 267, purchased it for $55 million, put it on contract for $109,000 day. Pretty attractive rates of return in the low 20% range and this rig, I think, will have a lot of opportunities to re-contract beyond just the initial 3-year term.
The second acquisition that we announced earlier this year is of the Titan 2 liftboats, which we renamed the White Shark. It's a $42 million acquisition. This acquisition really checked a lot of the boxes. It's a fairly new asset, it was constructed in 2008. We know we need to renew our fleet both from the jackup side as well as the liftboat side and this was a good step in renewing our liftboat fleets. The demand for this vessel is very robust. In West Africa, the liftboat market is, probably next to the Gulf of Mexico, is the second strongest market globally. The demand for high-spec liftboats is probably even greater. This vessel is, I believe, about the third high-spec vessel in the region. Before we even signed the closing contracts for -- closing out the documents for this vessel, we already had several customers knocking on our door to get it. We put the rig -- put the vessel on its first contract at $65,000 a day, operating cost is in the midteens so very high margin, and we expect this vessel to generate very good rates of return for many years to come.
Not only do we look to optimize our fleet by growing it, but we also need to look for opportunities to prune assets where those assets aren't productive or aren't core to our business. We announced last -- yesterday morning, the sale of our Inland barge fleet. Basically, $45 million for 11 rigs. 3 rigs are working, 8 rigs cold-stacked. And really this acquisition -- this divestiture made a lot of sense. I mean, these asset classes are really structurally challenged. They've been structurally challenged for about 5 years now. And there's nothing on the horizon, in our opinion, that would change that dynamic anytime in the near future. Over the last 3 years, these assets have basically broken even on an EBITDA basis and after CapEx, they're slightly negative, cash flow, so obviously very poor returns. And with those poor returns, there's no wonder that's non-core to us. But more importantly, we can take that $45 million and feel very confident that we can redeploy that to more attractive assets.
So going through our core business segments more in-depthly, starting with the domestic market. The U.S. Gulf of Mexico has been in a structural decline in terms of jackup rig counts, probably for the last 12 years now. The count was really peaked out back in 2000 at about 150 jackups. Today, we're at about 40 jackups, probably closer to 35 if you strip out some of the workover rigs. And those jackups have basically been fully contracted now since the fourth quarter of 2011. The big change over the last couple of years is the -- on the demand side, I think the operators have shifted a lot of their joint activities to focus more on oil and liquids-rich type opportunities. And on the supply-side, obviously the overall decline in the rig count but also a consolidation of the players. Today, there's really only 2 main competitors, ourselves and Ensco. Rowan has a few rigs that we don't compete against on a day in, day out basis, but that's the big shift in the market dynamics there.
This is a snapshot of where the rig count is in the U.S. Gulf of Mexico today. Basically, there's about 60 rigs in the U.S. Gulf of Mexico. If you strip out the cold-stacked rigs which is about 20 and you strip out the rigs that are kind of earmarked for international mobilization, we really have a sub40 rig count marketed in the U.S. Gulf, of which, there's -- again, there's about 4 or so workover rigs, so really about 35 kind of drilling-capable jackups in the Gulf. And those rigs have been fully contracted now, really, since the fourth quarter. Hercules has 19 of those marketed jackups and we've been fully contracted on those 19 for quite some time.
The improvement in the U.S. Gulf of Mexico has really translated to a big step up in our backlog and dayrates. If you look at our backlog, it's been averaging now about 8 months on average per rig ever since late fourth quarter of last year. If you kind of looked at where we're at the beginning of 2012, we're probably about -- only about 4 to 6 months of backlog. So we've been able to grow backlog over the past year and we expect that trend to maintain.
With backlog comes dayrates. dayrates for our leading class of assets, the 200 mat cantilever has moved up probably from the $60,000 a day range to now about $102,000. We've moved it quite aggressively over the last year. I think we're seeing a bit of a period of consolidation on pricing right now for that asset class and we'll kind of reevaluate where pricing stands in the next month or so. Our other asset classes are 250 mat cantilevers, our recent picture saw a nice step up there to about $120,000 day range. And so the path is still upwards but the pace is probably not point to be similar to what we saw in 2012.
As I mentioned, there's been a big shift in the demand for jackups. The operators are really focusing in on crude or liquids-rich type opportunities, and it's no wonder why the price disparity between gas and crude oil is pretty well documented. On top of the -- that price disparity operators at the U.S. Gulf of Mexico also enjoy the benefits of selling that crude at Louisiana Light Sweet pricing, which surprisingly to some, is still priced with a premium relative to Brent, so these guys are getting pretty attractive pricing on their commodity.
If you look at some of our largest customers, Apache, Chevron, EPL, Energy XXI, they have a fairly significant amount of their shelf production in crude. So so long as crude prices maintain at their current levels, I think demand is going to be where you're seeing it today.
