SDLP - Seadrill Partners LLC - Fourth Quarter 2013 Results

Highlights

• Seadrill Partners reports net income attributable to Seadrill Partners LLC Members for the fourth quarter 2013 of US$62.6 million and net operating income for the fourth quarter of US$134.4 million.
  • Generated distributable cash flow of $23.2 million for the fourth quarter 2013.
  • Declared an increased distribution for the fourth quarter of US$0.4450 per unit, an increase of 4.1% over the third quarter distribution and an increase of 15% for 2013.
  • Completed the acquisition of the company that owns the tender rig T-16 from Seadrill Limited for US$200 million.
  • Announced settlement agreement and 18 month extension for the semi-submersible West Aquarius with a total estimated revenue potential of US$337 million.
  • Total S.A. exercised their option to convert the contract extension for the West Capella from 5 years to 3 years due to transfer of operatorship.  As a result of this change in contract terms the dayrate has increased from US$580,000 per day to US$627,500 per day
  • Filed US$800 million mixed shelf registration statement to add flexibility to financing future rig growth
  • Completed the acquisition of the companies that own and operate the West Sirius and West Leo for US$2.3 billion on a 100% basis. The acquisition was financed with debt and a US$465 million unit offering for the Company's equity share. Management has recommended a quarterly distribution increase as a result to between US$0.50 and US$0.5125

Subsequent Events

• Seadrill Partners completes US$1.8 billion term loan B and US$100 million revolving facility.  Proceeds of the term loan are to be used to refinance existing indebtedness and increase liquidity 

Financial Results Overview

Seadrill Partners LLC¹ reports:

Total contract revenues of US$282.1 million for the fourth quarter 2013 (the "fourth quarter") compared to US$262.4 million in the third quarter of 2013 (the "third quarter"). The increase is primarily driven by the $22 million West Aquarius write off in the third quarter and the contribution from the T-16 for the full quarter after commencement of operations. This was partly offset by planned downtime on the West Capella for 5 year classing, and in particular by 34 days downtime during the quarter for the West Aquarius related to five year classing and anchor chain repairs.

Net operating income for the quarter of US$134.4 million compared to US$118.1 million in the preceding quarter. The improvement is largely as a result of the improvements in revenues noted above.

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¹⁾ All references to "Seadrill Partners" and "the Company" refer to Seadrill Partners LLC and its subsidiaries, including the operating companies that indirectly own interests in the drilling rigs,  Seadrill Partners LLC owns: (i) a 30% limited partner interest in Seadrill Operating LP, as well as the non-economic general partner interest in Seadrill Operating LP through its 100% ownership of its general partner, Seadrill Operating GP LLC, (ii) a 51% limited liability company interest in Seadrill Capricorn Holdings LLC and (iii) a 100% limited liability company interest in Seadrill Partners Operating LLC. Seadrill Operating LP owns: (i) a 100% interest in the entities that own the West Aquarius, West Leo and the West Vencedor and (ii) an approximate 56% interest in the entity that owns and operates the West Capella. Seadrill Capricorn Holdings LLC owns 100% of the entities that own and operate the West Capricorn and West Sirius. Seadrill Partners Operating LLC owns 100% of the entities that own and operate the T-15 and T-16 tender barges.

Net Income for the quarter of US$113.6 million compared to US$78.4 million in the previous quarter. This is after the recognition of the  gain/loss on derivative instruments, which reflected a gain of US$16.1 million in the fourth quarter as compared to a loss of US$11.8 million for the third quarter as a result of  an increase in long term interest rates in the fourth quarter. The unrealized non-cash element of these amounts are US$19.1 million gain and US$9.2 million loss respectively.

Net income attributable to Seadrill Partners LLC Members was US$62.6 million for the fourth quarter compared to US$14.2 million for the previous quarter.

Distributable cash flow was US$23.2 million for Seadrill Partners' fourth quarter as compared to US$15.9 million for the previous quarter² giving a coverage ratio of 0.86x for the fourth quarter.  The increase is mainly as a result of the contribution from the T-16 for the full quarter and from the West Leo and West Sirius for part of December in addition to the West Aquarius improvement noted above.

The coverage ratio has been negatively impacted by the increase in units outstanding following the December equity issuance as the fourth quarter distribution is payable on all outstanding units at the record date.  Were the distribution to be paid pro-rata on the new units for the 19 days of the December that the Company benefited from the West Leo and West Sirius cash flow, coverage would have been 1.08x.

Distribution for the period of US$0.4450 per unit, equivalent to an annual distribution of US$1.78, represents an approximate 15% increase from the Company's minimum quarterly distribution set at its IPO.  Subsequent to the acquisition of the semi-submersible rigs the West Sirius and West Leo in December, Management have recommended to the Board an annualized distribution increase to between $2.00 and $2.05 per unit which would become effective for the distribution with respect to the quarter ending March 31, 2014 and would represent an approximate 30% increase since IPO. Any such increase would be conditional upon, among other things, the approval of such increase by the Board and the absence of any material adverse developments that would make such an increase inadvisable. 

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²⁾  Please see Appendix A for a reconciliation of DCF to net income, the most directly comparable GAAP financial measure.

