Hercules Offshore (HERO)

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See all Bulls Reasons Bulls: Reasons To Buy Bullish on Hercules Offshore 0% agree Bullish on Hercules Offshore The oil story is can never calm down so easily going into the future and the advances of the world economies, bigger populations and needs to sustain industry. Needs will only increase, how can they decrease? Hercules is another player who will exploit offshore... read more View or Edit Reason 0 votes 0% agree Bears: Reasons To Sell Feeling Bearish? Be the first to explain why this would make a poor investment Send the authors a comment or suggestion Be the first to make a suggestion See All Suggestions

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Hercules Offshore (HERO)^[1] provides shallow-water and land contract drilling to both integrated energy companies and independent oil and natural gas companies. Founded in 2004, HERO focuses its operations in the Gulf of Mexico (GOM) region, but also operates in Qatar, India, and West Africa. To enhance its advantage in the GOM, Hercules Offshore purchased TODCO in a deal completed in July 2007 for $2.3 billion^[2]. The addition of TODCO's ships introduced the 27 barge rigs that HERO now operates and dramatically increased the number of HERO's jackup rigs from 9 to 33, giving Hercules Offshore the largest fleet of jackup drilling rigs in the Gulf. HERO also owns and operates as well as the world's largest fleet of liftboats, which are floating platforms from which drilling platforms can be maintenanced and built. Hercules Offshore's liftboat fleet offer the firm some diversification from the rest of its fleet, which are primarily jackup and barge drilling rigs used for drilling in relatively shallow water. Such diversification would be useful if the market for shallow-water offshore oil drilling temporarily slowed. Offshore drilling could slow while deepwater drilling remains strong as offshore reserves, which are typically cheaper to drill from than deepwater reserves, are depleted. Also, adverse weather in the Gulf of Mexico poses one of the main threats to HERO's business, as a storm could severely damage HERO's equipment; in such a case, with HERO's drilling capacities limited, the liftboat units could prove useful in repairing the rigs and in generating revenue for the company.

HERO remains susceptible to global oil demand and oil prices. Rising demand and limited supply contribute to higher prices, which in turn make drilling in unconventional reserves more profitable. This means that companies will move increasingly from land reserves, which are generally the lowest cost, to offshore reserves as prices rise. However, if prices rise even more and as offshore and land reserves are depleted, deepwater drilling may become more feasible as an alternative.

[edit] Company Overview

Hercules Offshore is split into two main divisions, each of which primarily operates one type of equipment. HERO has a drilling division, which operates shallow-water drilling rigs, and a marine services division, which operates the company's liftboats.

HERO's operations are concentrated in the domestic Gulf of Mexico market, with slightly greater revenues from drilling than marine services^[3].

As of September 30, 2007, HERO's shallow-water drilling rigs consisted mainly of 33 jackup rigs and 27 barge rigs ^[4]. Jackup rigs are floating platforms which can be towed to the drilling site. Upon reaching its destination, the jackup rig's four legs are planted into the seabed, stabilizing the platform and allowing the platform to rise above the water. This creates a raised platform from which the drilling rig can operate^[5]. Each of HERO's jackup rigs is capable of drilling in water depths up to 250 feet^[6]. Barge rigs are used for drilling in shallower, calmer waters, mainly in inland waters, and can be used for drilling in water depths up to 20 feet^[7]. HERO's merger with TODCO gave HERO control of three submersible rigs, nine land rigs, and one platform rig^[8]. These new types of equipment, while relatively small compared to HERO's main jackup and barge rig operations, give the company to opportunity to explore new markets. The land rigs previously owned by TODCO were sold to Saipem, in a deal that closed in December 2007^[9].

HERO's marine services division also owns and operates 60 liftboats and operates 5 additional liftboats^[10], which comprise the world's largest liftboat fleet. These liftboats provide a variety of offshore supportive services for drilling rigs, including platform maintenance and platform construction^[11].

HERO's growth has been steady, with net revenue increasing every quarter since the company's inception^[12].

