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Avinash Gandhi

RDC AT A GLANCE

P/E ► 5.17 AVG EV/EBITDA ► 3.43 AVG ROA ► 10.1% AVG ROE ► 15.9% AVG Debt to Equity ► 0.587 AVG Current Ratio ► 2.30 AVG Interest Coverage Ratio ► 198 HIGH

 

 

 

 

 

 

Rowan Companies is an oilfield services company that operates 29 onshore deep-well drills and 21 offshore shallow-water jack-ups. It also manufactures drilling rigs and equipment, as well as heavy machinery for the the forestry, mining, and steel industry through its wholly-owned subsidiary, LeTourneau Technologies Inc. Rowan benefits from rising oil prices, as they increase demand for the limited number of drilling rigs in the world, driving up dayrates and increasing the company's revenues and income. With only shallow-water rigs in its offshore portfolio, though, LeTourneau is missing out on the fastest-growing, highest-margin sector of the oilfield services industry: deepwater oil exploration. In the Gulf of Mexico, the company's dayrates declined between 2006 and 2007 because shallow-water demand subsided, but this was offset by dayrate growth in the North Sea, which requires the high-spec, harsh environment jack-ups that Rowan specializes in. The company has kept capital expenditures and operating costs down thanks to its ownership of LeTourneau, which also helps it supply its drilling segment with rigs and parts at low cost. However, Rowan announced in March 2008 that it will be divesting from LeToureau by the end of the year, ending this symbiotic relationship; details as to how the divestment will occur are as-yet-unknown, though it is thought that LeTourneau is being cut loose in order to appease a small group of large shareholders. Rowan Companies competes with drill contractors like Transocean and Nabors Industries, with drill manufacturers like National-Oilwell Varco, and with heavy equipment manufacturers like Caterpillar and Deere & Company.

Business and Financials

Rowan Companies operates two divisions: Drilling Operations and Manufacturing Operations.

Rowan's Drilling Operations division is an oilfield services company that earned nearly $1.4 billion in revenue in 2007, with around $662 million in operating income - up from 2006 revenue of $1.1 billion and operating income of $447 million.^[1] Rowan Drilling operates 21 offshore jack-ups with water depths ranging from 250 to 550 feet and well depths ranging from 20,000 to 35,000 feet. It also operates 29 deep-well onshore rigs, with drilling depths of 18,000 to 35,000 feet. Rowan Drilling has rigs in the Gulf of Mexico, the Middle East, Trinidad, the North Sea, offshore eastern Canada, and offshore West Africa. Saudi Aramco is the company's biggest customer, accounting for 13% of Rowan's overall revenues.^[2] Rowan's Manufacturing Operations division, LeTourneau Technologies Inc., operates in two separate segments.

• Drilling Products and Systems (DPS): This segment makes oilfield services equipment, specializing in high-performance, harsh environment jack-ups, as well as many of the smaller equipment and parts needed to service the rigs. DPS saw revenues of $499 million in 2007, up from $241 million in 2006. Operating income also rose, from $23.5 to $43 million.^[3]
• Mining, Forestry, and Steel Products (MFSP): This segment makes heavy machinery for the mining, forestry, and steel industry. Its steel-plate making business converts scrap metal to high-end steel. It built all 21 of Rowan's jack-ups. Revenues for MFSP increased from 2007 to 2006, from $202 million to $214 million. Operating income increased from $14.5 million to $29.1 million.^[4]

In 2007, Manufacturing had a backlog of $348 million, down from $530 million in 2006.

Trends and Forces

Rising Oil Prices are Driving Up Oilfield Services Dayrates, Especially for Offshore Drilling

Oil and gas prices have fluctuated heavily over the past few years, though since mid-2007, the trend has been up. Oil traded on international markets for $120/bbl in early May, a record high, while natural gas traded at over $10/Mcf.^[5] As oil prices rise, E&P companies are desperate to ramp up production, causing demand for drilling rigs to skyrocket. Of Rowan's drilling division's $315 million increase in revenue between 2006 and 2007, $120 million could be attributed to rising dayrates^[6], as rising demand for drilling rigs coupled with the limited number of offshore rigs worldwide to cause an increase in dayrates all over the world.

