Ocean Rig UDW Inc

8/14/2019 Ocean Rig UDW Inc.

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IB Equity Research November 11th, 2013

OCEAN RIG UDW INC.

Thesis OverviewOcean Rig (ORIG) is an offshore driller with EBITDA set to more than double by 2015 asthe company expands its fleet. As its newbuild program comes to an end, levered FCF willreverse from -$0.5b this year to more than +$0.5b. These cash flows are supported by long-term contracts with an average duration of 3 years (4.5 years including extensions). At itscurrent market cap of $2.6b, youre creating the company for less than 4x. This seemsextremely cheap as a pure-play operator in the very attractive ultra-deepwater market, wheresupply and demand should remain balanced for the foreseeable future. To close the valuationgap, management will begin funding a dividend in 1Q14 and form an MLP in 2Q14. The onlyoffshore driller thats structured as an ML P (NYSE: SDLP) trades for $1,350mm per rig

compared to ORIGs current valuation of $685mm per asset. ORIGs also valued at a 10%discount to tangible book value, while peers with older fleets and much smaller revenue

backlogs trade for 1.3x. I believe this stock could double over the next year from $20 to $40as its rerated due to the lucrative MLP structure.

Stock Rating BUCatalyst Category 6-12 Month

Price Target $40.

Price (11/11/13): $20.15Upside: 100%

Ticker: ORIGExchange: NASDAQIndustry: Energy

Trading Stats ($USD millions)

Market Cap: $2,663Enterprise Value: $7,531

Price / Tangible Book: 0.9x

Dividend Yield: 4.0%

EV Per Rig: $685EV / 2015E EBITDA: 6.9xSource: Company filings, Analyst Estimates

Price Performance

52 Week range:$13.45 - $20.58

Analyst Details

IB Username: Chris ColvinEmployer: Freeman Group, LLC Job Title: Portfolio Manager

Analyst Disclosure

ORIG Position Held: Yes
http://freemangp.com/http://freemangp.com/http://freemangp.com/http://freemangp.com/


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Future Profits Are Supported by a Large BacklogORIG currently operates six rigs, then one will come online in 4Q12, two more will be delivered in 1Q14, and another two in2015 bringing the total to 11. Only one of these does not have a customer contract tied to it because it was ordered a few weeksago. The backlog has grown from $1.6b in early 2012 to $5.8b today, which is equal to nearly 5x todays revenue. Stated

differently, nearly 70% of my projected cash flows for the next three years (Table 3 on the next page) are backed by contractsfrom large, creditworthy E&P operators including ConocoPhillips, Eni, Lukoil, Petrobras, Repsol, and Total (Table 2). If thesecustomers exercise extensions, then almost 80% of the forecasted cash flows are covered. Therefore, the outlook for ORIG andits expected earnings are fairly visible over the next few years regardless of the fundamentals in the general UDW market.

Table 2:

EBITDA Should Grow by 2.5x and FCF Should Improve Exponentially (Table 3)Currently, ORIGs six rigs are generating $400mm of annual EBITDA, but this will grow to $1b run -rate by 2015 when it

increases its fleet to 11 because each new rig will generate $120mm of EBITDA. Over the next two years, the company willspend $1.8b finishing the construction of these newbuilds, then its cash flow should increase significantly. Its 11th rig will bedelivered in 4Q15 and at that point, ORIG should be generating $660mm of levered FCF and $880mm of unlevered FCF. Myforecast below is sligh tly more conservative than consensus, which I believe is because Im using the companys guidance of93% utilization while theyve been achieving above 96% recently.


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Table 3:

Trading at Discount Despite Premium Assets, a Large Backlog, & High Growth ExpectationsThe company currently trades for 6.9x 2015 consensus EBITDA and $685mm per rig, which is a premium to its peers but thesehave older & more commoditized fleets, lower growth prospects, and less contract coverage. The only true comparable is PacificDrilling (NYSE: PACD) because it operates solely new UDW assets and its also expected to grow its EBITDA by 2.5x before

2016. This company trades at a 10% premium to ORIG. Also, ORIG is valued at 90% of tangible book value (TBV), w hile itsindustry currently and historically has traded for 1.3x TBV (Table 4).

