Esso Exploration Refuses Delivery of Marine Drilling Rig

If not resolved, the Exxon division's action could knock down Marine's stock and reduce its price tag in a takeover.
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Twenty-six months and more than $200 million after its initial investment in the Marine 700, a huge floating drilling rig,

Marine Drilling

(MRL)

is facing the drillers' nightmare, 1999 style.

Last week,

Esso Exploration

, an

Exxon

(XON) - Get Report

division, refused to accept delivery of the rig. Exxon declines to say whether it has terminated the contract, and neither company will comment on the status of their discussions. But five industry observers who were interviewed for this story believe the discussions are centered on Exxon's desire to cut the daily rental rate of the five-year contract.

The contracted daily rental rate for the Marine 700 was $165,410, plus an additional $4,600 per day for recovery of certain construction costs. But the current market rate for a similar rig is anywhere from $65,000 to just over $100,000 per day.

This incident highlights the vulnerability of contract drillers, especially those with small fleets, when dealing with customers that represent large portions of annual revenue. The possible termination follows a string of contract cancellations since late last year, caused by the lowest oil prices in a decade. Idle rigs led to a plunge in rental rates and a desire by oil companies to obtain rigs at lower rates.

As at least four analysts and investors have pointed out, Marine, with its relatively small fleet of 15 jack-ups and two semisubmersible rigs (one of which is the 700), is on the industry short list of possible takeover candidates. That makes the outcome of the negotiations crucial. With the contract in dispute, Marine's earnings power for the next 12 to 18 months is up in the air, especially since its jackup, or shallow-water fleet, is expected at most to break even over the next several quarters. If Marine can't come to some agreement with Exxon, and its prize rig goes idle for any length of time, then its position is weakened to the point that it would command far less of a premium in a takeover situation.

As one investor points out, the Street is going "hog wild" in coming up with various offshore driller combinations, especially in the wake of

last week's deal between

Sedco Forex Offshore

,

Schlumberger's

(SLB) - Get Report

contract drilling unit and

Transocean Offshore

(RIG) - Get Report

. But a merger involving Marine could be among the quickest to happen, especially if Exxon turns the screws on Marine, says this Marine shareholder, who declined to be named. Conversely, he says, "if Exxon takes the rig and they pay the full price, the stock would zoom and they'd be out of the woods."

Marine's shares were hit in May, falling to near 12 from 17, when Marine said there was a possibility it wouldn't meet the July 15 deadline. Exxon expressed further concern over quality and construction timing in a

June letter to Marine. Marine met the deadline, however, and tendered the rig to Exxon on July 14, but the delivery was rejected. MRL was down 1/4, or 1.8%, at 13 5/8 in early trading Thursday.

Scott O'Keefe, Marine's chief financial officer, says the Exxon issues aren't relevant to the company's "philosophy or desire or willingness" to talk to other parties. He declines to comment further on market speculation.

In an interview several months ago, Jan Rask, Marine's president and chief executive, said Marine would likely be involved in the industry's consolidation at some point, but it was premature to say whether that consolidation involved buying or selling. He did note that he wanted to beef up Marine's deep-water asset base before doing anything, a process he began by acquiring the Marine 700 and its sister rig, the Marine 500.

"It's a sticky situation and not good for Marine," says Matt Conlan, who follows the drilling sector at

Prudential Securities

in Houston. He has an accumulate rating on Marine due to the Exxon situation; Prudential hasn't performed underwriting for Marine. Without the rig working, he says, "on a takeout value, Marine is probably worth $2 to $3 per share less."

Looking at next year's earnings, it's easy to see why. Lewis Kreps, an industry analyst at

Frost Securities

, a division of Dallas-based

Cullen Frost

, figures Marine will earn 55 cents next year, but without the 700, his estimate "goes to zero," he says. He has no rating on Marine currently; his firm hasn't performed underwriting for Marine.

If Exxon does cancel the contract, that "makes

Marine vulnerable to someone taking it over. It could potentially pose some financial difficulty for the company because they just took on some debt and did an equity offering," he says.

Prudential's Conlan sees Rask, Marine's president, as being a willing seller of the company -- for the right price. "His No. 1 rule of running an offshore company is don't fall in love with the iron," Conlan says. "He has always been a very successful trader of rigs, buying them at attractive valuations and increasing the value by upgrading them and then selling them." He notes that Rask, while at the helm of

Arethusa Drilling

, sold to

Diamond Offshore

(DO) - Get Report

in 1996.

Rask has greatly increased the value of the Marine 700 by "outfitting it with a first-class drilling package," Conlan says. Now that the balance sheet is at the point where it's more levered -- the long-term debt-to-equity ratio stands at 34% -- Marine can't afford to acquire anything else. The maximum value Rask can create is to sell the company, he says.