Noble’s Nefarious Contractual Nuances


Noble’s Nefarious Contractual Nuances

Even with predictions for significantly higher day rates for floating drill ships (floaters), it may be too early for new investors to begin investing in Noble Corp. plc. (NE). Recently Diamond Offshore (DO) CEO, Marc Edwards, predicted that in 2020 contract rates for deep water drilling ships were about to increase maybe double. Since in our view Noble Drilling is slightly cash flow negative with existing contract rates, we wanted to explore how Noble’s cash flow might change during the next few years. Obviously, we are assuming that rates increase as predicted. Noble has been particularly protective of its cash uses delaying until roughly 2024 major debt repayment. This action puzzles us. A slide from the company’s most recent presentation illustrates how dedicated Noble management has been toward delaying its debt repayment, owing only approximately $300 million of its $4 billion in debt through the next five years.

A Look at Past Contract Durations

Noble, in the past, has provided slides showing contractual end dates. The first slide included below is from the company’s 1st quarter 2018 report. Four of the drill ships are contractually tied up until at the earliest, mid-2021. The next slide is the latest fleet update.

The Floating Ship Market Place

Figuring cash flow begins with average rates. Vladimir Zernov wrote in a recent article referring to floaters, This improvement led to a modest increase in dayrates, which are now $175,000, according to Bassoe estimates.”

Our assumptions are hypothetical and simple. Contracts beginning in 2019 will be at the current rate of $175,000/day until into 2020. Thereafter, the rates double to $350,000/day. The margin for the first $175,000 is 50%, the balance is operating profit. Future on-stream time is assumed at 80%. Floaters already under contract will remain at the current rate. The table below consists of the floaters for which contracts expire before 2022.

Floaters Contract End Date Operating Profit 2019 (Millions) Operating Profit 2020 (Millions) Operating Profit 2021 (Millions) Total (Millions)
Tom Madden March 2020 0 $75 $75 $150
Sam Croft Mid 2019 $12.5 $75 $75 $160
Don Taylor May 2019 $17.5 $75 $75 $180
Total $30 $220 $220 $480

We understand that contract upgrades won’t magically occur for all assets on January 1. A hypothetical simple average ramp adds some level of accuracy. When adding revenue in yearly order and prospective, 2019 may add $30 million, 2020, $100 million and 2021, $200 million. In our article, Noble Corp.’s Precarious Position, we calculated for Noble to continue bleeding cash at $100 million or more with revenues of approximately $1.05 billion under its current cost structure. The company’s need for spending a $100 million more in capital than normal, further exaggerates 2019 cash flows.

The following table projects a hypothetical cash flow through 2021.

Cash Flow Balance by Year (Millions)* 2019 2020 2021
Beginning Cash $400 $230 $230
Net Operational Cash Flow ($100) ($100) ($100)
Extra Capital Expenses ($100) $0 $0
Cash From Floater Contractual Increase $30 $100 $200
Cash Balance $230 $230 $430

*Excludes bond repayments.

Under this hypothetical, Noble recaptures its cash in 2021, but doesn’t make extra debt payments. In our view, debt reduction to $3 billion from $4 is absolutely the single most important goal Noble needs to achieve. After 2021, should increases in contract continue to materialize, Noble could begin paying down significantly its debt. That doesn’t begin for three years.

We admit that these numbers are best guesses based on the information we have, nothing more. But, the results tell an important story, how important and difficult increases in contractual rates might be to level this ship. We suspect that management really understands the nuances of its contractual structure. This contractual structure seems to also come with a nefarious affect, which could hamper Noble’s near-term financial health and investor faith. We also fully understand that our best knowledge, especially regarding the truth about Noble’s cash flow circumstances, may be in error. A simple change of being a $100 million too low, matters.

What Might This Mean?

Noble might continue its outward appearance of being susceptible to bankruptcy for some years. If so, it will or could trade with significant price penalties longer than others. Unless we see significant cash flow improvement, we plan to continue selling covered calls. New investors may want to wait until a truer understanding of cash flows is known.

Disclosure: I am/we are long NE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: We are selling covered calls on large portions of our holdings.