HERO's recent merger with TODCO, completed in July 2007, also gave HERO control of a fleet of marine support vessels, which are now operated by Delta Towing, a wholly owned subsidiary of Hercules Offshore^[13].

Hercules Offshore has seen extremely rapid growth in its short history, with both revenue and net income more than doubling from 2005 to 2006. Even more encouragingly, the strong growth has been spread over both drilling and liftboat operations, and has been steady every quarter of HERO's history. This upward trend is due to strong demand for drilling and liftboat services, which allowed HERO to raise dayrates for its rigs and liftboats. HERO also expanded its drilling services overseas in 2006, adding an international drilling division that charged, on average, higher dayrates than the domestic division due to decreased competition in other regions.

[edit] Trends and Forces

[edit] Higher oil and natural gas prices increase the demand for HERO's drilling and liftboat services

With the rise of rapidly-developing economies such as those of India and China, the global demand for energy has been rising rapidly. As developing economies gain in wealth and industrialize, their ability to pay for energy rises. More specifically, wealthier countries are able to move from coal power to oil and natural gas, which are relatively cleaner, but more expensive, sources of energy. Rising global demand for energy, combined with restricted supply from oil-producing regions such as the Middle East have contributed to rising oil prices in recent years. Prices of natural gas, which are highly correlated with oil prices, have also been rising, due to potential shortages arising from depletion of reserves and rising demand from seasonal fluctuations, as natural gas is commonly used for heating. Higher oil prices mean that it is economically feasible for companies to tap into reserves that were previously too expensive to drill from profitably. This boosts demand for companies such as HERO, which can provide companies with drilling and maintenance services for offshore drilling, which is generally more expensive than onshore drilling, but is becoming more and more important as existing onshore drilling sites are depleted.

The recent frenzy of oil exploration and production has only been fed by concerns that the world's supplies of oil and other fossil fuels will run out and production will eventually decline to zero. Major oil and gas companies, facing the threat of scarcity, have become even more competitive in discovery and exploration of new reserves and of nonconventional reserves such as oil sands. This benefits HERO, which can play off higher demand to generate increased revenue.

Worldwide energy consumption is destined to grow steadily in the near future.

[edit] Adverse weather in the GOM could cause significant fleet damage

The Gulf of Mexico is HERO's most important region, accounting for more than half of HERO's 2006 revenue. HERO's fleet in this area is vulnerable to hurricanes and tropical storms. Furthermore, recent adverse weather such as Hurricanes Ivan, Katrina, and Rita have pushed up insurance prices for companies that operate in the Gulf of Mexico^[16]: for the period ended July 1, 2007, HERO's insurance costs had increased 151% annualized from the period before^[17].

[edit] Depletion of shallow-water reserves and higher oil prices could promote deepwater drilling as a feasible alternative to offshore drilling

The U.S. Gulf of Mexico, where HERO generates about half of its revenue, is a mature region that has already experienced significant exploration and drilling activity. The average size of oil and natural gas deposits discovered in the GOM has been declining since the early 1990s^[18]. Higher oil prices, combined with depleted shallow-water and land reserves, could promote deepwater drilling, which is typically more expensive and requires heavier equipment than offshore drilling. HERO is not exposed to deepwater drilling whereas many of its competitors, such as Transocean (RIG), are active in the deepwater segment. This trend may harm HERO's competitiveness by replacing HERO's offshore drilling in the GOM with deepwater drilling services of other companies.

[edit] Competition

HERO operates the 4th largest jackup fleet in the world, behind Transocean (RIG), ENSCO International (ESV), and Noble (NE)^[19].

By a wide margin, HERO operates the most liftboats in the Gulf of Mexico^[20].

HERO operates the largest jackup rig fleet in the Gulf of Mexico by a wide margin^[21].

Hercules Offshore's main competitors in jackup rig drilling are:

• Transocean (RIG): Transocean is an offshore and deepwater contract drilling company with 89 drilling units around the world. However, Transocean has only a weak presence in the Gulf of Mexico, with only 11 total units in the Gulf.
• ENSCO International (ESV): ENSCO is an international and U.S. offshore contract drilling company serving government-owned, international, and independent oil and gas companies. ENSCO operates in the Americas, Europe, Africa, and Asia Pacific, and is HERO's closest competitor in jackup rig drilling in the Gulf of Mexico.
• Noble (NE): Noble provides contract drilling in Middle East, India, the North Sea, Brazil, West Africa, and Canada. NE also offers other drilling-related services, such as project management services and engineering services.

