Post-Reorg Analysis: Valaris Notes’ Pricing Implies About $1.7B of Emergence Equity Value vs. $2.4B Plan Value; Company DS Projects Negative FCF Until 2025; Current Fleet Retains Upside Optionality to Hypothetical Market Recovery

Relevant Items:
Plan / DS / DS Supplement
Aug. 2020 Cleansing Materials
2020 10-K
Link to Excel Download on Data Page

The Valaris debtors on March 3 received confirmation of their plan of reorganization, which will fully equitize the company’s $7.1 billion of prepetition funded debt and result in $550 million of new secured notes at exit. Interest on the notes would range from 8.25% cash to up to 12% paid in kind, at the reorganized company’s option, allowing the company to save significant cash as a result of the reduction in interest. However, given continued Reorg-calculated negative EBITDA reported by Valaris as recently as the fourth quarter of 2020, Valaris is reliant on an improvement in end markets in order to generate cash. Continue reading as our Americas Core Credit team analyzes and reviews Valaris post reorg and Request a Trial for access to the linked documents as well as our analysis and reporting on hundreds of other stressed, distressed and performing credits.

The plan solves myriad prepetition complexities including varying levels of structural seniority among its fully unsecured creditors, inter-bondholder disputes and litigation items, including the Harris County litigation related to the legacy Rowan notes and other alleged litigation claims. Based on holdings in Valaris’ prepetition notes, legacy Rowan notes and participation in the rights offering, GoldenTree and Oak Hill could own over 20% of reorganized Valaris equity.

A comparison of Valaris’ prepetition capital structure with its pro forma emergence structure is shown below:


The restructuring transactions provide Valaris with a fresh start following years of industry decline since the late 2014 oil price collapse and more-recent Covid-19-related demand shock. However, given the significant deterioration in EBITDA, the elimination of cash interest alone will not be enough to turn cash flow positive as EBITDA turned negative in 2020.

Valaris’ bankruptcy-related five-year projections, which are further detailed below, estimate limited FCF, predicting a continuation of the offshore market’s supply-demand imbalance:

These projections model revenue transitioning to positive growth in 2023, driven by day-rate improvements, and an increase in working rigs starting in 2024, leading to positive FCF in 2025. Additionally, EBITDA, which was negative in the fourth quarter of 2020, is anticipated to turn positive in the first quarter of 2021, according to the debtors’ projections.

The timing and magnitude of a potential offshore market recovery is difficult to predict. As shown below, Valaris’ annual floater day rates and utilization in the 2020 10-K implied a fourth-quarter bump in these metrics:


Absent a fundamental improvement in market conditions, Valaris will continue to generate limited free cash flow. However, factors such as continued industry consolidation, like the recent Pacific Drilling and Noble combination, could accelerate excess rig supply scrapping and generate cost synergy savings for participants. The equitization of creditors in industry competitors Diamond Offshore and Seadrill might further extend this trend. Additionally, elevated oil prices could increase rig demand.

Operators continue to stack rigs, choosing to incur recurring stacking costs rather than scrap rigs, in order to maintain operating leverage. Valaris scrapped 16 rigs for $42.5 million in 2020 and preservation-stacked 15 rigs during a similar time frame.

Given Valaris’ meaningful cash generation potential in a “healthy” market environment and operators’ continued willingness to incur stacking costs to maintain this upside optionality, Reorg analyzed the potential operating leverage of the company’s Feb. 22 active fleet. The analysis assumes operating costs, day rates and utilization rates in line with Valaris’ February 2020 presentation and does not include preservation-stacked rigs.

Reorg estimates that Valaris’ Feb. 22 active fleet would generate $292 million of free cash flow with the company’s midpoint operating assumptions and that it would generate $1.332 billion with the company’s high-case operating assumptions. In our view, the high-case assumptions might be untenable, although they illustrate the significant operating leverage of the business. For context, floater day rates peaked at $480,616 in the second quarter of 2014 and floater quarterly utilization rates peaked at 92% in the second quarter of 2016 since Valaris started reporting the metrics in the fourth quarter of 2011. However, the company’s high case assumes $500,000 day rates and 95% utilization for high-specification drillships.


Reorg has derived implied post-reorganized equity and enterprise creation values based on the market prices of the company’s five note classes. As shown below, the pricing of Valaris’ five classes of notes implies equity creation values ranging from $1.61 billion to $1.7 billion. This compares with a plan equity valuation midpoint of $2.376 billion. While the company’s DS projections do not include positive levered FCF until 2025, a comparison to the midpoint and high cases above implies FCF yields of 17% and 79%, respectively, for the Valaris Holdco notes in more optimal rig operating environments, illustrating the potentially option-like return profile for the reorganized equity.

