Seahawk Drilling (HAWK) update
Last Friday Seahawk filed for bankruptcy and announced that an agreement had been reached for Hercules Offshore (HERO) to potentially purchase Seahawk’s 20 rigs for 22 million HERO shares and $25 million in cash.
Time to own up to this mistake. I don’t see anything good in this maneuver/deal. First because management has acted like complete dunderheads; until last week they were basically saying that each of their 20 rigs was worth at least $10 million apiece, then this week they sell out for $5 million apiece. What gives? But, second, and more important than less-than-candid management, is POOR management and SECOND RATE assets. This was a company that was spun out of Pride International (which announced that it was being taken over with a nice little premium a week or so ago, thank you) 18 months ago with no debt and assets with a book value of over $35 per share, including substantial cash. How could management have dissipated most of this in only 18 months? One could excuse them by saying this whole thing was caused by the fallout from the BP oil spill (moratorium on new drilling) but I don’t think that the ‘environment’ was but a contributing factor. Rather, it appears to me that management was sitting on its hands, twiddling its fingers, whatever you want, but not really managing. They were simply waiting for drilling to resume and rates to move upwards, crossing their fingers and hoping for a rebound. No contingency planning, no nothing. Shame on me for not seeing the signs. I thought it was a bit strange that they were unable (or unwilling) to stem the cash bleed; the expense burn didn’t seem to change quarter to quarter. Even the announcement last December that they were selling off a rig for $15 million should have sounded a warning bell. The cash drain was there for all to see, and so was the lack of a plan to make it through another few ‘dry’ years. Why didn’t I take notice? In retrospect, of course, I see it clearly. It’s just that I didn’t want to acknowledge that my deep value investment really didn’t have deep value because the barriers to realizing the value were formidable. I was lulled into thinking that the scrap value of the rigs was greater than the economic value of the company. But I neglected to consider that not only is the cost to monetize the value of the rigs’ value large, but more importantly the incentive for management to return value to shareholders by scrapping the rigs was simply not there and therefore any analysis concerning scrap value was just that, scrap without the ‘s’. I’m interested to see what some of the large shareholders will do. I wonder, in fact, if they have any recourse. This is a bankruptcy after all, not a sale, or that is, it’s a planned sale while in bankruptcy. There are no creditors here to control the process; management is basically in control. That’s right, the same management that was telling us 10 days ago that the rigs they had ‘cold stacked’ were worth at least $10 million dollars apiece in scrap value. Sorry, I don’t have much faith. And I doubt anyone does. Is this an asset play now at this lower price? a bankruptcy play? Well, it might be, but I wouldn’t venture in at today’s price ($4.86). Maybe down around $2-$3 a share I might think about it. HERO has offered about 1.88 HERO shares plus $25 million for HAWK assets (leaving the Mexico and Pride litigation liabilities/assets with Hawk, about $49 million). Does this mean HAWK shareholders will get the 1.88 HERO shares per share of HAWK? That’s not quite clear to me. It looks like there is also a $35 million DIP credit that will be used to fund HAWK operations until the asset sale can be completed, so this is coming off the top of the asset value. If all of the line of credit is used to fund the current cash bleed and bankruptcy costs and HAWK eventually has to pay the $49 million to Pride to reimburse the Mexican tax obligation, then the per share asset value of HAWK post bankruptcy looks somewhat meager indeed.
Mr. Market has apparently had some problems interpreting the deal. Monday, pre-market, shares traded down below $2.00 a share. In regular trading, they started the day at around $3.50 and trended up in the morning to peak at around $5.40, but closed at around $4.65. 10 million shares (out of 12 million outstanding) traded Monday, though it may be that only 2 million shares traded 5x, we’ll never really know. Tuesday, another 4 million shares traded with the price fluctuating between $4.08 and $4.96. What is perhaps just as important, HERO shares traded up from $3.60 pre deal to close at $4.12 yesterday, making the 1.88 shares of HERO worth about $7.75 per HAWK share. Of course if the entire $35 million in DIP financing is used up on working capital and bankruptcy expenses, this leaves HAWK shares worth about $4.75, less, of course any liabilities from the Pride lawsuit. Interestingly, that’s just about where HAWK shares ended yesterday, $4.86. Seems to me that Mr. Market is assuming that the Pride lawsuit will not result in any payments. From my perspective I can only hope someone gets excited by the value in HAWK; if share prices were to get toward $6.00, I will think about exiting my position.
In any case, here I am eating crow on this investment idea. If there’s any comfort, and its very, very little, I’m not alone; there are others who are in for far more that I. The key takeaway here is that I let myself be wooed into ‘never-never land’ by the promise of rock solid asset values that simply weren’t there. I did not give enough emphasis to management incentives, and then I did not follow closely enough exactly what was transpiring and put it to the common sense test; Was management doing what I would expect them to do. With the bankruptcy and asset sale announcement the value of my shares is now irretrievably impaired. So I ended up breaking uncle Warren’s rule #1, “Don’t lose money”. Let it be a lesson I don’t forget easily!