Global's Strategy Drills a Dry Hole

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As the market for drilling rigs heated up throughout much of 1997, it looked like a great strategy.

Global Marine

(GLM)

leased 15 jackup rigs on long-term contracts to ensure its turnkey operations would have enough equipment to meet customers' drilling needs.

But by early this year the jackup market, which focuses on shallow water, had turned south, and Global's strategy turned and bit the company. Global, it turned out, had too many rigs on its hands.

Today, several are idle. In addition, Global is losing money on its working turnkey rigs. It's paying $10,000 to $12,000 more per day to rent rigs than it is receiving under its turnkey contracts. (Turnkey operators, which provide complete drilling services for a set price, rent rigs to cut overhead.) Global's rigs were leased primarily from

Falcon Drilling

(FLC) - Get Report

and

Marine Drilling

(MDCO) - Get Report

.

Dave Herasimchuk, Global's vice president of market development, says "1998 is going to be a bad year for us" in the turnkey division. In the second quarter, the company "had about $5.5 million worth of idle time on rigs. That number is going to be larger in the third quarter."

Global's disappointing turnkey performance, when paired with the overall decline in dayrates and drilling activity, bodes ill for earnings in the second half of this year. In fact, the third quarter will mark Global's first year-over-year earnings drop since 1994, to 39 cents, according to the

First Call

consensus, from 45 cents last year. For the year, the consensus estimate calls for only a 1.9% increase in earnings per share, compared with increases of 178% in 1996 and 144% in 1997.

Matt Conlan, who follows the company at

Prudential Securities

in Houston, estimates a 1998 operating margin of 1.5% on the $480 million in revenue he estimates Global's turnkey division will garner this year, down from a 10.5% operating margin in 1997.

On hearing that figure, Herasimchuk was not the least bit sanguine -- "Frankly, I hope we can do 1.5%."

Global's turnkey problems are exacerbated since it is the largest turnkey operator, but the turnkey margin squeeze is affecting other turnkey drillers as well.

Noble Drilling

(NE) - Get Report

, for example, after taking on what director of investor relations Steve Manz termed "high-risk wells," watched its margins erode after taking large charges. Noble's turnkey division,

Triton Engineering Services

, reported a loss of $441,000 in the first quarter and net income of just $1 million in the second quarter. For all of 1997, Triton Engineering drilled 35 wells, bringing in $180 million in revenue, but had operating costs of $165 million. By contrast, in 1996, Noble brought in $115 million in revenue and had operating costs of about $81 million.

"We took a beating," Manz says. Now, rather than compete on volume, "we are trying to scale it back and look for niche opportunities." The focus now is being able to contract a profitable well, he says. By sticking to bids on which it'll see a gross margin of at least 25%, "we've bid ourselves out of a lot of wells."

Other firms have gotten out of the business -- at least in the Gulf of Mexico -- altogether. After taking a $12.6 million charge on its fourth-quarter earnings,

Transocean Offshore

(RIG) - Get Report

announced it was exiting the turnkey business in the gulf due to unsatisfactory performance. Earlier in 1997,

Rowan Companies

(RDC)

did the same.

That leaves Global, Noble and, to a small extent,

Cliffs Drilling

(CDG)

. But with Noble pursuing high-margin wells only, the bulk of the business will be left to Global Marine.

In 1994, Global began to pursue volume over margins for its turnkey division,

Applied Drilling Technology

. The decision to sacrifice margins in exchange for market share was a deliberate strategic move, says Herasimchuk. The goal was to increase the company's customer base while providing stiff competition to new entrants in the turnkey arena, which was revving up as smaller independent oil companies gained access to the Gulf of Mexico drilling market.

The plan worked. Turnkey revenue jumped to $480.5 million in 1997, about 45% of total company revenue, from $57 million in 1993, or 21% of total revenue. Global sacrificed a percentage of its profit margin, but has been comfortable with the 9% or 10% margin in the division since 1994.

Turnkey, or drilling management, as it is also called, has always presented something of a challenge to drilling companies. The drilling contractor acts as project manager in lieu of an oil company's drilling department. In handling the start-to-finish operations of getting the well drilled, the contractor bears the financial risk of any delays. If a well is completed ahead of schedule, the contractor makes money. If the driller runs into complications and the operation runs longer than expected, the contractor eats the loss. Since the contractor typically does not use its own rigs, it saves on interest and depreciation charges. The biggest outlays for contractors running turnkey operations are crew costs -- the engineers, geophysicists and drilling crew that run the operation.

So how does Global avoid the situation it is in now?

In 1997, too many rigs were contracted at once, says Herasimchuk. "We bunched them up too much." If the contracts had been staggered, "we could have been releasing rigs as we didn't need them." Staggering the term contracts will significantly lower the risk, he adds, part of Global's rejiggering strategy for the division in the future. But for now, he says, "we're stuck until the end of the year."