Operations

Seadrill Partners has an interest in eight rigs in operation.  The fleet is comprised of four semi-submersible rigs, one drillship and three tender rigs operating in Canada, the US Gulf of Mexico, Ghana, Nigeria, Angola and Thailand respectively.

During the quarter,  Hibernia Management and Development Company Ltd, (HMDC) agreed to an 18 month contract extension for the ultra-deepwater harsh environment semi-submersible West Aquarius thereby extending the operations for the rig off the east coast of Canada until April 2017.

Total S.A. have exercised their option to convert the contract extension for the West Capella from 5 years to 3 years.  As a result of this change in contract terms the dayrate has increased from US$580,000 per day to US$627,500 per day. The use of the option to convert to a shorter contract with a higher dayrate reflects a transfer of operatorship for the license and the wish for the new operator to retain flexibility. The Company is confident however that there will be additional requirements for the rig in Nigeria post 2017.

With the exception of 20 days downtime linked to the West Aquarius anchor chain event, the Company's fleet performed well during the fourth quarter achieving an overall economic utilization rate of 91%.  Average utilization has been particularly impacted by the 34 days downtime on the West Aquarius, 14 of which were related to 5 year classing and the balance due to faulty anchor chains.

Total operating expenses for the fourth quarter were US$148.0 million, compared to US$147.9 million in the third quarter.  The Company has good cost controls in place and sees little risk of changes to the operating cost structure.

Acquisitions

On October 18, 2013 Seadrill Partners completed the acquisition of the company that owns the tender rig T-16 from Seadrill Limited ("Seadrill") for a total purchase price of US$200 million. The T-16 is contracted with Chevron in Thailand at an initial contract dayrate of US$115,500, which is subject to escalation to cover cost increases and is currently US$121,268.

On December 13, 2013 Seadrill Partners completed the acquisition of the companies that own and operate the West Sirius and West Leo for a total consideration of US$2.3 billion on a 100% basis.  The West Sirius was acquired by Seadrill Capricorn Holdings LLC (51% owned by SDLP) and the West Leo acquired by Seadrill Operating LP (30% owned by SDLP).  Debt funding for the acquisition was US$936 million comprised of back-to-back bank loans with Seadrill and a related party loan from Seadrill.  The Company's equity portion, for its share of the rig acquisitions, of US$528 million was funded with Seadrill Partner's first public equity offering and a $70 million sellers loan. All the related party debt with Seadrill in connection with the transaction will be  refinanced by funds from the term loan B financing.

The West Sirius is contracted with BP in the US Gulf of Mexico at a dayrate of US$490,173 until the third quarter of 2014, at which time the rate increases to US$535,000 per day through the third quarter of 2019.  The West Leo is contracted with Tullow Oil in Ghana at a dayrate of US$605,000 through the second quarter of 2018.  The long term contracted cash flows of these acquisitions further enhance Seadrill Partners' cash flow profile and visibility in distributable cash flows, as well as further diversifing Seadrill Partners fleet and reduces the risk operating result volatility.

Financing and Liquidity

As of December 31, 2013, the Company had cash and cash equivalents, on a consolidated basis, of US$89.7 million and a revolving credit facility of US$300 million provided by Seadrill as the lender, which has subsequently been reduced to US$100 million as part of the term loan B refinancing described below.  As of December 31, 2013, US$125.9 million was drawn on this facility to finance short-term working capital needs and to help manage the Company's debt amortization requirements.  Total debt excluding the drawn revolver balance was US$2,234.6 million as of December 31, 2013; US$1,825.2 million of this debt was originally incurred by Seadrill, as borrower, in connection with its acquisition of the drilling rigs.  Subsidiaries within the Seadrill Partners group that now own the drilling rigs entered into agreements with Seadrill, pursuant to which each rig owning subsidiary will make payments of principal and interest directly to Seadrill.  These loan agreements with Seadrill  are classified as related party transactions.

As of  December 31, 2013 the Company had five secured credit facilities.  The two facilities maturing in June 2014 and Dec 2017 have since been refinanced with the term loan B described below and as a result has been reclassified as long term as at December 31, 2013.  The remaining three facilities expire in 2015, 2016, and 2017 respectively and a similar refinancing strategy should be expected at maturity debt levels or higher.  Additionally the Company has a US$110 million vendor loan from Seadrill maturing in 2016 relating to the acquisition of the T-15 and two zero coupon discount notes from Seadrill (US$70 million and US$230 million) that mature in June 2015 relating to the West Sirius and West Leo acquisition. Both these zero coupon discount notes will be refinanced as part of the term loan B refinancing.

In February 2014, Seadrill Partners executed a US$1.8 billion term loan B and US$100 million revolving credit facility.  The term loan was upsized from US$1.7 billion and priced at Libor plus 3%, the low end of the price range, and subsequently swapped to a fixed rate of 5.5%.  In conjunction with the formation of Seadrill Partners in 2012 and subsequent dropdown of the West Sirius and West Leo, back-to-back and related party loans were used to finance the debt portion of the transactions.  As well as being overly reliant on Seadrill Limited, this structure had an steep amortization profile that was not optimal for Seadrill Partners.  The 1% amortization profile of the new facility will enable the Company to more efficiently manage its replacement capital expenditure reserves by investing in new assets.  In conjunction with the term loan B and revolver Seadrill Partners obtained a credit rating of BB- / Ba3.  As a rated entity Seadrill Partners' access to and cost of funding should be improved, thus increasing financial flexibility.

