Pacific Drilling Continues to Execute

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), a company that specializes in ultra deepwater drilling, is piling up contracts. On Nov. 15, the company reported that its Pacific Khamsin drillship has been awarded an initial two year contract with an option for a third year by Chevron (NYSE: CVX). The contract has a total estimated revenue value (for the two years) to Pacific Drilling of $527 million.

Pacific Drilling is moving fast and has made great progress since being founded in 2006. The company has a total of seven drillships, with three under construction and four in operation. After being awarded a contract for the Pacific Khamsin, Pacific Drilling has six of its total seven ships under contract. The company has four ships under contract with Chevron, one with Total SA (NYSE: TOT), and one with Petroleo Brasileiro SA (NYSE: PBR) (Petrobras). The following table summarizes the contracts for Pacific Drilling.

<table> <tbody> <tr> <td>Drillship</td> <td>Contract Customer</td> <td>Contract Backlog ($)</td> <td>Actual/Expected Contract Commencement</td> <td>Contract Length (years)</td> </tr> <tr> <td>Pacific Bora</td> <td>Chevron</td> <td>367,162,000</td> <td>08-26-11</td> <td>3</td> </tr> <tr> <td>Pacific Scirocco</td> <td>Total</td> <td>212,461,000</td> <td>12-31-11</td> <td>2</td> </tr> <tr> <td>Pacific Mistral</td> <td>Petrobras</td> <td>422,613,000</td> <td>02-06-12</td> <td>3</td> </tr> <tr> <td>Pacific Santa Ana</td> <td>Chevron</td> <td>859,542,000</td> <td>03-21-12</td> <td>5</td> </tr> <tr> <td>Pacific Sharav</td> <td>Chevron</td> <td>1,076,430,000</td> <td>Q2 2014</td> <td>5</td> </tr> <tr> <td>Pacific Khamsin</td> <td>Chevron</td> <td>527,000,000</td> <td>Q3 2013</td> <td>2</td> </tr> </tbody> </table>

It should be noted that the Pacific Meltem, the drillship without a contract, is not due for delivery until the second quarter of 2014. Thus, Pacific Drilling has plenty of time to negotiate a contract for it. In addition, the Pacific Meltem is dual gradient drilling capable, which should help Pacific Drilling win a more lucrative contract.

On Nov. 16, Pacific Drilling announced the pricing details for a $500 million offering of senior secured notes that the company is conducting. Pacific Drilling will use the proceeds to fund construction payments on the Pacific Khamsin and for other purposes. Standard & Poor’s assigned the company a B rating and the senior secured notes a rating of B+. Standard & Poor’s defines its rating of ‘B’ as an issuer that is “more vulnerable to adverse business, financial and economic conditions but currently has the capacity to meet financial commitments.” Currently, Pacific Drilling is highly dependent on a few customers and has a lot of debt obligations. Luckily for Pacific Drilling, its customers, Chevron, Total, and Petrobras, are world class businesses. In 2011, Chevron, Total, and Petrobras had revenues of $252 billion, 185 billion Euros, and $183 billion, respectively.

Due to its start up nature, Pacific Drilling has a lot of debt, and most of its income is going into its debt payments. In Q3 2012, Pacific Drilling reported revenue of $172 million and operating income of $29 million. The company used $27 million of its operating income to pay interest expenses. Going forward, Pacific Drilling still has lots of obligation payments to make, as shown in the following table taken from the company’s 6-K report.

<img src="/media/images/user_12906/pacific-drilling-continues-to-execute_large.jpg" />

In two previous reports (Q1 and Q2), the company was analyzed using contractual obligation data from the previous quarters. The company’s current situation is an improvement from the previous quarters, but the additional $500 million (offering) in notes due in 2017 have added additional obligations. Focusing on the obligations from 2012 to 2016, Pacific Drilling has about $3.5 billion in total obligations. Using Pacific Drilling’s contractual backlog and the company’s EBITDA margin in the past nine months, it can be roughly estimated that the company will pile up about $1.2 billion in profits (EBITDA) by the end of 2016. In addition, the company has about $726 million in current assets and restricted cash, plus the $500 million it will raise from the offering.

Thus, the company will be short by about $1 billion in its obligations from 2012 to 2016 and another $500 million in 2017. Again, this is a very rough estimate. Compared to the two previous analyses (Q1 and Q2), the company’s situation has improved. The improvement is mostly due to the award of the Pacific Khamsin contract. It should be noted that the two previous calculations used operating margin instead of EBITDA, and as a result underestimated the company’s earnings power. Regardless, Pacific Drilling’s financial situation has improved.

Looking forward, there are risks to the company. The global economy continues to be slow and if the situation gets worse, Pacific Drilling could see a drop in demand for ultra deepwater drilling. In addition, the business of ultra deepwater drilling is pushing the limits of engineering and, as a result, there is a high risk of an accident occurring. Finally, the company has a lot of debt. Regardless, Pacific Drilling is executing well and should continue to steadily work its way out of its debts. During this process, the company will probably post losses like it did in Q3 2012. While this process could take a few years, it will likely be sped up by a contract award for the Pacific Meltem and additional contracts when current ones expire. Overall, Pacific Drilling is trading under tangible book value per share and could turn out to be a great investment in the long run.

iamgreatness has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Chevron, Petroleo Brasileiro S.A. (ADR), and Total SA. (ADR). 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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