Without Deepwater Oil Exploration Technology, Rowan is Missing Out on the Highest-Growth Sector of Oilfield Services

Despite the fact that Rowan's dayrates rose overall, in certain regions they actually fell because of the changing dynamics of the oilfields. Specifically, the company actually saw average dayrates decline from $138,800 to $129,399 from 2006 to 2007 in the Gulf of Mexico.^[7] The maximum water depth to which any of Rowan's rigs can drill is 550 feet, making the company's rigs only capable of operating on the shallow Gulf Shelf. Historically, the Shelf has been responsible for much of U.S. oil and gas production; in 2007, for example, it was responsible for 7.6% of U.S. oil production and 10.2% of U.S. gas production. These production numbers, though, are part of an overall decline in production rates since 2003. The Minerals Management Service (MMS) estimates that production in the region will fall from 329,000 barrels per day to 182,000 barrels per day in the next nine years - a decline of 55%, and a big reason why many of the oil majors are leaving the shallow shelf for deeper waters.^[8]

Deepwater oil exploration is becoming increasingly important to upstream petroleum companies, as they move from mature regions with declining reserves in search of new places to expand production. While deepwater exploration is risky, with the average success rate for striking hydrocarbons in the deepwater Gulf at just 45% in 2007^[9], the rewards can be great. In April of 2008, for example, Brazilian oil major Petrobras discovered a deepwater oilfield reputedly containing 33 billion barrels of oil equivalent (though more research will be needed to fully assess the field's worth).^[10] There are very few deepwater rigs in the world, so these pieces of capital can contract for upwards of $800,000 per day.^[11] Rowan's focus on harsh environment drilling, however, means it lacks the equipment to see demand and dayrates really rise in the Gulf of Mexico. While the company's jack-ups are ideal for the turbulent North Sea oil fields (indeed, the company's North Sea rigs saw average dayrates of $241,000^[12]), the Gulf of Mexico is a relatively calm region, except during the hurricane season. Going forward, for oilfield services companies to grow in the Gulf, they will have to offer rigs with either the ability to extract more from mature wells or to drill in deeper waters - neither of which Rowan's nine rigs in the area can do.

Ownership of LeTourneau Gives Rowan the Advantage of Vertical Integration

Rowan's manufacturing arm, LeTourneau, specializes in high-end, harsh-environment jack-ups. It's no surprise, then, that most of Rowan's offshore rigs are high-end, harsh-environment jack-ups. By owning LeTourneau in full, Rowan has the ability to build and repair its rigs without paying value-added costs. Worldwide, 93% of jack-ups are already being utilized.^[13] With only a limited number of available jack-ups combining with a high demand for oilfield services, jack-up manufacturers can sell their rigs and rig equipment at artificially inflated prices. While this would cut down on Rowan's margins if it were to purchase equipment from other manufacturers, LeTourneau sells to Rowan at cost, allowing the company to keep capital spending down and, thus, margins up. Furthermore, Rowan's ownership of LeTourneau allows it to expedite construction and delivery of equipment it needs, minimizing rig downtime.

Rowan's Plans to Sell or Spin-off LeTourneau Mean the Company's Advantage will be Short Lived

On March 31st, 2008, Rowan announced that it would divest from LeTourneau, either by spinning it off or selling it. Though LeTourneau built all of Rowan's jack-up rigs, Rowan agreed to divest as a may of getting Steel Partners II LP, a 9% overall stakeholder, to withdraw its three nominations for the board of directors. If LeTourneau is not sold by the end of 2008, Steel Partners II LP will be allowed to appoint a director to the board. Rowan is also planning on using $400 million of the sale's earnings to initiate a share buyback.^[14] Though the deal allows the current board of directors to stay stable, LeTourneau was responsible for 30% of the company's income, and for allowing Rowan to keep its operating costs down. Unless the company keeps a significant stake in LeTourneau, which is unlikely, Rowan will not only lose a significant source of income, it will lose the cost advantage is gets from being vertically integrated. Though it's unclear exactly why Rowan's management agreed to cut the potentially lucrative LeTourneau loose, it's possible that this is a classic case of executive self-interest: Steel Partners wanted Rowan to focus on its drilling business, and had nominated three people for the next board elections in order to make it happen. By agreeing to spin LeTourneau off, Rowan's current board members eliminated the threat of replacement, as Steel Partners agreed to remove their nominees.

