Since the oil price slump began in 2014, some prominent offshore rig operators have struggled -- including Transocean (NYSE: RIG) and Ensco (NYSE: ESV), down 76% and 89% respectively. These are the kinds of results that make investors hide under the blankets and keep their cash under the mattress. But it also may mean the industry is ripe for a turnaround.
Continue Reading Below
Let's look at offshore rig operator Seadrill Partners LLC (NYSE: SDLP) to see whether it looks like a buy at these beaten-down prices.
Out of the frying pan
The first thing investors need to know about Seadrill Partners LLC is that its parent, Seadrill, has filed for bankruptcy -- after losing 99.5% of its value. The second thing investors need to know is that this isn't as bad for Seadrill Partners as it sounds.
Thanks to some savvy financial maneuvering from Seadrill Partners, its assets -- including its primary assets: the rigs it owns -- are insulated from Seadrill's bankruptcy. Like Seadrill and many other offshore rig operators, Seadrill Partners still has creditors and debt of its own, but those credit agreements will be handled completely separately from its parent's Chapter 11 proceedings.
That's obviously good for investors. But it also makes Seadrill Partners' future a bit uncertain. Still, even an uncertain future is better than a certain trip to bankruptcy court.
Continue Reading Below
Where to go from here
Of course, with Seadrill (the parent) in bankruptcy, its assets will have to be disposed of, and those assets include a 28.6% stake in Seadrill Partners. Nobody knows what's going to happen to that position, but it could have big implications for Seadrill Partners' future.
For example, the parent company could simply sell off its stake as a public offering to raise cash for its creditors. That would set up Seadrill Partners as a completely independent entity. But it could also decide to sell its stake to a larger competitor like Transocean or Ensco, both of which have a recent history of gobbling up smaller competitors.
If a competing rig operator like Ensco or Transocean gets hold of a 28.6% stake in Seadrill Partners, it would probably try to make a play for the rest of the company. That would likely benefit shareholders, who could expect to receive a premium for their shares. With just 11 rigs, Seadrill Partners' fleet would be relatively easy for a larger competitor to absorb. On the flip side, if no buyer steps forward, that also means an independent Seadrill Partners would be a very small fish in a very big ocean. An ocean full of other companies' drilling rigs.
The new normal
That brings us to the big reason I'd be hesitant to buy Seadrill Partners right now: There's no guarantee that the offshore drilling industry is likely to recover anytime soon.
Offshore plays are notoriously risky and expensive to develop. That hasn't prevented companies from making promising offshore discoveries recently, so there's no worry that the industry is going to vanish completely. But in a world of $50/barrel oil, some projects simply aren't going to be as economically feasible as they would have been at $90/barrel oil. That's why companies like Royal Dutch Shell and ConocoPhillips allowed their Arctic offshore drilling rights to expire last year.
Brent crude oil prices have risen above $50/barrel recently, which has enabled oil producers to start turning profits again, thanks in large part to aggressive cost-cutting measures. As they look to increase production while controlling costs, though, they may be more inclined to invest in traditional onshore shale plays rather than the deepwater and ultra-deepwater plays that are the most lucrative for offshore rig operators.
Data compiled by Rystad Energy indicates that while onshore shale plays have an expected breakeven of $50/barrel, deepwater plays have an expected breakeven of $82/barrel. It also takes longer to recoup the investment on a deepwater play.
Offshore drilling has always been a risky business, and the industry's future is by no means assured. So Seadrill Partners looks like a risky bet simply by virtue of its industry. When you factor in the uncertainty surrounding Seadrill Partners' future, in particular, considering its parent's bankruptcy, that's probably too much risk to recommend.
Investors who are determined to invest in the sector despite the risks may want to consider Transocean. But I would recommend sticking to other areas of the oil and gas industry, like the oil majors, where rising crude prices will have a more immediate impact and your money will be more secure.
10 stocks we like better than Seadrill Partners
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*
David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Seadrill Partners wasn't one of them! That's right -- they think these 10 stocks are even better buys.
Click here to learn about these picks!
*Stock Advisor returns as of November 6, 2017