Rig-Lock: How Borr Drilling Wins in a Constrained Supply Environment

Structural shortages and undervalued assets align for a multi-year recovery

Market Cap: $870,120,000

P/B: 0.71x

Net Debt: $1,960,000,000

EV: $2,830,120,000

Shares Outstanding: 289,080,000

Business Overview

Borr Drilling is the owner of 24 premium jack up (JUs) vessels incorporated in Bermuda with a global operation that reaches from North America to Asia. The jack ups Borr owns drill in shallow water environments with legs that extend and touch the sea floor, typically in water depths of between 300 – 400ft of water. They are called jack ups because once the infill activity they are contracted for is complete the legs are “jacked up” off of the sea floor and the vessel is able to be moved to its new location. Borr’s fleet was built on the other side of one of the worst depressions in the offshore services market, presenting an attractive opportunity to acquire assets at a 50% discount to easily identifiable replacement cost of roughly $300M per vessel.

Borr’s fleet average age is just 8 years old vs 20% of the industry being 40 years of age or older, suggesting attrition of vessels will grind higher as the types of vessels Borr owns have 30-35 year useful lives and the industry broadly wants higher spec vessels and must be extra cognoscente of safety standards and though the risk of a blow out that exists with drill ships isn’t present in the JU market, legs collapsing on older tonnage has dire consequences and it’s a matter of life and death for the workers aboard.

Though the journey has been tumultuous, we think Borr is extremely well positioned to take advantage of the upcoming cycle in offshore shallow water drilling. The economics associated with offshore development are now advantaged over onshore for the first time in over a decade and as the worlds demand for hydrocarbons in all forms grows we think offshore shallow water production plays an essential role with its faster time to market against its deep water competition which we think will be essential to maintain the energy needs associated with bringing the worlds poor out of extreme poverty.

Historical Overview

Borr Drilling traces its roots back to 2016 in the peak of despair in the energy markets broadly and the offshore services business in particular. Oil prices had languished after a period of relative strength from 2010-2014 when oil prices traded in a range of $80-$120 per barrel. Following a period of constructive oil pricing the energy value chain broadly began to perform poorly on the back of Saudi supply floods in 2014 and years of cost overruns in the offshore supply industry even as oil prices allowed for new capital to be spent on exploration activity.

In 2016 Borr acquired two premium jack up rigs from Hercules Offshore before adding 15 more in 2017 from Transocean for $1.35B, and an additional 9 vessels in October from Semcorp’s PPL Shipyard. In the following year, Borr acquired 2 more jack ups from Paragon, and 5 more from Keppel FELS for $745M. The final piece of the amalgamation of Borr Drilling is a purchase of a single vessel from Hakuryu 15 in 2019.

On its face, these transactions made a lot of sense. The market in offshore drilling had been decimated on the back of enormous interest in new building activity that led to 25% of the fleet on back order at the end of 2014, as well as Singapore shipyards that were producing over half of the worlds jack ups allowing for just 5% down payments to build new JUs. Not only did oil prices fall precipitously from their peaks in 2014 which killed demand anyhow, but you also had a significant amount of new capacity hitting the water just as demand was cresting.

As a result, the market for JUs saw utilization rates of 95%+ fall to 60% and day rates go from a peak of $300K per day to just $50K per day which was essentially break even to own even the most premium JUs at the time. On the back of poor demand and oversupply of a long-lived asset base, the price of new JUs fell for secondhand transactions. What would normally be purchased for $300M from a new shipyard to build was trading on the open market for $110-$140M per vessel.

While the value investor in me can appreciate the interest in doing deals as this large of a discount, the business had become overleveraged right before the longest protracted downturn in energy market history with no end in sight, thanks in part to the Permian Basin and tight oil production in West Texas.

By the end of 2022 the business had $1.87B in debt outstanding with $1.61B maturing in 2023. To avoid solvency issues Borr issued $275M of fresh equity and had to undergo extensive negotiations with shipyards to extend terms through 2025. In addition to the rolling of the debt and dilution, Borr also took a new $150M facility that replaced the existing bridge loans plus sold a new build vessel Gyme for $120M to offset PPL loans.

Even after all of scrambling the business did in 2022 Borr was not out of the woods. In February of 2023, Borr placed $250M at 5% via senior unsecured notes maturing in 2028. Also, in 2023 the company placed $1.225B of senior secured notes at 10% due 2028 and an additional $515M at 10.375% due in 2030. By 2024 Borrs capital structure was comprised of $1.92B of gross debt with 1.18B in 2028 notes, $502M of notes due 2030 and $240M of convertibles.

If the leverage was not enough, even as the market began to slowly recover, Borr began to bring down debt modestly, and offshore capex increased, every single major market for shallow water drilling presented its own set of challenges. The Middle East is the largest demand driver for JUs in the world and has been suspending vessels in the last few years. In 2022 Saudi Arabia requested 45 JUs to enter the market and by year end 2024 had suspended 30 of them, sending them back to the world market to try to find contracts. The North Sea, another hot bed for shallow water exploration and production activity, is trying to ban hydrocarbon extraction driven by misguided climate goals that undermine basic physical realities alongside Europe. Finally, Mexico, a market that Borr is disproportionately exposed to has stopped paying its customer base in the name of solvency issues for Petroleos Mexico or PEMEX. So not only did you have a broader bear market in energy services, a leveraged balance sheet and weak utilization but the markets you served were detractors as well.

As it stands today, we think the risk of solvency is behind Borr, but that does not mean it is time to get complacent, it means that from this point on prudent capital management and intelligent uses of cash are incredibly important. There have been some leadership changes as time has gone on, but we think leadership is strong and will use this opportunity to position themselves well for what we believe is the early innings of the offshore services bull cycle. We abide by the best operator principle, and we think that Borr is best positioned to take advantage of the cycle in shallow water drilling. Borr’s fleet quality separates it from its competition and allows for a lean cost structure and improves unit economics for the vessels they own.

In addition, nearly 70% of Borr’s customer base is National Oil Companies (NOCs) who have a vested interest in drilling shallow water resources for domestic energy security. Working alongside NOCs like Saudi Aramco, PEMEX, and ADNOC you are aligning yourself with a customer base that will be more willing to sign longer duration contracts and provide a nice source of demand for your asset base over time. In addition, the motivation for drilling these wells is tied to balancing government budgets rather than pure economic purposes.

While there are puts and takes to both IOC and NOC clientele, we think a strong back log of NOC work alongside contracts with IOCs to leverage the increase in day rate due to shorter contract duration makes a lot of sense. In addition, 90% utilization is a magic number for the leverage Borr holds with its customer base to shift into their favor with 92-93% positions Borr to have significant pricing power. When utilization is under 90% the lessee of the vessels has the upper hand.

In times of lower utilization rates things such as mobilization costs which are significant for JU rigs are paid by the asset owner themselves. When utilization begins to tick higher in excess of 90% and toward say, 95%, the leverage moves to the lessor and in times where the global fleet is sold out, duration of contracts will increase, rate will obviously tick higher and marginal costs will be paid by the lessee with those costs simply wrapped up in the day rate paid similar to a home mortgage that includes insurance or other associated fees.

“Just to give you a number. So, in the last boom where I participated, the shipyards were asking for 5% or lower down payments and then literally everything at delivery. And I think these days, you'd struggle to get anybody to accept even 50% down payment. They would still challenge that. So, you probably end up with even more than that…” – Industry Expert: VP of Sales for major JU player

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