Drillers to Favor Buying over Building?

The cyclical downturn in the offshore oil and gas-drilling market may provide an opportunity for drillers with financial flexibility to buy high-yield peers at favorable prices, rating agency Fitch Ratings said. In this environment, master limited partnerships (MLPs) may provide additional financial flexibility for corporate parents looking to acquire assets.

Near-term offshore demand has moderated, and new builds, equal to roughly one-third of the working worldwide rig fleet, are scheduled to be delivered through year-end 2018.

“This has led to contracting delays and it will also probably result in shorter contract terms and lower day rates over the near-term. These factors may lead drillers to favor buying rather than building as a means to improve asset quality and gain market share. Secondary benefits of consolidation would likely include improved driller pricing power and, if necessary, a more orderly fleet attrition process,”Fitch Ratings went on to say.

According to Fitch, high-yield offshore drillers with a large share of contracts rolling off during this time are likely to come under pressure, since some newer smaller drillers have higher quality fleets and limited financial flexibility to ride out a prolonged downturn.

“Establishing an MLP has the potential to introduce asset quality and cash flow risks at the parent level, if asset profiles and capital structures are not co-managed properly. However, an affiliated MLP can also be used to help fund an acquisition at the corporate parent via dropdown proceeds, or to purchase peers directly at tax-advantaged multiples.

Both options provide further acquisition advantages to corporate drillers with an affiliated MLP. In either case, parent driller stakeholders would directly (via a corporate acquisition) or indirectly (via an MLP acquisition) improve asset quality and cash flow prospects, as well as reduce the need for debt at the corporate parent to fund an acquisition.

Affiliated MLP stakeholders would realize additional asset and cash flow growth,” Fitch Ratings added.

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Source: Fitch Ratings, August 28, 2014; Image: anadarko