Customer base is probably interesting to look at. Historically, the top 3 customers in the U.S. Gulf of Mexico eat up about 1/3 to 40% of the jackup supply. Today, if you look at it, it's about 40%. So really, if you're in a 35-rig market, that really only leaves about 20 to 25 jackups remaining for everybody else. And if you look at our customer base in 2011, 2012, we have 35 customers to talk about and that's just Hercules so a lot of customers on a very small supply of rigs.
M&A activity, we look at this because it's a good barometer of activity on a go-forward basis. Typically, the sellers, they're not very active with their property base and the buyers will probably look to put a little bit more capital than their previous owners, which usually translates to more rig demand. So this chart is a little bit busy but respectively you're seeing a lot of activity on the M&A front, project exchanges in the U.S. Gulf of Mexico shelf. And the other interesting point about this is if you look at the oil and gas mix, a lot of this property has a pretty good component of oil. So just another indicator that the Gulf of Mexico these days is driven more by crude oil and liquids pricing as opposed to historically when it was more of a natural gas products.
We get a lot of questions on reactivations with the shrink in the U.S. Gulf of Mexico. When are we going to do our next reactivation? We recently completed our first reactivation, the Hercules 209. For the most part, it came in on time and on budget. And that will probably -- we'll probably get a full payback of our capital in about a 7 to 8 months kind of timeframe. The second reactivation, which we had previously earmarked, the Hercules 203, the capital cost on that is now currently estimated at about $20 million. If you look at the current dayrates for that asset class, that would probably equate to about an 11, 12-month type payback. Still pretty good return on our investment there but what I would say is, really, this is just math. What really we need to see to pull the trigger is that introducing this next rig, how that would kind of play into the overall supply/demand of the U.S. Gulf of Mexico jackup space. There's a few rigs in our market fleet right now that's of the same asset class, which has some contract availability. So more likely than not, we would need to see not just these rigs get contracted but we'd have to see the cold-stacked rig get some contract coverage on its capital cost as well. We won't reactivate a rig on spec.
Everybody probably knows that in this business, there's a lot of operating leverage and this is just an example of how much leverage you can get from just a few thousand dollars a day of movement.
Turning over to our international markets. International markets are very strong as well. As strong as the U.S. Gulf of Mexico is. I would probably say that international markets are, at minimum, keeping pace. The backdrop in the international jackup market is really supported by crude oil prices, and crude oil prices have been very resilient over the last couple of years. Probably more so -- probably just as important is the overall stability of the crude oil markets. You need -- for the national oil companies to increase their demand, you really need crude oil prices to not only be relatively strong, but you need some stability in that market, and that's what we're getting today. If you look at the international jackup rig count, we're well surpassed the prior peaks. Right now, there's about 380 rigs contracted in the international markets. If you look at the major regions, Middle East, Southeast Asia, West Africa, Mexico, they're all past their prior peaks. If you look at the major consumers of jackups, those are the NOCs, the Saudi Aramcos, the PEMEXes in the world and they have been very aggressive at adding to the rig fleet. If you look at what they've done over the last few years, they've basically doubled their rig count over that period.
One of the questions that we get asked often these days is that, with the strength in the U.S. Gulf of Mexico, that will cause rigs to mobilize to the U.S. Gulf of Mexico from other parts of the world. And the problem with that argument is that everything is relative. So when you look at the international markets, those international markets would have to be disadvantaged in terms of either dayrates or term structure for them to be attracted to go to the U.S. Gulf of Mexico. But when you look at those markets, both on a dayrate and on a term basis, they're at minimum equal to the Gulf of Mexico, and in many cases, they're much better than the U.S. Gulf of Mexico. So that's why it's hard for us to envision really a massive influx of rigs in the U.S. Gulf of Mexico. And when you layer in mobilization costs, when you layer in the opportunity costs, when you layer in higher labor costs, typically, it's very challenging to get insurance in the U.S. Gulf of Mexico. There's a lot of barriers right now that would suggest that you're not going to see a whole lot of mobilization to the U.S. Gulf.
This is a snapshot of our international rig fleet. As I mentioned, we have 6 working rigs internationally, 3 are in the Middle East. I'll just point out a few that I find interesting. The 2 in the Middle East, the 261 and the 262, they're contracted through the end of -- through the fourth quarter of 2014. We'll have opportunities to reprice there with Saudi Aramco. These rigs are currently earning about $80,000 a day. If you look at the current market for similar rigs, they're probably in the low $100,000, kind of around the $110,000 to $120,000 range, so we'll have an opportunity to up price there in the back half of '14. The 208 is in the Southeast Asian market. It's probably contracted through midyear this year. The operator has an option well that we -- right now we feel pretty confident that they're going to exercise. If they do exercise that option, that will keep the rig contracted through the end of the third quarter. After that, we'll probably take the rig to shipyard to do our special survey and beyond that, where we have a pretty attractive opportunity in the region that we're working on, we feel very good about that rig.