Of these larger drilling companies, only ENSCO and Transocean have drilling presence in the Gulf of Mexico, which is HERO's primary focus, and Transocean's operations in the Gulf are extremely small (3 jackup rigs). HERO has as many jackup rigs in the Gulf of Mexico as its two closest competitors combined.

HERO now also has a strong barge drilling fleet, with 27 barge rigs, more than twice the number of its next closest competitor, Parker Drilling Company (PKD)^[22]. Barge rigs, while a significant new market for HERO to explore, are limited in their usefulness because they are limited to waters up to only 20 feet deep.

In liftboat services, HERO divides its units between the Gulf of Mexico and in West Africa, and is a leader in both regions. About two-thirds of HERO's liftboats are in the Gulf of Mexico, which is the more competitive market, with over 115 liftboats operated by 15 companies. The market in West Africa is much smaller, with HERO operating 18 liftboats and 4 other firms operating a combined total of 7 liftboats.

HERO's rig utilization rate in 2006 was very similar to that of its main competitors. However, HERO earns lower dayrates than RIG and ESV for its jackup rigs. Hercules Offshore's lower dayrates overall across all drilling operations reflect HERO's focus on jackup rigs, which typically command lower dayrates than other types of rigs such as submersible rigs, which HERO did not operate in 2006 while its main competitors did.

[edit] References

1. ↑ Hercules Offshore company website.
2. ↑ From "Hercules Offshore to Acquire TODCO for $2.3 Billion, Rigzone.
3. ↑ Data from HERO's 2006 10-k Filing, pages 27-28.
4. ↑ From HERO's 3Q 2007 10-Q Filing, page 6.
5. ↑ Description from "Getting to Know a Hero," Seeking Alpha.
6. ↑ From HERO's company website, Corporate Overview.
7. ↑ From HERO's company website, Corporate Overview.
8. ↑ From HERO's 3Q 2007 10-Q Filing, page 6.
9. ↑ From HERO's presentation at the January 2008 Goldman Sachs Energy Conference, page 9.
10. ↑ Figures from HERO's 3Q 2007 10-Q Filing, page 6.
11. ↑ From HERO's company website, Corporate Overview.
12. ↑ Data from HERO's 2006 Annual Report, page 1.
13. ↑ From HERO's 3Q 2007 10-Q Filing, page 6.
14. ↑ Data for period from inception to start (not a full year).
15. ↑ Data from HERO's 2007 10-k Filing, page 22.
16. ↑ From HERO's 2006 10-k Filing, pages 11-12.
17. ↑ From HERO's 2006 10-k Filing, pages 5-6.
18. ↑ From HERO's 2006 10-k Filing, page 10.
19. ↑ Data from HERO's presentation at the January 2008 Goldman Sachs Energy Conference, page 4.
20. ↑ Data from HERO's presentation at the January 2008 Goldman Sachs Energy Conference, page 6.
21. ↑ Data from HERO's presentation at the January 2008 Goldman Sachs Energy Conference, page 4.
22. ↑ Data from HERO's presentation at the January 2008 Goldman Sachs Energy Conference, page 5.
23. ↑ Data from RIG's 2006 10-k Filing, page 51.
24. ↑ Data from ESV's 2006 10-k Filing, page 31.
25. ↑ Data from HERO's 2006 10-k Filing, page 22.
26. ↑ Data from PKD's 2006 10-k Filing, page 45.
27. ↑ Data from HERO's 2006 10-k Filing, page 27.
28. ↑ Data from RIG's 2006 10-k Filing, pages 24, 27, and 30, respectively.
29. ↑ Data from ESV's 2006 10-k Filing, page 37.
30. ↑ Data from NE's 2006 10-k Filing, page 21.