The Board is confident that a similar refinancing can be executed on the remaining back to back loans and related party debt in order to achieve a capital structure that is independent from Seadrill Limited and further facilitate Seadrill Partners growth.

As of December 31, 2013, Seadrill Partners had interest rate swaps outstanding on principal debt of US$2,068.0 million. All of the interest rate swap agreements were entered into subsequent to the IPO Closing Date and represent approximately 93% of debt obligations as of December 31, 2013. The average swapped rate, excluding bank margins, is approximately 1.64%. The Company has a policy of hedging the significant majority of its long-term interest rate exposure in order to reduce the risk of a rising interest rate environment.

Market

The short term outlook for floaters is influenced by the low activity level caused by reduced growth in the capex from the major oil companies.  In this regard, 2014 and 2015 may show slower activity levels than earlier anticipated.  The oil price has remained firm and in recent weeks has shown a stronger trend.  The primary challenge for oil companies is the negative real cash flow situation they are currently encountering.  Due to increasing depletion rates, more capex needs to be spent in order to maintain production levels.  Combined with a relatively high dividend payout and increasing development cost to bring new production on stream, oil companies have limited opportunities to fund exploration activities.  We have encountered numerous instances of oil majors reducing spending, especially in exploration and in certain high cost areas of production such as onshore North America.  As budgets are re-allocated, the entire spending complex tends to slow down.  In turn, demand for offshore drilling assets is being pushed into 2015-2016.

The Board is of the opinion that this trend will lower oil production in the years to come.  Together with the  generally tight supply demand balance and political uncertainties in several oil producing countries, another upward movement in oil price may occur.  The funding of the approximately 10 million barrels per day growth in global production level from 2003 to 2013 was to a large extent financed by an oil price that moved from US$30 to US$110 per barrel.  This created additional cash flow to reach current production levels.  It is likely that the next production increase will be dependent on another upward movement in oil price.  Alternatively, oil companies will have to accelerate the time between discovery and production, thereby materially increasing the net present value of development projects and improving their cash flow situation.

As a result of the pause in upstream spending we have observed a decline in the overall number of fixtures, lead times and contract duration.  We also expect to see a number of sublets adding to near term available supply.  Importantly, Seadrill Partners has no exposure to re-contracting during 2014 and only the West Vencedor available through 2015.

We are presently seeing a slight increase in inquiries for 2015 availability.  Given the amount of work required to retain licenses that expire in 2015, this has been expected.  A total of 17 uncontracted ultra-deepwater floater units will be delivered from the yards in 2015 and 2016.  This is significantly lower than 2012 for instance when all together 17 units were delivered.  Based on the current low contracting activity level it should be expected that this capacity can be absorbed in the market without leading to significant downtime for any ultra-deepwater capacity.  An increase in oil companies' activity level in 2015 is likely to push rates higher.

Looking at the market as a whole, the acute challenges lie with fourth and fifth generation assets.  The oil companies' new requirements after Macando and the focus on increased water depth areas has significantly limited the use of older equipment.  The owners will face the choice of investing several hundred million dollars into twenty or thirty year old assets in order to try to meet the new demands or simply just lay up the unit.  It has been shown from the prior cycles that such upgrades carried out by several of our competitors has had a materially lower return than Seadrill's focus on building a modern high specification fleet.  Therefore, expectations for additional older assets to be stacked remain.  Pricing may slip as utilization declines and operators of these asset classes will face a difficult environment for the foreseeable future.

Current production in ultra-deepwater regions is a mere 1 million barrels per day.  There are approximately 130 rigs which can serve this market today.  It is expected that by 2020 production in these regions will approach 5 million barrels.  The approximate 20% CAGR represents one of the strongest production growth profiles globally.  Although the current market for ultra-deepwater floaters is at lower activity levels than 2012, we are confident that significant new rig capacity will need to be added to explore and develop these reserves.

Mexico presents a particularly interesting opportunity for future work in ultra-deepwater.  Legislation is moving forward at an impressive pace and we expect the opening up of projects to potentially impact 2015 demand.  Seadrill has operated the West Pegasus in Mexico for the last 2.5 years and has developed a solid operational track record and good working relationship with its customer, Pemex.  As capital from major oil companies enters the country, demand for rigs is sure to follow.

Seadrill Partner's ultra-deepwater rigs current dayrates range from US$490,173 per day to US$605,000 per day.  As of December 31, 2013 Seadrill Partners' total fleet's average remaining contract term was 3.7 years and current backlog is US$4.5 billion.  Given the Company's expectation of continued strength in dayrates, it is possible that the Company's below market contracts will be re-contracted at higher rates as their contracts expire. This may create the potential for increased distribution from existing assets.