Below are the Valaris notes’ implied creation values highlighted in yellow. A more complete discussion of the creation mechanics is described further in this report in the implied creation values section.

 

 

Plan Distributions and Rights Offering

The Valaris plan provides for the issuance of $500 million of secured notes and 30% of post-reorg equity, prior to newbuild and MIP dilution, to be provided to rights offering participants through a rights offering that was open to senior noteholders and RCF lenders. The offering is backstopped by certain noteholders and lenders. In addition, a group of initial backstop noteholders and participating lenders shared in a “holdback” of 37.5% of the secured notes and pro rata stapled equity. The initial backstop noteholder and backstop lenders also share a $50 million backstop premium payable in kind in secured notes, bringing the emergence date secured notes’ principal amount to $550 million.

Additionally, all backstop participants will receive an incremental 2.7% of post-reorg equity, prior to newbuild and the MIP.

Reorg previously analyzed the debtors’ initial restructuring support agreement prior to a plan modification that allowed the RCF lenders to participate in the rights offering and backstop. The mechanics of the rights offering remain substantially the same with the RCF lenders participating at a 2.427% pro rata rate, including in the $187.5 million holdback, $312.5 million rights offering, 2.7% backstop equity allocation and $50 million backstop premium notes. A disclosure statement exhibit implies that 17.3%, or approximately $100.5 million, of RCF claims have opted to participate in the rights offering and backstop.

A summary of the rights offering is shown below:

Equity Splits and Cash Distributions

The debtors’ prepetition RCF lenders will receive 28.32% of the company’s post-reorg equity, prior to newbuild and MIP dilution. More specifically:

• Prepetition RCF lenders that participate in the rights offering and backstop will receive, separate from rights offering and backstop equity distributions, $7.8 million of cash and 5.34% post-reorg equity, prior to newbuild and MIP dilution.


• Prepetition RCF lenders that do not participate in the rights offering will receive $96.05 million of cash and 22.98% of post-reorg equity, prior to newbuild and MIP dilution.

Valaris’ senior notes were issued under indentures with five different obligor structures. As such, under the plan, the notes are subcategorized as: Valaris holdco notes, legacy Rowan notes, Pride notes, Ensco International notes and Jersey notes.

The plan provides for 38.98% of post-reorg equity, prior to newbuild and MIP dilution, to be distributed to a “Senior Notes Distributable Pool.” The distribution to the pool is further distributed to each subcategory of notes based on each group’s “Deemed Claim Amount” as shown in the column titled “Adjusted” below.

The plan’s deemed claim amounts include principal and accrued interest up to the petition date, multiplied by a unique multiplier for each subcategory of notes. The senior notes multipliers and cash distributions, as seen below, are intended to account for varying levels of structural seniority, resolve inter-bondholder disputes and settle litigation, including the Harris County litigation related to the legacy Rowan notes and other alleged litigation claims.

The newbuild claims related to payments owed to DS-13 and DS-14 manufacturer Daewoo Shipbuilding & Marine Engineering Co. Ltd. will receive 0.5% of post-reorg equity, prior to MIP dilution.

A management incentive plan term sheet attached to the Valaris’ Feb. 5 restructuring term sheet provides for an MIP reserve of post-reorg equity “representing between 5% and 10% of Holdco’s Common Stock, determined on a fully diluted and fully distributed basis (i.e., assuming conversion of all outstanding convertible securities and full distribution of the MIP Pool).”

A summary of the post-reorg equity and cash distributions is shown below:

Prepetition common stockholders will share in a distribution of seven-year warrants to purchase up to 7% of the company’s post-reorg equity “with a strike price set at a price per share equal to the value at which holders of the Senior Notes would receive a 100% recovery on their Claims (calculated as of the Petition Date), subject to dilution on account of the Management Incentive Plan.”

Estimated Emergence Equity Splits by Holder

Based on the plan treatments described above and the ad hoc noteholders’ Sept. 22 holdings, Reorg estimated emergence equity splits for the group members. The estimates assume that the initial backstop parties represented 50.9% of deemed claims with senior note holdings of identical proportions among the group members. Additionally, the estimates provide minimum and maximum splits based on the rights offering participation level of nonbackstop parties.

