CHICAGO--(BUSINESS WIRE)--Fitch Ratings has assigned a 'BBB' rating to Nabors Industries Inc.'s new issuance of $350 million of 2.35% senior unsecured notes due 2016 and $350 million of 5.10% senior unsecured notes due 2023. The rating Outlook remains Negative.
KEY RATING DRIVERS
The ratings reflect Nabors's leverage, free cash flow (FCF) and capex profile, and position as a major onshore rig operator in North America and internationally. Adequate liquidity and an extended maturity profile support the 'BBB' rating.
The Negative Outlook is the result of a long-term trend of declining market share in the United States, low utilization on older equipment, industry conditions including a lower average U.S. rig count in 2013 and the risks to the rig count from the transition to pad drilling and other higher efficiency operations.
Leverage and Free Cash Flow
As of June 30, 2013, Nabors had $4.6 billion in debt outstanding. The company generated latest 12 months (LTM) EBITDA of $1.7 billion. This resulted in leverage of 2.67x debt-to-EBITDA. Following the new issuance of $700 million, $785.4 million in principal of the 9.25% due 2019 were tendered for a total price of approximately $1.0 billion.
FCF was negative $41.1 million in 2012. Given expectations for capital spending, Fitch expects Nabors to be modestly FCF positive again in 2013. This depends upon the level of newbuild rig activity in the second half of 2013.
EBITDA Expected to Weaken Near Term
A U.S. rig count lower than 2011 and 2012 levels and continuing margin pressure in completion and production services drive lower EBITDA expectations for 2013 versus a 2012 high of $1.98 billion. Credit metrics could weaken in line or the company could apply FCF to reduce revolver balances and defend its current credit metrics.
Decreasing Market Share and Utilization in the U.S.
Compared to the first quarter of 2007 (1Q'07), the U.S. rig count has currently been flat at approximately 1,750 rigs running. Since 1Q'07, Nabors' Rig Years in the lower 48 states -- a measure of the average number of its rigs running -- has fallen from 243 to 176. This implies a market share reduction from 14% to 10%.
Nabors' AC (alternating current drive) rig fleet is highly utilized (128 out of 141 for a utilization of 91%), but its legacy rigs in the lower 48 states had utilization of only 40% (48 out of 122) as of 2Q'13.
Other characteristics of a premium rig besides an AC drive are moving systems and the ability to drill on pads. The ability to move rigs from one well to the next more efficiently improves the time required to develop a play and is increasingly an area of focus to drive shale economics for the exploration and production company. Fitch estimates the rig rental is typically only about 10% to 15% of the cost of drilling a well, but the economic impact comes from pulling production growth forward, not simply cost savings.
Impact of Premium Newbuild Rigs
Nabors newest rig model, the 'PACE-X' is designed to target the premium high-efficiency market. The company has five rigs deployed and 16 newbuilds under contract. This newbuild program should help Nabors defend its market share, but it demonstrates how capital expenditures are required to build rigs and replace legacy models, and it explains in part why the company has not generated material positive FCF over the last four years.
There is also a risk that more efficient rigs from Nabors and its competitors will put pressure on the total U.S. rig count, as the same number of wells can be drilled with fewer rigs. Increases in wells drilled per year are subject to the opportunity set; while shale economics are compelling, major plays are beginning to mature and natural gas prices continue to limit activity in dry basins. Further, wells drilled are limited by the capital budgets of E&P companies. The exhaustion of many operators' capital budgets was a contributor to the decline in activity at the end of 2012.
Nabors should be able to charge a premium for more efficient newbuild rigs, but that premium may be limited by competition and replacement cost. Those premiums may not be high enough to offset the effects of a scenario where the total rig count declines.
Completion and Production Services
Separate from North America drilling, it is important to note that Completion and Production services make up approximately 23% of adjusted LTM EBITDA. Results have declined since peaking in 4Q'11 due to industry overcapacity in the completion services market. First-half Completion and Production EBITDA was $224 million lower than 2012.
Shareholder Activism
Pamplona Capital Management, a British private equity firm, owns approximately 8.7% of Nabors' common stock. The chairman of Pamplona, Alexander Knaster, was a member of Nabors' board of directors from his appointment in October 2004 until he resigned in October 2008. He is the former CEO of Alfa Bank, a portfolio company of Alfa Group, the Russian conglomerate, and he also served on the board of TNK-BP until its sale to Rosneft. Pamplona is also the largest shareholder and controls a majority of the board of KCA DEUTAG, a competitor of Nabors in international markets that owns 60 land drilling rigs operating in Russia, the Caspian and the Middle East.
In January 2013, Pamplona filed a 13D modifying the intent of their stake in Nabors from passive to active. In the time since, Nabors has initiated a dividend of $0.16 per share (approximately $46 million per year), reached a standstill agreement with Pamplona to appoint two new directors (Howard Wolf and a second to be named in advance of the 2014 annual meeting), and hired an advisor to 'evaluate strategies to enhance shareholder value, including optimizing the company's capital structure, reviewing its mix of businesses and improving operating performance.'
Corporate Governance Concerns
The results of the 2013 annual shareholder meeting demonstrate material shareholder dissent. The issues with executive compensation are not new and Nabors has made changes to address the problem. While the 'say on pay' votes against were lower this year, they were still above 50%.
While 'say on pay' dissent decreased in 2013, votes against it in the elections of directors increased this year. Two directors including John Yearwood, lead independent director, did not receive a majority of the votes cast. Their resignations were not accepted by the remaining board members and they continue to serve.
Increasing uncertainty around shareholder activism and corporate governance could increase the risk of a change in financial policy, such as: an increase in debt levels, share repurchases, or dividends.
Liquidity
Liquidity remains adequate and stems from cash balances ($508.1 million), short-term investments ($99.8 million), availability under Nabors's $1.5 billion senior unsecured credit facility (maturing in November 2017) and operating cash flows ($1.5 billion for the LTM period ending June 30, 2013). Nabors had $905 million available under its credit facility at June 30, 2013 with $300 million of borrowings and $295 million of commercial paper outstanding.
Capital Structure and Maturities
The next note maturity will be the newly issued $350 million of 2.35% notes due in 2016.
Nabors' RCF has one financial covenant, a net funded indebtedness-to-capitalization limit of 0.60 to 1.0. Fitch calculates Nabors' net debt-to-cap ratio at 0.4 to 1.0 as of June 30, 2013.
RATING SENSITIVITIES
Positive: Future developments that in some combination could lead to positive rating actions include:
--Improving operational performance combined with capex discipline that result in material positive free cash flow and the use of those proceeds to repay revolver balances;
--Resolution of shareholder activism and corporate governance concerns that reduce uncertainty and risk of a material change in financial policy;
--Increasing U.S. rig counts driven by a material upswing in commodity prices.
Negative: Future developments that in some combination could lead to negative rating action include:
--Further declines in utilization and market share in the United States;
--A material change in financial policy driven by shareholder pressure or a change in control;
--A major operational problem or a sustained period of low oil and natural gas prices without offsetting adjustments in capital spending;
--Debt-to-EBITDA above 2.5x on a sustained basis and sustained negative FCF would be more in line with a 'BBB-' rating.
Additional information is available at 'www.fitchratings.com'
Applicable Criteria and Relevant Research:
--'Corporate Rating Methodology' (Aug. 05, 2013).
Applicable Criteria and Related Research:
Corporate Rating Methodology - Effective from 8 August 2012 - 5 August 2013
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=684460
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=802309
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