Seadrill (SDRL-NYSE) is a $3.4 billion offshore drilling company from Norway, currently headquartered in Houston, TX, and trading on the NYSE. The company is expected to generate ~$500M in EBITDA and ~$200M in FCF in 2023. More importantly, as Seadrill’s contracts roll off within the next 24 months, the company could generate FCF of ~900M, representing nearly 1/3 of the current EV. Seadrill also has a net cash position, making it unique amongst publicly traded offshore companies and giving it significant strategic advantages over its near-bankrupt competitors. All-in-all, this investment could return 175-200% within the next 2 years based on historically conservative 10x NTM FCF or 7-8x EV/EBITDA multiples, stable market day rates, and excluding additional upside coming from what could be up to ~$1.5B in buybacks.  

The Company

The offshore industry enjoyed a great run from the early 2000’s all the way to 2014 with day rates peaking at $600k-$700k for 6^th and 7^th generation floaters and ~$200k for premium jack ups. However, the music stopped abruptly when oil prices went from ~$105/bbl. in 2014 to a low of ~$35/bbl. in 2016 causing up stream capex for offshore projects to plunge. With no new investment in addition to an overblown rig count that was fueled by market participants’ irrationality in the final innings of this bull run, rig utilization rates dropped from 88% in 2014 to ~50% in 2017 and drill ships day rates consequently decreased from $700K to $150K and from $200K to $40K for jack-ups in 2017. Until the end of 2021, days rates never really picked up due to the oversized rig count as well as oil prices constantly below the former offshore industry’s breakeven oil price of roughly 60$/bbl.  

As there was nowhere to hide, Seadrill first needed to restructure $12B debt in 2016. Due to uneconomic day rates remaining, the restructuring was not sufficient, and the company initiated a second restructuring in February 2022. Subsequently, SDRL had $944M in loan and $486M in cash, providing enough flexibility for the company to embark on a floater-focused fleet remodeling strategy that is yet to be completed as I am writing. Starting with 21 owned units, the company first sold 7 jack ups in September 2022 for ~$700M or $100M/unit.

In December 2022, Seadrill then acquired Aquadrill for $958 million via an all-stock deal, which resulted in the addition of 5 floating rigs and 3 tender-assisted rigs, which were later resold for $85 million. With these strategic initiatives completed, Seadrill now has a high-spec floater-focused fleet with fourteen floaters comprising of ten drill ships and four semi-submersibles, representing 11% of the global floater’s market.  Other than the 14 units just discussed, SDRL has 5 high-end jack-ups it wishes to sell in the near term and three of them are already subject to active sales negotiation in Quatar. Finally, the company’s balance sheet is now rock-solid with a net cash position composed of $697M in cash and only $608M in debt that include a recently refinanced $500M’s 8.375% fixed rate notes maturing in 2030.

Today’s Landscape

Although the last decade has been very painful and explains why investors are not enthusiastic about the industry and the company, the landscape is now completely different.

The offshore industry is heavily driven by both the high prices of oil today and the need for more oil supply after years of underinvestment. Indeed, the latest 120-pages EIA’s Annual Energy Outlook Report points repeatedly that new offshore project sanctioning is expected to increase from a decade low of $69B in 2020, to $151B in 2023, and a decade-high of $226B in 2026 assuming a conservative $70/bbl. Looking at individual companies’ reports, you will also read that nearly all  new massive projects are offshore as it is where most of the big untapped reserves left are. In addition, the industry's economics have been improved by the use of new offshore techniques since 2014, with a breakeven oil price now hovering around the low $40s, enabling companies to not only produce oil but also gas in a lot of projects.

With respect to rig supply, the market is much more constrained than before. In fact, practically no new rigs had been built since 2015 and more than 300 rigs of all types have been scrapped since then because fleet maintenance was not even economical. For the floater market specifically, the number of rigs has decreased by 43% from 281 in 2014 to 159, which is one of the main reasons for Seadrill's interest in the market segment. As a result. the utilization rate for active drill ships has reached 94%, and today's day rates have skyrocketed from $150k in 2020 to $450k. For Semis, the active utilization rate is much lower at 73%, but day rates are already approaching $400k as rig location and specifications are paramount. Indeed, the supply for these rigs is inelastic considering that: (1) it costs over $100M just to prepare a rig currently idle for a contract; (2) there are practically no shipyard that can built a rig as no order were made for more than 8 years and; (3) It is estimated that building a new high-spec drillship will take over three years and cost more than $1 billion. To justify a billion-dollar rig investment, multiple market participants recently said that it would require a 90-95% utilization rate couples with $650k-$700K day rates for a period of 25 years which is nowhere near today’s market conditions.

Investment Case

As Peter Lynch once said, “you can’t go bankrupt if you don’t have debt” and this quote seems to perfectly fit Seadrill’s case given it has a ~$260M net cash position and no maturity until 2030. Even if the market sees this company and its industry as extremely risky, Seadrill is already profitable and owns the youngest fleet in the industry (10Y avg) and is definitively in high demand judging by (1) its $2.2B contract backlog, (2) a current utilization rate of 93%, and (3) that 77% of the company’s operating capacity is already booked for 2024 and 55% for 2025. Not only do Seadrill’s rigs generate revenue from being active, but it also means that the significant fleet reactivation’s capex is already done. Moreover, because Seadrill is not strap for cash or in urgent need of more revenue, the management said that its remaining three idle rigs (including one held-for-sale jack up) will only be reactivated once they have signed contracts that are profitable enough to justify the reactivation investments. In contrast, many players still have a substantial portion of their fleet lying idle and will be require spending up to $100M per rig only for them to become available for contracts.

On the upside, the market value of SDRL’s fleet based on recent transactions is approximately $8.8B and its replacement cost is north of $13B. Under the assumption that drill ships and semis have steady day rates of $450k and $400k, Seadrill has the potential to generate annual EBITDA of $100M per drillship and $70M per semi. After considering corporate expenses, the company's consolidated operation could produce an EBITDA of approximately $1.18B and a FCF of $900M. Accounting for the five jack-ups that are held-for-sale, total EBITDA would be closer to $1.35B and FCF would be over $1B. To get there however, the company must renew its contract, of which ~50% are up for renewal before year-end 2024 and more than 90% of its contract will be repriced by year-end 2025. Therefore, earnings should really take off in 2025 with what could be $800M to $900M of EBITDA and FCF of $500M to $600M, before reaching $1.18B in EBITDA and FCF of $900M in 2026 assuming no jack-ups left.

Valuation & Potential Return

Finally, Seadrill is already doing a fantastic job on investors’ behalf with its $500M buyback program, representing 16% of its market cap. If the company was to use the $500M to $600M it should receive from its future jack-ups sales, in addition to the ~$500M in FCF it should generate by the end of 2025 to buyback more share, the current share count could be cut in half and the company would still have no net debt. Regarding valuation, offshore peers are currently trading at 7-8x EV/EBITDA despite much higher debt and capital expenditure required going forward. Applying this multiple to Seadrill, the company could potentially be priced close to $9B by year end 2025, which is in line with its fleet's current market value and lower than its replacement cost. In other words, this net cash and profitable investment opportunity could provide a return of 175-200% within 2 years with room for much more upside from either buyback, higher day rates or higher multiple.