A summary of the estimated emergence equity splits is shown below:


Exit Capital Structure

Following the secured notes rights offering detailed above, Valaris will exit bankruptcy with $550 million of total debt, consisting entirely of the secured notes. The debtors estimate $548.5 million exit date cash following exit fees and the cash distributions detailed above. An estimated exit date sources and uses summary is shown below:

Valaris’ estimated exit date capital structure is shown below:

Additionally, Valaris sponsors the Rowan pension plan. The pension plan is a single-employer defined-benefit pension plan covered by ERISA and insured by the Pension Benefit Guaranty Corp., the PBGC. Upon the effective date, the plan provides that the pension plan and its liabilities will be assumed by “New Valaris Holdco” or another reorganized debtor (excluding reorganized Valaris). The PBGC, the debtors and the reorganized debtors agree that all proofs of claim filed by PBGC will be deemed withdrawn with prejudice as of the effective date.

The 2020 10-K disclosed a $283.6 million pension net benefit liability and $15.9 million other benefits net benefit liability as of Dec. 31, 2020. In cleansing materials projections discussed further below, Valaris provides the following annual pension payment estimates:

The restructuring term sheet indicates that the reorganized company will trade publicly, providing the following: “(i) the New Valaris Equity shall be registered under the Securities Act and, unless otherwise agreed by the Debtors and the Required Consenting Creditors, shall be listed for public trading on a national securities exchange, and (ii) each of New Valaris Holdco and the Reorganized Debtors will be a reporting company under the Exchange Act.”

Emergence Corporate Structure

A March 3 plan supplement from the debtors details the reorganized company’s planned organizational structure:

New Secured Notes

The interest rate on the new secured notes will be, with respect to any interest period and at the reorganized company’s option, either: (i) 8.25%, paid in cash, (ii) 10.25%, with 5.125% paid in cash and 5.125% payable-in-kind, or (iii) 12%, payable-in-kind through the issuance of notes.

The secured notes will be secured by a first lien priority “at least pari passu in right of payment with other permitted senior indebtedness of the Obligors” by all present and after acquired property and assets of each obligor and all proceeds thereof, including the ARO JV equity interest and ARO notes obligation.

Exit Date

The debtors’ exit date is unclear, but the Feb. 5 amended RSA provides for a plan effective date of no later than June 15. As another data point, the plan provides for the new warrants’ record date to be “on April 1, 2021, or such later date as the Company sets as the record date and informs DTC and FINRA, which date may, but is not required to be, the Effective Date.”

Governance

Valaris’ Feb. 5 restructuring term sheet provides for a new seven-member board of directors comprising:

• The CEO;


• Four members appointed by the ad hoc noteholder group; and


• Two members appointed by a majority of holders by principal amount of credit facility claims.

A plan supplement filed on Jan. 28 lists Thomas Burke as CEO and Jonathan Baksht as CFO.

Operations/Fleet

Valaris’ fleet consisted of 11 drillships, two drillships under construction, five semisubmersibles and 45 jackups as of Feb. 2. Of these rigs, four drillships, two semisubmersibles and 32 jackups were contracted or leased.

While Valaris has not produced fleet status reports during its bankruptcy, Reorg has estimated its rig contract customer information and remaining contract length based on the most recent status updates from the company, including the 2020 10-K, August 2020 cleansing materials and prebankruptcy April 22 fleet status report.

Below is Reorg’s summary of the company’s floaters and estimated contract information. All of Valaris’ floater contracts are projected to end in 2021:


Reorg’s summary of the company’s jackups and estimated contract information is shown below:


Valaris has recently limited its rig-level day-rate disclosure more than peers such as Transocean. However, the company has disclosed that certain rigs have recently operated at discounted rates, such as all of the jackups the company has contracted to Saudi Aramco outside of the ARO Drilling joint venture.

Valaris’ total backlog stood at $1.205 billion as of Dec. 31. A historical summary of the company’s backlog since December 2012 is shown below:

Note: Valaris (formerly Ensco) acquired Pride International on May 31, 2011.

Rig Scrapping and Stacking

In 2020, Valaris accelerated its fleet rationalization through rig disposition and stacking. The company scrapped three drillships, six semis and seven jackups during the year. A summary of the scrapped rigs is shown below:

The DIP provides a carve-out for the disposition of and the cleansing materials projections assume 2024 year-end retirement of:

• JU-36 (formerly Charles Rowan);


• JU-22 (formerly Rowan Middletown); and


• JU-37 (formerly Arch Rowan).