Using peer metrics, the implied value per share of ORIG is $25 $30 translating to 20% 40%+ upside (Table 5).

($ in MMs) Actual Results Estimates2008 2009 2010 2011 2012 2013 2014 2015 2016

Rigs 2 2 2 6 6 6 9 10 11 Available Days 1,995 3,090 3,530 3,895 Utilization 96% 93% 93% 93%

Revenue Earning Days 1,908 2,858 3,265 3,603 Dayrate 539$ 549$ 566$ 567$

Drilling Revenue 219$ 388$ 406$ 700$ 942$ 1,028$ 1,568$ 1,850$ 2,044$Y/Y 77% 5% 72% 35% 9% 52% 18% 11%

EBITDA 117$ 234$ 266$ 371$ 295$ 514$ 749$ 936$ 1,055$Margin 54% 60% 66% 53% 31% 50% 48% 51% 52%

Cash Interest Expense (23) (52) (43) (32) (73) (145) (252) (248) (230) Cash Taxes (10) (17) (18) (31) (41) (50) (78) (92) (102) Newbuild CapX - (131) (705) (1,865) (212) (686) (916) (920) - Maintenance CapX (17) (14) (7) (78) (98) (106) (51) (56) (62) in NWC / Other (64) 175 17 (37) 98 24 - - -

Levered FCF 5$ 196$ (490)$ (1,673)$ (32)$ (449)$ (548)$ (381)$ 660$

Debt Principal Payments 846 (191) (191)

Excess Cash Flow 298$ (572)$ 469$

After-Tax Int Exp 22 50 41 31 70 138 239 235 219

Newbuild CapX - 131 705 1,865 212 686 916 920 - in NWC / Other 64 (175) (17) 37 (98) (24) - - -

Recurring Unlev FCF 90$ 201$ 239$ 260$ 152$ 352$ 607$ 774$ 879$

Net Leverage 2.2x 5.9x 4.8x 4.2x 3.1x


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Table 4: Comps

Table 5:

Closing the Valuation Gap through Dividends and MLP FormationThe Board recently approved the companys first dividend for $25mm, which will be paid from cash flow in 1Q14. This willequate to a 4% yield and should grow significantly over time considering the excess cash flow ORIG will have once its entirefleet is complete. In addition and as part of this effort, the company will form an MLP that will go public in 2Q14. The plan is tolikely sell a minority interest in its four rigs built in 2011 to this MLP entity. Over time, Id e xpect ORIG to drop down its fiveassets being completed between now and 2015. Seadrill Partners (NYSE: SDLP) is the only offshore driller structured as anMLP and it currently trades for $1,350mm per rig.

Assuming (i) a 40% interest in nine of ORIGs ri gs are sold to the MLP (3.6 rigs), (ii) each of those is valued for $1,350mm, and(iii) the retained interest of rigs held at ORIG (7.4 rigs) is appraised at $750mm per asset, then the implied share price is above$40 or 2x todays price (Table 6). SDLPs parent Seadrill Ltd (NYSE: SDRL) trades at an 8% dividend yield (Table 5). Im

($ in MMs, Except per Share) Current Valuation Fleet MixShare Mkt EV Net Div '15/LTM EV/ '15 EV per P / Jackups Floaters Total

Ticker Name Price Cap. (w/CapEx) Lev. Yield EBITDA EBITDA Rig TBV Old New Total Old New Total Rigs

