Diamond Offshore Drilling - Prepare For Bankruptcy After Company Skips Interest Payment And Retains Advisors

On Thursday morning, leading offshore driller Diamond Offshore Drilling ("Diamond Offshore") shocked investors with its decision to not make the semiannual interest payment under its 5.7% 2039 notes. In addition, the company disclosed having retained restructuring advisors.

While the company still has the usual 30-day grace period to make the payment, investors should not expect this to happen as the recent double whammy of new oil price war and COVID-19-related demand destruction has caused key customers to reduce capex across the board as already evidenced by the most recent updates from peers Noble Corporation (NE) and Borr Drilling (BORR), leaving basically the entire industry with unsustainably high debtloads relative to the anticipated levels of business activity going forward.

Despite Diamond Offshore's debt repayment schedule appearing rather light with only $250 million of unsecured notes due in 2023, the bond market has already reflected market participants' expectations for a potential debt restructuring in recent months. Even before yesterday's carnage, the company's notes were trading at massive discounts to face value, clearly signaling expectations for a massive haircut.

On average, the company's approximately $2 billion in bond debt is now changing hands at just below 15% of face value which calculates to an anticipated recovery of not even $300 million for noteholders.

our weeks ago, the company disclosed a $400 million draw under its previously undrawn $950 million revolving credit facility.

Given Thursday's disclosures one would have expected Diamond Offshore to draw down the entire amount before skipping the interest payment as the company won't be permitted to borrow additional amounts under the credit facility during the grace period.

Unfortunately, the facility is subject to a borrowing restriction as outlined in the company's most recent 10-K (page 64):

The $950 Million Credit Facility includes restrictions on borrowing if, after giving effect to any such borrowings and the application of the proceeds thereof, the aggregate amount of available cash, as defined in the $950 Million Credit Facility, would exceed $500.0 million.

Diamond Offshore reported $156 million in cash at the end of FY2019 so it is fair to assume that the company burned at least another $56 million until March 17, the date of the disclosed $400 million drawdown, as otherwise the company wouldn't have been able to draw that much under the facility.

Also keep in mind that the company is controlled by Loews Corporation (L), the Tisch family's publicly-listed investment holding which still owns an approximately 53.1% stake according to its most recent filing with the SEC.

That said, Diamond Offshore recently disclosed that James Tisch has notified the company of his resignation as chairman of the board and CEO Marc Edwards having been elected to replace him.

In addition, current director Andrew H. Tisch has not been nominated for re-election at the annual meeting.

With the Tisch family's involvement apparently on the retreat, a potential bailout by Loews appears highly unlikely now as also evidenced by management's commentary on the most recent Loews conference call:

Mary Skafidas

Next question relates to Diamond. What's the role of Diamond in the Loews portfolio?

Jim Tisch

So Diamond may have a big impact in a GAAP sense on Loews’ results. But our downside is really limited to our stake in the company, which today represents less than $1 per Loews corporation share. I would say that the current share price Diamond is really trading more like an option than it is like a stock. Regarding the offshore drilling industry in '89, knowing that it was highly cyclical when the current downturn started in '14, we thought we've seen this movie before having weathered a number of drilling cycles downside. However, this downturn now has lasted much longer than we are, I dare say anyone could have anticipated. (...)

Moreover, in case Loews decides to sell some or all of its holdings in Diamond Offshore, the change of control covenant requiring the company to make a cash collateral deposit would likely be triggered.

Having already witnessed a number of bankruptcies in the offshore drilling and offshore support vessel space, here's my expectation for things to unfold:

The company will likely use the 30-day grace period to enter into forebearance agreements with lenders to provide additional time for negotiating a comprehensive restructuring support agreement.

Once the parties have come to terms, the company is likely to file for chapter 11 bankruptcy protection with the intent to emerge within weeks as a financially stronger entity with very little or perhaps even no debt at all.

Given where bonds are trading, existing equity interests are unlikely to recover anything under this scenario. That said, current equityholders might still retain a small stake in the restructured company or at least be allocated some out-of-the-money warrants in order to ensure quick court confirmation of the upcoming plan of reorganization.

Bottom Line:

Diamond Offshore has apparently decided to not longer fight a losing battle and instead gain some head start by moving swiftly to restructure its debt obligations and emerge as a financially stronger entity better prepared to weather the protracted industry downturn.

Expect most of the company's peers to follow suit. In fact, I have already outlined my expectations for Valaris PLC and Noble Corporation to restructure rather sooner than later. Seadrill recently retained restructuring advisors, too.

In my opinion, even market leader Transocean is likely to consider restructuring its massive debtload despite no material short-term debt maturities and still plenty of available liquidity. It just doesn't make sense to waste more precious cash on servicing outsized amounts of debt mostly amassed in the good old times of oil prices north of $100, particularly not if competitors are soon going to emerge from bankruptcy with much lower break-even requirements thanks to most or even all of their debt having been equitized.

As usual, current equityholders are facing the very real risk of getting wiped out in bankruptcy thus my advice to sell existing holdings or even consider an outright short position as the company's current market capitalization of approximately $125 million still offers plenty of potential downside.

Source: seekingalpha.com

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