Competition

Rowan competes in several industries.

In the oilfield services industry, Rowan is a niche player, with a small fleet size composed of only a few types of rigs. Its competitors include:

• Transocean - This drilling behemoth has 138 offshore rigs, including 10 high-spec jack-ups and 56 standard jack-ups^[15], as well as 48 deepwater rigs.^[16]
• Noble: 86% of Noble's fleet of 66 rigs were deployed internationally in early 2007^[17], with its markets ranging from the Gulf of Mexico to India, Mexico, the North Sea, the Middle East, and West Africa.
• Diamond Offshore Drilling: 21 of Diamond's 44 rigs were deployed in the American Gulf of Mexico^[18], with the rest divided between Brazil, Malaysia, Australia, New Zealand, Egypt, Vietnam, the North Sea, and the Middle East.
• Nabors Industries - Nabors is one of the largest onshore drilling companies in the U.S., with 535 land drilling rigs; the company also contracts 51 offshore rigs.^[19] Aside from oilfield services operations, Nabors is one of the few companies that drills for geothermal resources.
• Unit - Unit Drilling owns 129 land rigs with depth ranges from 5,000 feet to 40,000 feet in Wyoming, Utah, Colorado, New Mexico, Texas, Oklahoma, Kansas, and Louisiana. Most of these rigs are designed to drill for natural gas, and are either used by Unit Petroleum or contracted to other E&P companies.^[20]

Rowan's Drilling Products and Systems segment competes mostly with National-Oilwell Varco, the world's largest rig builder; National-Oilwell Varco has a 60% share of the rig equipment industry, and 90% of all rigs worldwide have some NOV part or another.^[25]

Rowan's Mining, Forestry, and Steel Products segment competes with Caterpillar and Deere & Company, both of which build heavy machinery. Caterpillar specializes in mining equipment, while Deere & Company has a forestry equipment segment.

This graph shows market share for the United States' contract onshore drilling market in FY 2007. Market share is determined by the number of rigs owned and operated by the respective drilling companies.^{[26][27][28][29][30][31][32][33]}

References

1. ↑ RDC 2007 10-K, Page 11
2. ↑ RDC 2007 10-K, Page 29
3. ↑ RDC 2007 10-K, Page 35
4. ↑ RDC 2007 10-K, Page 36
5. ↑ Energy Prices Data, Accessed May 7th, 2008
6. ↑ RDC 2007 10-K, Page 29
7. ↑ RDC 2007 10-K, Page 30
8. ↑ Access My Library: "The Gulf of Mexico shelf: still a cash flow machine: majors out, independents in.(GULF OF MEXICO)(Cover story)"
9. ↑ Oil Savvy
10. ↑ MarketWatch: "Petrobras cautions more data needed on oil find"
11. ↑ Energy Current: "Deepwater rig day rates hit new high", November 9th, 2007
12. ↑ RDC 2007 10-K, Page 30
13. ↑ SeekingAlpha: Schlumberger Q4 2007 Earnings Call Transcript, Page 3
14. ↑ MSN Money: "Rowan Cos. to sell LeTourneau Tech."
15. ↑ Yahoo! Finance: "Transocean Inc. Provides Fleet Status Report", April 4th, 2008
16. ↑ International Herald Tribune, July 24th, 2007
17. ↑ Reuters, Noble Corp NE
18. ↑ Diamond Offshore Drilling Inc DO
19. ↑ Reuters Full Description: Nabors Industries Ltd NBR (NYSE)
20. ↑ Unit Web Site: Rig Fleet Map
21. ↑ RIG 2007 10-K
22. ↑ NE 2007 10-K
23. ↑ RDC 2007 10-K
24. ↑ ESV 2007 10-K
25. ↑ Morningstar Analysis, National-Oilwell Varco, January 10th, 2008
26. ↑ Pioneer Drilling Company Rig Fleet List
27. ↑ Grey Wolf, Inc. Summary
28. ↑ Nabors Industries Ltd Summary
29. ↑ Patterson UTI Summary
30. ↑ Helmerich & Payne Rig Fleet
31. ↑
32. ↑ Rowan Companies Land Rig Fleet
33. ↑ Parker Drilling Fleet