Value Investors Club / TIDEWATER INC (TDW)

Description

lottery ticket on an offshore recovery. I then exited for more than a double less than 5 weeks later, as it

looked increasingly likely that a BK was the ultimate outcome here (thank-you short squeeze). Please

see that write-up for more details.

I think it’s time to look at TDW again as it has emerged from bankruptcy with the best balance sheet in

the industry (net cash of $460m cash vs $451m debt), covenant light, with no near-term maturities, while it wrote down its vessels so

egregiously in the bankruptcy process that it trades at a silly fraction of replacement cost on newish

equipment (237 vessels with a 9.3 year average age—though the more valuable equipment is a few

years younger). Additionally, there is only $4m outstanding on a $4 billion new ordering program that

ended in 2017 and basically bankrupted the company.

I have no strong opinion on the price of oil or when an offshore recovery will happen—though it does

seem as though we’re past the worst in both regards. In the end, there’s a place for offshore oil

production globally and that will require offshore service vehicles that a global OSV firm like TDW

provides. Following TDW’s exit from bankruptcy, you can buy that equipment at 22% of net depreciated

value of $3.5 billion before bankruptcy and impairments. My hunch is that it should trade at something

closer to book value than 22% (say 50-70% of book) as the offshore recovery picks up moderate steam.

For a point of reference, the stock traded at 1-1.5 times book for most of its history until 2014 when oil

prices hit the skids. Finally, in Q3/2017, the company operated at roughly cash-flow neural if you

remove bankruptcy and restructuring costs. Therefore, TDW is no longer a melting ice cube and any

marginal recovery should push it over the line to be cash flow break even.

Apologies in advance if I don’t have any fancy earnings or cash flow models here. Either you think the

equipment has value or you don’t.

Balance Sheet (all numbers in $USD) (sorry that I cannot seem to format this)

Cash 460.0

Trade & Receivable 120.3

Due From Affiliate 245.1

Marine Operating Supplies 31.1

Other Current Assets 14.8

Investments in Unconsolidated 25.7

Net Properties and Equipment 868.7

Deferred Drydock .4

Other Assets 46.8

Total Assets 1812.9

Accounts Payable 39.4

Accrued Expenses 61.1

Due To Affiliate 112.6

Accrued Liability Losses 2.8

Current Portion of LT Debt 5.2

Other Current Liabilities 38.0

LT Debt 445.7

Accrued Liability 2.6

Other Liabilities 62.6

Total Liabilities 770.0

Net Assets 1042.9 $34.73 per share (30m shares outstanding)

Net Cash 9.1

Net Assets – Equipment 174.2

Net Book Value with equipment at $3500m depreciated Value $174.2 + $3500 = $3674.2m

Net Book Value per share with equipment at $3,500 $122.47 per share

Why the sector will recover?

Let’s face it, I have no idea if offshore ever recovers to 2014 levels. However, I don’t think you need that

to happen in terms of TDW. All you need is for a marginal recovery in the number of total rigs, while the

supply side in terms of vessels trails off.

On the demand side, at the peak in 2014, there were roughly 700 operating rigs. Today, roughly 420 are

operating and this number has now stabilized and even started to recover slightly from the lows. I

believe that the number of operating rigs will ultimately stabilize at around 500 total based on an oil

prices in the $50-60 range. This is due to offshore costs dropping rapidly while onshore shale pricing is

seeing some cost inflation which should get both sectors to normalize costs in the same range. If

anything; offshore is actually cheaper now per full cost of a barrel produced, offset by the need for

substantial upfront capital which shale doesn’t need.