New Floaters Only

ORIG OCEAN RIG UDW INC 20.22$ 2,663$ 7,532$ 6.0x N/A 2.5x 6.9x 685$ 0.9x 0% 0% 0% 0% 100% 100% 11 PACD PACIFIC DRILLING SA 11.71$ 2,459$ 6,051$ 5.2x N/A 2.5x 7.5x 756$ 1.1x 0% 0% 0% 0% 100% 100% 8

Primarily JackupsHERO HERCULES OFFSHORE INC 6.58$ 1,051$ 1,910$ 3.1x N/A 1.9x 3.7x 50$ 1.1x 100% 0% 100% 0% 0% 0% 38 RDC ROWAN COMPANIES PLC-A 36.90$ 4,583$ 7,669$ 1.7x N/A 2.0x 6.6x 219$ 1.0x 37% 51% 89% 0% 11% 11% 35

Mixed FleetATW ATWOOD OCEANICS INC 54.20$ 3,467$ 6,323$ 2.1x N/A 1.6x 7.3x 422$ 1.7x 13% 27% 40% 20% 40% 60% 15 DO DIAMOND OFFSHORE DRILLING 60.35$ 8,391$ 10,878$ 0.2x 5.8% 1.7x 5.3x 259$ 1.8x 14% 2% 17% 67% 17% 83% 42 ESV ENSCO PLC-CL A 59.55$ 13,907$ 20,190$ 2.0x 5.0% 1.4x 6.5x 262$ 1.5x 45% 17% 62% 13% 25% 38% 77 NE NOBLE CORP 37.62$ 9,533$ 18,011$ 2.8x 2.7% 1.6x 6.0x 231$ 1.2x 51% 12% 63% 23% 14% 37% 78 RIG TRANSOCEAN LTD 49.03$ 17,671$ 30,770$ 2.1x 4.6% 1.3x 6.9x 354$ 1.1x 8% 6% 14% 48% 38% 86% 87 VTG VANTAGE DRILLING CO 1.88$ 568$ 3,374$ 9.2x N/A 1.9x 7.0x 422$ 1.3x 0% 50% 50% 0% 50% 50% 8

Mean 6,429$ 11,271$ 3.4x 4.5% 1.8x 6.4x 366$ 1.3x 27% 16% 43% 17% 39% 57% 40

SDLP SEADRILL PARTNERS LLC 33.12$ 1,370$ 1,726$ N/A 5.2% 1.0x 14.3x 1,351$ N/A 0% 0% 0% 0% 100% 100% 1 SDRL SEADRILL LTD 46.95$ 22,031$ 39,515$ 4.3x 7.8% 1.6x 9.6x 682$ N/A 2% 52% 54% 1% 45% 46% 58

Using Peer's Valuation MetricsPACD's Value per Rig 750$ PACD's EV/2015 EBITDA 7.5xORIG's Rigs 11 ORIG's '15 Consenus EBITDA 1,010$

Implied EV 8,250$ Implied EV 7,576$(-) Current Net Debt (3,032)$ (-) Current Net Debt (3,032)$(-) Newbuild Payments (1,836)$ (-) Newbuild Payments (a) (1,311)$

Equity Value 3,382$ Equity Value 3,232$Implied Value per Share 26$ Implied Value per Share 25$

Upside 27% Upside 21%

Peer's P/TBV 1.3xORIG's TBV 22$

Implied Value per Share 29$Upside 43%

(a) Doesn't include CapEx for the 11th rigbeing delivered in 2016 since that's notincluded in 2015 EBITDA.


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forecasting ORIG to generate $470mm of excess FCF after debt amortization once its rigs are complete (Table 3). ApplyingSDLRs 8% dividend yield to $470mm would result in a $45 share price (Table 6).

Table 6:

Creating the Assets at a 35% Discount to Replacement Cost Providing Downside Protection(Table 7)At ORIGs current price of $20 per share, an investor is effectively paying $7.5b or $685mm per rig after factoring i nconstruction payments outstanding. Based on its current backlog, ORIG should generate $2b of levered FCF, so this reduces theimplied cost basis to $5.5b or $500mm per rig. Assuming that customers exercise their options to extend contracts, then this willgenerate another $0.9b of FCF and result in a cost basis of $425mm per rig. This effectively implies that youre buying ORIGsassets at a 25% to 35% discount to their replacement cost of $650mm each. Rig prices haven t been below $500mm since 2005.