These three rigs are currently bareboat charter leased to ARO Drilling with September expirations.

In total, Valaris preservation-stacked seven drillships, one semi and seven jackups from Jan. 1, 2020, through Feb. 22, 2021. The company explains that preservation stacking is a less expensive alternative than warm-stacking a rig with hopes of simply pursuing “short-term work at near break-even levels.” Instead, Valaris has chosen to preserve its rigs, which will remain stacked “until market conditions become more favorable.” The company estimates that preservation stacking reduces annual costs by $15 million for a drillship, $9.8 million for a semisubmersible rig and $6.8 million for a jackup. A summary of the company’s stacked rigs is shown below:

Based on the average annual stacking costs Valaris previously disclosed, the company’s 23 stacked rigs as of Feb. 22 would cost the company $71.6 million on an annualized basis. This assumes that the company’s “available” DPS-1 semi, JU-247 and JU-117 are incurring costs in line with warm-stacking annual costs.

According to the DS, warm-stacked rigs maintain a significant number of crew members and are kept operational and ready for deployment. Cold-stacked rigs are stored in a harbor, shipyard or other designated offshore area, and the majority of the crew is dismissed or reassigned to another rig.

A summary of Valaris’ stacked rigs as of Feb. 22 is shown below:

Competitor Transocean recently estimated preservation-stacked floater reactivation costs to be “anywhere from $25 million to well over $100 million,” which might put into question the viability of future reactivations of Valaris’ nine preservation-stacked floaters. Transocean CEO Jeremy Thigpen asserted that “you've got to think that as more time passes, the more cumbersome the reactivation and probably the more expensive.” Eight of Valaris’ preservation-stacked floaters were stacked in the last year. On historical reactivations, Thigpen said, “[Y]ou might have stacked one asset for over a year or two and then brought it back out. But to see some of these sit now for multiple years, I don't know that we fully understand what the process is going to be, what the cost is going to be.”

ARO Drilling Joint Venture

Separate from the rigs discussed above, Valaris’ 50/50 joint venture with Saudi Aramco, ARO Drilling, owns seven jackups. These rigs are under long-term contracts with Saudi Aramco. In addition, ARO leases nine rigs detailed above from Valaris on a bareboat charter basis, with substantially all of the operating costs borne by ARO.

Valaris holds $442.7 million of notes receivable from ARO, governed under Saudi law, maturing in 2027 and 2028.

ARO generated $137 million of estimated EBITDA in 2020. Dec. 31 cash at the entity is undisclosed.

Reorg has previously analyzed Valaris’ ability to distribute cash from ARO Drilling. Neither the DS projections nor cleansing materials projections, discussed further below, project dividend or principal payments in the five-year projection period.

ARO has said it plans to purchase 20 newbuild jackups over an approximately 10-year period with available cash and/or third-party debt financing. In January 2020, ARO ordered the first two newbuild jackups, which cost $176 million each, for delivery scheduled in 2022. The JV paid a 25% down payment for both of the newbuilds with cash on hand upon ordering the rigs. The initial contracts for each newbuild rig will be determined using a pricing mechanism that targets a six-year payback period for construction costs on an EBITDA basis. The initial eight-year contracts will be followed by a minimum of another eight years of term, repriced in three-year intervals based on a market pricing mechanism.

In the event ARO has insufficient cash from operations or is unable to obtain third-party financing, each partner may periodically be required to make additional capital contributions to ARO, up to a maximum aggregate contribution of $1.25 billion from each partner to fund the newbuild program. Each partner's commitment will be reduced by the actual cost of each newbuild rig on a proportionate basis.

Implied Creation Values

Based on the plan treatments and transactions described above along with market notes pricing, Reorg has derived Valaris’ implied equity and enterprise creation values.

It is our understanding that the following pricing reflects a buyer’s pro rata subscription to the notes’ post-holdback rights offering of $304.9 million principal amount of new secured notes and 17.29% of post-reorg equity, post-newbuild and MIP dilution. For example, a buyer of Valaris Holdco notes at 10.75 cents would pay an additional 3.7 cents ($112 million new secured notes divided by $3.031 billion of total prepetition Valaris Holdco notes) to receive a pro rata amount of new secured notes and stapled post-reorg equity.

As shown below, the pricing of Valaris’ five classes of notes implies equity and total enterprise value (including pension liabilities) creation values ranging from $1.61 billion to $1.7 billion and $1.91 billion to $2 billion, respectively.