In the immediate term, the reason for the collapse in the OSV sector is that the number of active rigs

dropped by about 40% over 2 years. However, that isn’t the whole story. The other half is that OSV

operators ordered a substantial number of new vessels to match the expected increase in new rigs and

the total number of global OSV is now roughly 3500. The industry is considered in balance if there’s

around 2.5 OSVs per active rig after subtracting the 1000 or so that are involved in production activities

that will be employed no matter what happens to the oil price as lifting costs are so low offshore. So at

the peak, we were at 2500 OSV involved in drilling (3500 global OSV – 1000 production OSV). At 700 rigs,

that’s 3.6 OSV per active rig, which is higher than the last decade average of 2.5-3.0 but deep water rigs

tend to need more OSVs so the average per rig has been shifting higher. Unfortunately today, we’re at

6.0 OSV per rig (2,500/420) and there’s a glut.

If we return to an average of 3.0 OSV per active rig (moderate OSV surplus) at today’s level of 420 rigs,

we need 1260 OSV (3.0 X 420) on drilling, plus 1000 in production activities or 2260, which means that

either 1240 active OSV need to retire or drilling needs to increase or a combination. Fortunately, both

are happening, which is gradually bringing equilibrium back.

To start with, 600 global OSV are over 25 years old. An additional 400 OSV are between 25 and 15 years

old. With day rates often not covering operating costs, these assets are increasingly marginalized and

retired due to the much higher upkeep and operating costs for older vessels. Once a vessel is stacked,

it’s unlikely to return to work due to the roughly $1 million cost of a special survey to return it to work.

So once these are gone, they’re gone. Simply sidelining these vessels will create an equilibrium moment

and that moment is happening as I write this, especially as smaller operators go bankrupt and cannot

pay for recurring surveys and inspection. Additionally, since most offshore work is contracted by super

majors and NOCs, they are demanding newer equipment in tendering, due to lower insurance costs and

less perceived environmental and operational risk. It will just take some more time to wind through this

older supply.

Unfortunately, roughly 300 new OSVs are still on order from when times were good. Fortunately, many

of these vessels will continue to get deferred as their purchasers do not have the capital to acquire

them. Even with them coming to market over the next few years, as older vessels are scrapped, it will

still lead to a rough equilibrium for the market. If you include all the vessels on order, there are 1560 too

many vessels today (1240 currently + 300 on order). If the industry scraps the 1000 that are older than

15 years and add in 80 more active rigs (500 total active rigs), you only have about 320 too many OSV—

which isn’t a crisis—especially with other offshore activities like wind turbines taking up additional slack.

Fortunately, those 300 on order are only going to trickle into the market, giving more time for

equilibrium.

In summary, I do not expect any heroics here in the short term. I expect a few more quarters of awful

utilization levels and roughly break-even cash results, with a gradual recovery into 2019 as older vessels

are scrapped and demand increases slightly. This should eventually increase utilization and give TDW a

bit of pricing power to earn sub-par returns on capital. If that happens, I believe the company is worth

50-70% of net depreciated fleet value or 64.13 to 87.47 per share or 138% to 224% upside in the next 2

years.

50% of 3500 = 1750 + 174 net book excluding fleet = 1924m total value or $64.13/shr

70% of 3500 = 2450 + 174 net book excluding fleet = 2624m total value or $87.47/shr

Of course, oil could stabilize at $75/bbl or $14 higher than today’s quote and fleet utilization could

increase to historic levels at 90% making TDW worth 1.25 times book (midpoint of historic range) and

we’re at 151.6 a share. Could oil go up 20% from here? Why the hell not. Fortunately, with net cash on

the balance sheet and the cleanest balance sheet in the industry, TDW will certainly survive and it gives

you a low risk way to play this recovery, as opposed to many of the other offshore players at 10-20% of

book value, but with huge debt loads.

Finally, TDW has stated on conference calls that they’re looking to be consolidators in the OSV sector

and I anticipate that they’ll buy additional vessels at sector bottom pricing which could prove highly

accretive.

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.

Catalyst

Increased OSV scrapping

Increased rig usage

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			2018	2019
Price:	27.00	EPS	0	0
Shares Out. (in M):	30	P/E	0	0
Market Cap (in $M):	810	P/FCF	0	0
Net Debt (in $M):	-9	EBIT	0	0
TEV (in $M):	801	TEV/EBIT	0	0