Impact of MLP on ValuationRigs per Rig Value Non-MLP

Non-MLP 7.4 750$ 5,550$ Excess FCF 469$

MLP 3.6 1,350$ 4,860$ Dividend Yield 8.0%

Value of Rigs 10,410$ Equity Value 5,863$(-) Current Net Debt (3,032)$ Implied Value per Share 45$(-) Newbuild Payments (1,836)$ Upside 120%

Equity Value 5,542$Implied Value per Share 42$Upside 108%


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Table 7:

ConclusionORIG has a premium set of assets covered by customer contracts that will increase EBITDA by 2.5x, yet its valued below TBV.

Once its fleet is fully developed, the company will generate substantial cash flow, so management plans to close the valuationgap with the formation of an MLP. This news is out in the market, but ORIG is still a relatively underfollowed stock. Id e xpectORIGs value to appreciate as more details on the planned MLP are released. If not, then youre left with ownership in acompany that should have the ability to fund a dividend equal to nearly 20% of its current market cap once its entire fleet isoperating.

Additional Analyst DisclosureI am long ORIG. I wrote this article myself, and it expresses my own opinions. I have no business relationship with any companywhose stock is mentioned in this article.

Implied Value Paid per RigShare Price 20$

Shares 132 Market Cap 2,663$

(-) Current Cash (529) (+) Current Debt 3,561 (+) Newbuilds Payments Remaining 1,836

Current EV 7,531$Value per Rig 685$

(-) Levered FCF from Contracts (1,994)$

Value Paid for the Business 5,537$

Value per Rig after Contracted FCF 503$

(-) Levered FCF from Extensions (870)$

Value Paid for the Business 4,666$Value per Rig after Extensions 424$


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Financial Summary

($ in MMs) Actual Results Estimates2008 2009 2010 2011 2012 2013 2014 2015 2016

Rigs 2 2 2 6 6 6 9 10 11 Available Days 1,995 3,090 3,530 3,895 Utilization 96% 93% 93% 93%

Revenue Earning Days 1,908 2,858 3,265 3,603 Dayrate 539$ 549$ 566$ 567$

Drilling Revenue 219$ 388$ 406$ 700$ 942$ 1,028$ 1,568$ 1,850$ 2,044$Y/Y 77% 5% 72% 35% 9% 52% 18% 11%

EBITDA 117$ 234$ 266$ 371$ 295$ 514$ 749$ 936$ 1,055$Margin 54% 60% 66% 53% 31% 50% 48% 51% 52%

Cash Interest Expense (23) (52) (43) (32) (73) (145) (252) (248) (230) Cash Taxes (10) (17) (18) (31) (41) (50) (78) (92) (102) Newbuild CapX - (131) (705) (1,865) (212) (686) (916) (920) - Maintenance CapX (17) (14) (7) (78) (98) (106) (51) (56) (62) in NWC / Other (64) 175 17 (37) 98 24 - - -

Levered FCF 5$ 196$ (490)$ (1,673)$ (32)$ (449)$ (548)$ (381)$ 660$

Debt Principal Payments 846 (191) (191)

Excess Cash Flow 298$ (572)$ 469$

After-Tax Int Exp 22 50 41 31 70 138 239 235 219

Newbuild CapX - 131 705 1,865 212 686 916 920 - in NWC / Other 64 (175) (17) 37 (98) (24) - - -

Recurring Unlev FCF 90$ 201$ 239$ 260$ 152$ 352$ 607$ 774$ 879$

Net Leverage 2.2x 5.9x 4.8x 4.2x 3.1x

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Ocean Rig UDW Inc