 

 

Below are Valaris’ forward creation multiples based on the pricing and mechanics described above. Reorg includes forward EBITDA plus pension costs as well due to the approximately $299.5 million pension’s significant size in comparison with Valaris’ expected exit date net debt of $1.5 million. Additionally, implied annual FCF yields are included, with 2025 representing the only FCF positive year in the DS projection period.

Projections

Valaris released financial projections in cleansing materials on its Aug. 19 petition date and as an exhibit to its disclosure statement on Dec. 30.

As seen in the variance analysis below, the Dec. 15 DS projections’ estimate lower top-line and EBITDA results, relative to the August cleansing materials, while margins are somewhat consistent. Regarding capital expenditures, the DS projections estimate lower 2021 and 2022 spending, largely as a result of excluding $356 million for the DS-13 and DS-14 newbuilds in 2022, while the latter periods are estimated to include nearly identical capital spending.

Valaris entered amended agreements with Daewoo Shipbuilding and Marine Engineering, or DSME, for newbuild drillships DS-13 and DS-14 that become effective upon emergence from bankruptcy. The amendments provide Valaris with the right, but not the obligation, to take delivery of either or both rigs on or before Dec. 31, 2023. Under the amended agreements, the purchase price for the rigs are estimated to be approximately $119.1 million for the DS-13 and $218.3 million for the DS-14, assuming a Dec. 31, 2023, delivery date. Delivery can be requested any time prior to Dec. 31, 2023, with a downward purchase price adjustment based on predetermined terms. If Valaris elects not to purchase the rigs, the company has no further obligations to the shipyard. The amended agreements remove any company guarantee.

The DS projections include income statement, balance sheet and cash flow statement projections. The earlier-dated cleansing materials, however, provide previously undisclosed information on operating and cash flow drivers, including:

• Projected operating costs of floaters, jackups and managed rigs;


• Projected day rates and utilization by rig class; and


• Rig stacking, retirement and reactivation assumptions.

The cleansing materials project negative operating margins for drillships in 2020, implying that the company has prioritized keeping rigs active, albeit at a loss, rather than idling or stacking the rigs. Valaris’ 2020 10-K indicates that the floater segment generated negative $128 million segment-level EBITDA. In the cleansing materials projections, floater margins are forecast to turn positive in future periods as semi-utilization increases.

The cleansing materials project jackup revenue and margins to continue rising on increasing day rates and utilization over the projection period. Valaris disclosed three fourth-quarter jackup contract extensions and two new jackup contracts in its 2020 10-K.

Valaris provides BP with third-party drilling management services for two of its rigs, the Thunder Horse deepwater semi and the Mad Dog deepwater spar drilling rig. The company typically reports these financial statements under the “Other” segment under which it also reports certains services provided to ARO Drilling.

Operating Leverage Optionality

While Valaris’ projections estimate limited free cash flow over the five-year projection period, the company’s fleet management and current securities pricing indicate that stakeholders anticipate the company’s operations provide upside optionality.

Management’s decision to preservation stack the 20 rigs discussed above for about $44 million per year, in substance, is the choice to actively pay an option premium on potential future cash flows driven by reactivations or asset sales. Both outcomes would require improved market conditions. Similarly, management’s recent contracting of its floater segment at negative operating margins reflects a decision to position those rigs for future contract upside.

A February 2020 presentation from Valaris details operating costs by rig type and includes two illustrative market scenarios by rig type. Given the company’s 16 rigs disposed of and 15 rigs preservation stacked from Jan. 1, 2020, to Feb. 22, 2021, a fresh look at the fleet is helpful.

Reorg applies the company’s midpoint and high-case scenario day-rate and utilization assumptions as well as operating cost assumptions to the active Valaris fleet to derive hypothetical upside cash flow.


Given the limited visibility to an offshore market recovery, we view this analysis as a data point to frame the upside potential optionality of the go-forward fleet. While this is a static analysis ignoring fleet management decision, additional factors to consider include:

• Go-forward cash taxes;


• Stacking costs;


• Reactivation costs;


• Preservation costs; and


• Potential newbuild capex.

While annual disclosures in the 2020 10-K imply a meaningful fourth-quarter inflection in floater day rates and utilization, recent operating trends are significantly lower than the operating cases shown in the analysis above.


Valaris provided the following analysis on global drillship supply and demand in its Aug. 19 cleansing materials:

Similarly, the company provided the following global semisubmersible supply and demand analysis in the same deck:

Lastly, Valaris provided the following information on the global jackup market:

--Adam Rhodes