Discovery Offshore, 32% ownership interest in this. As I mentioned, the rigs -- the first rig has been completed. The second rig is due to be done with the shipyard in October. We're talking to several customers on contracting opportunities there. We'll need to finance these rigs as well so stay tuned on this.
North Sea is probably the market that these rigs will end up at some point. Right now, if you look at the availability of jackups in the North Sea, there's not a whole lot. Really, we're probably the only jackup that has 2012 availability -- 2013 availability off the spec.
Moving on to our Liftboat business, starting with our international liftboats. West Africa, the international liftboats is primarily driven by West Africa market. We have 20 liftboats in West Africa right now. We have 3 liftboats in the Middle East. The West African market is a very good demand market for the region. There is some risk involved in operating there, but we've been able to do very well in that market. The Middle East, we have 3 vessels there. The interesting thing about the Middle East market is that 2 of the 3 vessels, we recently contracted for basically 2 years which is really we've never seen that before ever. Margins in this business is very attractive. As you look at over the last 5 years, EBITDA margin has kind of ranged from a low of 40% to a high of 50%. Right now, we're running right around 45%, so very attractive margins there.
Domestic liftboats, a little bit more challenging market at this point, a little bit of an oversupplied market at this point. We've had a tough go at it over the last couple of years. But over the last 2 quarters, I think we're seeing signs that things are kind of picking up. We've been more aggressive at trying to price and I think some of that pricing is finally starting to show up in our margins.
So going through some of our corporate kind of initiatives in history, we've been a very acquisitive company since our formation in August of 2004. We took a little bit of a pause there after the financial crisis in Macondo but over the last couple of years, we've been successful at doing a few very attractive tuck-in acquisitions. And of course, we acquired our biggest competitor in the U.S. Gulf of Mexico, Seahawk, back in April of 2011.
We'll probably continue to always -- we're always looking for opportunities to add on to this, and it's just very opportunistic but that's just how it is in this market. We've been very judicious with our cash flow. We've been looking to pay down debt. We paid down over $400 million of net debt over the last 4 years in a very challenging operating environment. Some of that has been through asset sales with the recent announcement of the Inland sale. We're now up to about $260 million of asset sales since 2008.
Our debt structure, as I mentioned, we have about $870 million of debt on our balance sheet. $300 million of debt is callable in October. Current coupon on that is 10.5. If you look at where that instrument is trading right now, I think there's an opportunity there where we can possibly refinance that with about a 400-basis-points improvement, extend the maturities out. So we are hopeful that we can do that. We also have about a $68 million of convertible notes which will be callable to us or put to us probably at the end of this month. We have about $160 million of cash on hand so no issues with paying that instrument off.
So to wrap it up, U.S. Gulf of Mexico, very solid market, and I think that's going to continue for at least through 2013. 2014 is already starting to shape up to be a pretty good year. International jackup, market fundamentals are still very strong supported by very good, very solid, very stable oil prices. Hercules, we don't have a lot of recontracting opportunities other than the 208 this year, but we do have some recontracting opportunities in 2014.
Discovery Offshore, we're very focused on getting contracts for those rigs and subsequent financing for that, so we'll be talking to you soon about that.
Balance sheet, we did some work on it last year. We have opportunities to improve it this year as well and no presentation is complete without a plug to imagine.
So with that, questions?
Question-and-Answer Session
Unknown Analyst
The reactivations [indiscernible] rig, 206?
Son P. Vann - Vice President of Investor Relations & Planning
203.
Unknown Analyst
203? What kind of contract [indiscernible]. And do you need a 12-month contract to do that?
Son P. Vann - Vice President of Investor Relations & Planning
Yes, the reactivation time would probably run about 4 to 6 months. We do have several rigs that are scheduled to do their survey in the back half of this year. So if we pull the trigger now, it probably will be closer to 6-month timeframe. We do need a contract to pull the trigger. I don't think we need something of the 12 month duration that you referenced. I think our first reactivation, we pulled the trigger really after having only a 2-month contract, but we knew that there was demand behind that 2-month contract. So not so much a long-dated contract but we need to have some comfort that the visibility and demand for that rig is just going to be there beyond just the initial contract.
Unknown Analyst
Any other questions? All right. With that, thanks Son Vann and Hercules Offshore for presenting. Thank you.
Son P. Vann - Vice President of Investor Relations & Planning
Thank you.
News 
Market Data 
Discover 
AI
