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Pacific Drilling: A Promising Multi Bagger of the Deep

Alvin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Pacific Drilling (NYSE: PACD) has been quietly stacking up on drillships. The company, which was founded in 2006 and became public on November 11, 2011, currently operates four ultra deepwater drillships and has three more drillships under construction with Samsung Heavy Industries.

The company has been growing quickly. As the following table shows, its initial four ships are all under contract and the Pacific Sharav, which is scheduled to be delivered in 2013, was recently awarded a five year $1,076 million contract by Chevron (NYSE: CVX).

<table> <tbody> <tr> <td> </td> <td>Contract Backlog ($ million)</td> <td>Oil Company</td> <td>Contract Length</td> </tr> <tr> <td>Pacific Bora</td> <td>440</td> <td>Chevron</td> <td>3</td> </tr> <tr> <td>Pacific Scirocco</td> <td>289</td> <td>Total</td> <td>2</td> </tr> <tr> <td>Pacific Mistral</td> <td>490</td> <td>Petrobras</td> <td>3</td> </tr> <tr> <td>Pacific Santa Ana</td> <td>900</td> <td>Chevron</td> <td>5</td> </tr> <tr> <td>Pacific Sharav</td> <td>1,076</td> <td>Chevron</td> <td>5</td> </tr> </tbody> </table>

Pacific Drilling has a total revenue backlog of about $3.186 billion. In terms of day rates, the Bora, Scirocco, Mistral, Santa Ana, and Sharav are under contract at $475k, $475k, $458k, $468k, and $555k per day.

<img src="/media/images/user_12906/pacificdrilling_large.jpg" />

The company’s focus on the ultra deepwater drillship market and commitment to cutting edge drilling technology is a good strategy. First, oil exploration is on an inevitable trend to deeper water. The search for a resource naturally trends from easiest to hardest and oil is not an exception.

“In recent years, there has been an increasing trend towards deep and ultra deep water exploration. With the decline in the available resources in the onshore areas, there has been a marked shift towards increased offshore exploration. Initially, the offshore exploration was mainly in shallow waters. However, in recent years, with the near complete exploitation of the shallow water resources worldwide, companies have begun drilling deeper in the oceans.” – GBI Research, 2010

Second, relative to the number of jackup and semisubmersible rigs, there are only a few number of drillships. Globally, there are currently 79 drillships, 382 jackups, and 186 semisubmersibles (rigzone). The drillship market has less competition. If Pacific Drilling entered the jackup market or semisubmersible market it would have a hard time competing.

Ensco (NYSE: ESV) and Transocean (NYSE: RIG), the two largest offshore drilling companies, are already well established in those markets. Ensco has 20 semisubmersibles and 47 premium jackup rigs. Transocean, according to its 2011 fleet directory, has 50 semisubmersibles and 64 jackup rigs. However, Ensco and Transocean have only 9 drillships (including 3 under construction) and 23 drillships, respectively.

Third, drillships are faster at deploying than semisubmersibles or jackups. Since Pacific Drilling is a new company, it can only afford a few rigs. Thus, it needs to be able to to deploy its rigs quickly around the globe to accommodate potential customers.

Lastly, drillships have higher average day rates than semisubmersibles or jackups (rigzone). On average, deepwater drillships, deepwater semisubmersibles, and high spec jackups earn $469k, $411k, and $151k per day, respectively (rigzone). Pacific Drilling is targeting the top.

Moving on to the balance sheet, the company currently has total debt of $1,975 million. Taken from its 6K report for the first quarter of 2012, the following table shows the company’s contractual obligations.

<img src="/media/images/user_12906/pacddebt_large.jpg" />

The total amount owed is about $3,641 million. Using the company’s backlog and profit margin of 32% (excluding interest expense) for the first quarter of 2012, an approximate income model can be constructed.

<table> <tbody> <tr> <td> </td> <td>Revenue ($ million)</td> <td>Profit Margin Excluding Interest Expense (%)</td> <td>Net Income ($ million)</td> </tr> <tr> <td>2012</td> <td>589.5</td> <td>32</td> <td>188.64</td> </tr> <tr> <td>2013</td> <td>634.5</td> <td>32</td> <td>203.04</td> </tr> <tr> <td>2014</td> <td>631.9</td> <td>32</td> <td>202.20</td> </tr> <tr> <td>2015</td> <td>558.53</td> <td>32</td> <td>178.73</td> </tr> <tr> <td>Total</td> <td> 2,414.43</td> <td> </td> <td>772.61</td> </tr> </tbody> </table>

The decline in revenue in 2014 and 2015 is due to the expiration of the Bora and Scirocco contracts in 2014. It is partially offset by the start of the Sharav five year contract with Chevron in 2014. Including Pacific Drilling’s total current assets of $800 million, the company will have a total amount of about $1,573 million to meet its contractual obligations. Thus, Pacific Drilling will have to refinance about $716 million in debt and borrow about $1,352 million to fund construction of its remaining drillships.

The numbers presented are a worst case scenario because it assumes no contract renewals for Bora and Scirocco and no contracts for Khamsin and Meltem, which are due to arrive in years 2013 and 2014, respectively. Most likely, Pacific Drilling will be able to get drilling contracts for the ships because they are new and drillship utilization is at 83.5% (rigzone). As a result, there is a good chance revenues will be much higher.

Looking at the executive board, the company has experienced management. Christian Beckett (CEO) spent 10 years at Schlumberger and 4 years at Transocean, Bob MacChesney (COO) spent 20 years at Schlumberger and 9 years with Transocean, and Cees Van Diemen (SVP Operations) has over 34 years of experience in mobile offshore drilling, including 25 years with Noble Drilling Corp.

Currently, Pacific Drilling has a tangible book value per share of $10.56. At $8.45 the company is trading at a discount of about 20% to book value. However, book value will likely erode because of debt payments. Due to its debts and unproven nature, the company is a somewhat risky investment. However, investors that have an appetite for risk should take a look because Pacific Drilling is definitely a promising company and has multi bagger potential.

iamgreatness has no positions in the stocks mentioned above. The Motley Fool owns shares of Ensco and Transocean. Motley Fool newsletter services recommend Chevron. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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