Monday, December 01, 2008
Final update on COSL (2883)
Early last year I looked at COSL and found out it's less a service company but more an utility with old equipment. Subsequently to my amazement its price rocketed from $5 to over $20 in Oct 07, then it was sold all the way down to a little under $3 last month (i.e. one year later). Now the price is around $4.6. One peculiar thing was that share price this year pretty much moved against the rise in profits and the oil price until July, then it moved further down with the oil price and then entered a free fall zone like every other stock in Sept and Oct.
Meanwhile during this time COSL completed a huge acquisition of a Norwegian drilling company. The deal was announced in July and completed in Sept. So I think it's about time to have a second look of COSL.
The acquisition was huge at NOK 12.7b, which was about HK$20b at time of announcement and the same as COSL's own NAV. COSL's historical highest profit earned was a little more than HK$2 billion in last year.
The assets acquired were a fleet of 6 drilling rigs in operation and 7 rigs in shipyard under construction. These 13 rigs will eventually double the capacity of COSL which is 15 now. The Norwegian company was only set up in 2005 and was barely profitable until 2007 (as the rig was put into operation one by one). Given the lack of track record, this deal could be seen as an asset buy, for I don't believe there's much goodwill developed within the 2+ years of operation.
The deal also came with a lot of debt as those rigs were heavily geared. There was US$1.35b of debt against US$1.8b of fixed assets (including those under construction), making the rigs 75% bank financed. Overall gearing of the Norwegian driller was more than 260% and NAV was only US$515m. So HK$20b was spent to acquire HK$4b of net assets. It certainly looked quite expensive for asset purchase. One reason for the high cost maybe the long lead time (~2-3 years) required for manufacturing rigs, thus creating limited supply in the market. Another reason was of course the now-seen-overheated market for drilling equipment back then when everyone was searching for new oil.
This acquisition was ill timed as the deal was struck at beginning of July when the crude oil price was at its peak. Though luck may have it, the deal got to go through the lengthly approval process of the Chinese bureaucracy and wasn't completed until the last week of September, and during this time the NOK has dropped about 15% against the USD so making the cost slightly cheaper at HK$17b.
COSL intended to finance the acquisition with debt so it will have HK$27b debt to service for the new rigs acquired. Interest cost (say 5%) will be at least $1.35 billion a year. Revenue side is less certain now given the market environment has changed quite a bit, and half of the rigs are yet to be delivered and hence without having secured order. Rentals seem to fluctuate quite a bit and some rigs are only on contracts for a few months, subject to extension pending successful exploration which will then lead to multi-year contracts. I'm not really sure about exact dynamics, except the revenue side is much less stable than desired. Looking at the substantial increase in revenue of COSL over the last 5 years, when its fleet size only increased moderately, only confirmed the instability of the revenue stream.
The most COSL earned with its 15 rigs was $2 billion in last year, but it operated with almost no debt and inside Chinese waters, and paid a low 15% tax rate. How much the new rigs will contribute to the enlarged COSL group is really a question.
As said last time, the average useable life of COSL's existing fleet is only about 10 years (vs. 30 years of a new rig), so COSL will have to continue to upgrade its drillers in the future (think what it will do to dividends and debt level). This Norwegian acquisition alone already took up much more than all free cash flow of past 5 years combined! Future replacement cost may come down as the industry slows down and the raw material becomes cheaper. But having an extremely long capax cycle and great uncertainty in product pricing (which depends on oil price) making running a driller business not less difficult than an airline. Both require heavy and long term commitment upfront but profitability depends much on oil price movement.
The current price reflects a historical p/e of 8 times, which looks reasonable but is a result of last year's favorable industry conditions. This years' results should be even better (assume the newly acquired Norwegian driller can pay off the interest of acquisition debt at least), but it's difficult to work out a longer term sustainable earnings, as this entails a forecast of the oil price level. COSL needs both favorable oil price movement and good timed execution in capax to succeed in the long run.
