Noble-Maersk Merger: Potential Jackup Rig Divestitures (NYSE:NE)

Note: Noble Corporation (NYSE:NE) has been covered by me previously, so investors should view this as an update to my earlier articles on the company.

Last week, leading offshore drillers Noble Corporation (“Noble”) and Maersk Drilling provided an update on the ongoing merger control process.

While the transaction has already received unconditional approval from the competition authorities in Brazil, Norway, and the Republic of Trinidad & Tobago with Angola expected to follow later this month, the UK Competition and Markets Authority (“CMA”) is likely to require substantial jackup rig divestitures:

While the CMA is yet to take its phase 1 decision, the Parties expect that it will be necessary to divest certain jackup rigs currently located in the North Sea (the “Remedy Rigs”) to obtain conditional antitrust clearance in phase 1 from the CMA. The Parties currently expect the Remedy Rigs to comprise the Noble Hans Deul, Noble Sam Hartley, Noble Sam Turner, Noble Houston Colbert, and a CJ-70 design drilling rig which, at this point, the Parties believe is likely to be the Mærsk Innovator, although it is possible the Noble Lloyd Noble could be required to achieve phase 1 clearance. On this basis, the Parties have started to examine different options to divest the Remedy Rigs.

Apparently, the UK watchdog is concerned about the combined company’s market power in the North Sea thus the requirement to divest Noble’s entire jackup fleet located in this region. Particularly the potential loss of the world’s largest modern jackup rig Noble Lloyd Noble would impact the combined company’s earnings power.

Remember, the rig generated hundreds of millions of dollars in operating cash flow during its 4-year maiden contract with Equinor between 2016 and 2020.

While the Maersk Innovator is of similar design, it doesn’t match the specifications of the Noble Lloyd Noble and will be due for its 20-year special survey next year.

In sum, the required divestitures would reduce the combined company’s jackup fleet by more than 25% from 19 to 14.

Even worse, the North Sea market has been lagging the recovery witnessed in other regions of the world, particularly the U.S. Gulf of Mexico and South America. While activity is expected to pick up next year, a forced divestiture of five jackup rigs into a mediocre market would negatively impact potential sales proceeds.

Given this issue, I wouldn’t expect the rigs to be sold to a competitor in an all-cash deal but rather against stock to participate in potential future upside.

There are a number of exchange-listed competitors operating in the North Sea like Borr Drilling (BORR), Valaris (VAL), Odfjell Drilling (Oslo-listed) and Seadrill (expected to re-list on the NYSE soon). As Valaris already commands substantial market share in the region, only Borr Drilling, Seadrill and Odfjell Drilling can be considered serious options for a divestiture.

While Borr Drilling still needs to deal with material near-term debt maturities and the requirement to take delivery of five additional newbuilds next year, Seadrill just recently emerged from bankruptcy with decent liquidity and an improved balance sheet. That said, the company appears to be more focused on the floater segment with jackup activities mostly concentrated in the Middle East and Mexico. In addition, Borr Drilling’s shares appear overvalued relative to restructured competitors like Noble and Valaris.

Seadrill’s latest fleet status report shows just two jackup rigs (West Elara and West Linus) operating in the North Sea with both of them being employed on long-term contracts offshore Norway. Please keep in mind that West Linus is actually owned by SFL Corporation (SFL) and management of the rig will be moved to competitor Odfjell Drilling soon.

Up to date, Odfjell Drilling has been focused solely on semi-submersible rigs but after the recent spin-off of its well services and engineering activities, the company is now considering “accretive growth opportunities and consolidations“. Taking over management of the West Linus represents the company’s entry into the jackup segment.

With Seadrill soon being down to a single jackup rig in the North Sea and Odfjell Drilling specialized in semi-submersibles, it’s somewhat difficult to envision a transaction at this point.

While I would certainly expect Noble to enter into negotiations with potential acquirers, at least in my opinion, the most likely outcome will be a spin-off of the five rigs into a newly established company with management either provided by Noble, Seadrill or Odfjell Drilling.

This way, Noble shareholders would still own the assets and benefit from anticipated improvements in the North Sea market going forward. In addition, there would be no need to sell the rigs at potentially distressed prices.

Bottom Line

Suffice to say, the likely requirement to divest a meaningful part of its jackup fleet will impact the combined company’s earnings power materially.

Nevertheless, both Noble and Maersk Drilling remain committed to the merger at this point:

The Parties believe that the financial and strategic rationale underpinning the Transaction remains intact and compelling for all stakeholders irrespective of the divestment of the Remedy Rigs. The Parties’ estimated annual run-rate cost synergies goal also remains unchanged. Further, the Parties do not intend to change the exchange ratio agreed between them for purposes of the Transaction.

Though the Parties expect that they will be required to divest the Remedy Rigs in order to gain CMA clearance, the duration and outcome of the CMA review process remains uncertain. If the Parties are able to obtain a conditional phase 1 antitrust clearance from the CMA, they expect closing of the Transaction will occur in mid-2022.

That said, the short-term impact of the divestiture is likely to be limited as dayrates in the UK North Sea remain nothing to write home about and two rigs (Noble Sam Hartley and Noble Houston Colbert) sitting idle.

Should Noble manage to avoid the disposal of the Noble Lloyd Noble, I would support the companies’ decision to continue with the merger process.

Regardless of the ultimate outcome, I reiterate my “buy” recommendation on Noble Corporation as the company remains cheap relative to industry peers and appears well on the way to substantial near-term cash flow generation.

Should the proposed merger fail to obtain antitrust clearance, I would expect Noble to pursue alternative transactions with Diamond Offshore (DO) or even Seadrill as the most likely targets.