KCA Deutag - restructuring in the past, where to now?
All,
We have updated our model here.
KCA Deutag has successfully managed the exit from restructuring, what are the next steps? Underlying business is improving with metrics across the various segments pointing to higher revenues and EBITDA and continued deleveraging, which begs the question, where to next?
Underlying performance
- Land Drilling has underperformed the original 5yr plan but with improving utilisation over the last couple of quarters and Q4 likely to be higher again, the trajectory is definitely improving. In the coming quarters, further improvement in utilisation is expected and coupled with cost reductions in Oman (from staffing) EBITDA is likely to improve as we continue into FY22.
- Offshore has outperformed its 5yr plan and the Company see no reason for this not to continue - we have not projected any further EBITDA growth in this segment but acknowledge there is likely to be growth in this segment.
- In the engineering segments, which are going to be combined in FY22, projections are difficult to make. However, when pushed on potential new builds, management acknowledged they are in discussions with partners and although they remain cautious, there is upside from gaining new build contracts.
- Even ignoring the potential upsides, a conservative model produces further deleveraging into FY22. Cash balances increase towards $300m and net leverage reduces to 1.5x. Which begs the question:
What to do with the cash?
- Many investors, from the last couple of calls, are likely to seek capital return and a refinancing of the bonds.
- Firstly, for a business with a net leverage approaching 1.5x the bonds are expensive. Paying a c.10% coupon and callable in October 2022 at c.105%, they are likely to be refinanced.
- However, equity return is not as straight forward. Management repeatedly mention potential bolt-on acquisitions and other opportunities in order to take advantage of the underlying improving environment. - - Additionally, the Company may have to make larger capital investments to gain new contract wins currently in the market. Specifically, there is the potential to win contract to manufacture new build rigs, and although likely profitable, requires substantial investment in working capital.
- This may raise a conflict with some shareholders who are seeking an exit from the bond part of their exposure.
- Any large investment, >$100m, outside the normal business plan, needs shareholder approval, but we are unable to verify the exact details of any formal shareholder agreement. CAPEX for KCA Deutag has historically exceeded current levels and although the business is cash generative currently, the low CAPEX levels are likely not sustainable in the medium term.
Short term
- We don’t envisage KCA will arrive at decision time before FY21 numbers are released in late March 2022 when management can present a full year of positive momentum, before discussing further opportunities with its shareholders.
- Over the coming months, we should expect further announcements on contract wins in their Land Drilling business to confirm our thesis of the improving underlying macro environment. However, the recent new Covid variant, Omnicron , has the potential to disrupt the underlying macro environment.
Positioning
- We hold a 2.8% of NAV long position in the SSNs and a c.4% long position in the restructured equity as a result of a 5% long position in the pre-restructured bonds. At current levels, the package of new debt and equity is worth c. 72% on a pre-restructured price, versus c. 50% at the time of the restructuring.
- We are happy to maintain our position, but are seeking further information on any formal or informal shareholder agreements.
Happy to discuss.
Tomás
T: +44 20 3744 7009
M:+44 7786 705 806