My initial opinion about COSL hasn't changed. I'd modify it as an utility with unstable revenue stream and old equipment. It's mostly a speculation stock.
DISCLOSURE: I don't hold 2883 at time of writing.
Meanwhile during this time COSL completed a huge acquisition of a Norwegian drilling company. The deal was announced in July and completed in Sept. So I think it's about time to have a second look of COSL.
The acquisition was huge at NOK 12.7b, which was about HK$20b at time of announcement and the same as COSL's own NAV. COSL's historical highest profit earned was a little more than HK$2 billion in last year.
The assets acquired were a fleet of 6 drilling rigs in operation and 7 rigs in shipyard under construction. These 13 rigs will eventually double the capacity of COSL which is 15 now. The Norwegian company was only set up in 2005 and was barely profitable until 2007 (as the rig was put into operation one by one). Given the lack of track record, this deal could be seen as an asset buy, for I don't believe there's much goodwill developed within the 2+ years of operation.
The deal also came with a lot of debt as those rigs were heavily geared. There was US$1.35b of debt against US$1.8b of fixed assets (including those under construction), making the rigs 75% bank financed. Overall gearing of the Norwegian driller was more than 260% and NAV was only US$515m. So HK$20b was spent to acquire HK$4b of net assets. It certainly looked quite expensive for asset purchase. One reason for the high cost maybe the long lead time (~2-3 years) required for manufacturing rigs, thus creating limited supply in the market. Another reason was of course the now-seen-overheated market for drilling equipment back then when everyone was searching for new oil.
This acquisition was ill timed as the deal was struck at beginning of July when the crude oil price was at its peak. Though luck may have it, the deal got to go through the lengthly approval process of the Chinese bureaucracy and wasn't completed until the last week of September, and during this time the NOK has dropped about 15% against the USD so making the cost slightly cheaper at HK$17b.
COSL intended to finance the acquisition with debt so it will have HK$27b debt to service for the new rigs acquired. Interest cost (say 5%) will be at least $1.35 billion a year. Revenue side is less certain now given the market environment has changed quite a bit, and half of the rigs are yet to be delivered and hence without having secured order. Rentals seem to fluctuate quite a bit and some rigs are only on contracts for a few months, subject to extension pending successful exploration which will then lead to multi-year contracts. I'm not really sure about exact dynamics, except the revenue side is much less stable than desired. Looking at the substantial increase in revenue of COSL over the last 5 years, when its fleet size only increased moderately, only confirmed the instability of the revenue stream.
The most COSL earned with its 15 rigs was $2 billion in last year, but it operated with almost no debt and inside Chinese waters, and paid a low 15% tax rate. How much the new rigs will contribute to the enlarged COSL group is really a question.
As said last time, the average useable life of COSL's existing fleet is only about 10 years (vs. 30 years of a new rig), so COSL will have to continue to upgrade its drillers in the future (think what it will do to dividends and debt level). This Norwegian acquisition alone already took up much more than all free cash flow of past 5 years combined! Future replacement cost may come down as the industry slows down and the raw material becomes cheaper. But having an extremely long capax cycle and great uncertainty in product pricing (which depends on oil price) making running a driller business not less difficult than an airline. Both require heavy and long term commitment upfront but profitability depends much on oil price movement.
The current price reflects a historical p/e of 8 times, which looks reasonable but is a result of last year's favorable industry conditions. This years' results should be even better (assume the newly acquired Norwegian driller can pay off the interest of acquisition debt at least), but it's difficult to work out a longer term sustainable earnings, as this entails a forecast of the oil price level. COSL needs both favorable oil price movement and good timed execution in capax to succeed in the long run.
My initial opinion about COSL hasn't changed. I'd modify it as an utility with unstable revenue stream and old equipment. It's mostly a speculation stock.
DISCLOSURE: I don't hold 2883 at time of writing.
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