R&B Falcon, Talons-Deep in Cash, Says It's Ready to Take Flight

The stock lost more than 80% of its value in a recent swoon but now appears poised to recover.
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Like a barnstorming politician,

R&B Falcon

(FLC) - Get Report

has hit the road with a new message.

The Houston-based contract driller is saying that its widely chronicled

liquidity problems are receding into the past, and it can now focus squarely on operations, promising more predictability for investors. Charlie Ofner, an R&B senior vice president, says the rig construction that characterized Falcon's runaway growth since

Reading & Bates

merged with

Falcon Drilling

in July 1997 is now largely over, and no new projects are planned.

The balance sheet will take precedence, Ofner says. "It's a matter of harvesting the assets the company has."

Missteps in its drive to get big -- and plummeting oil prices -- helped drive Falcon's shares down to 5 1/2 in February from nearly 43 in October 1997.

During that period, several rig projects suffered long delays and multimillion-dollar cost overruns. Four projects were canceled, and charges to earnings hurt Falcon's credibility with Wall Streeters who weren't expecting problems. Falcon now keeps a much tighter rein on costs and timing, Ofner says.

So now Falcon's message, underpinned by the rapid rise in crude-oil prices, seems to have taken hold. Its shares have more than doubled since February to 12 3/16 Tuesday; it's even outperformed peers such as

Diamond Offshore

(DO) - Get Report

in recent months. Four analysts have upgraded their ratings on Falcon to strong buy or buy in the past two weeks.

Bears contend that higher oil prices are primarily responsible for Falcon's stock-price jump, adding that the company still has to prove it can execute the projects it has taken on. But the flurry of buying, the upgrades and the steps Falcon has taken to rectify its problems are proof Falcon has taken the lessons it learned to heart, Ofner says.

For one thing, Falcon is now telling investors exactly what the worst-case scenario might be on cost overruns for its rig-construction projects. Ofner says a "worst-case" estimate, if each of the projects goes over its current projected budget, is $75 million total -- a small proportion of the $900 million Falcon will need to complete the projects. In the past, Falcon failed to warn investors of potential cost overruns until they had actually taken place.

Falcon has also reduced upper-management overlap stemming from two mergers. This past April, Steven Webster, formerly Falcon's president and chief executive, stepped down. Three additional executives departed between May and July, according to filings with regulators.

In addition, Falcon hasn't been shy in reducing the number of rigs it has on the market in an attempt to bolster overall pricing, Ofner says. Falcon has taken 14 shallow-water, or jack-up, rigs and 27 barge rigs out of ready mode, saving on overhead costs.

Falcon put itself "in a pickle over the last two years by overspending, underfinancing and really screwing up their construction programs," says Matthew Conlan, an analyst at

Prudential Securities

in Houston. "Everyone knew they needed capital and they had to pay for it."

A "long, thorough meeting with management" helped convince Conlan that Falcon's liquidity concerns are behind it. On Aug. 5, Conlan upgraded his rating to strong buy; Prudential hasn't performed underwriting for Falcon.

Indeed, in an improving market, "you want to own the

company with the most leverage," says Stephen Gengaro at

ING Barings

, who upgraded his rating this past week to strong buy. ING has no underwriting relationship with Falcon.

The $1.3 billion that Falcon raised in the first half of the year started the turnaround, Ofner says. On June 30, Falcon had $680 million in cash on its balance sheet. It expects to generate another $345 million before October through two project-finance deals, and can generate $300 million in noncore asset sales, Ofner says.

But progress on the two complicated deals is creeping along. In May, Falcon said both would be closed by the end of June. As of this week, Ofner says, they are approved and in the documentation phase. One should be completed this month and the second before the end of September, he says.

Falcon can regain credibility by sticking to its game plan, Conlan says. Part of that plan is to tell "anybody who will listen," Ofner says, to focus on the company's potential. Ofner says that at some point in the future, R&B Falcon's fleet could generate as much as $1.6 billion in earnings before interest, taxes, depreciation and amortization. Though not a projection, that would mark a steep jump from Falcon's 1998 EBITDA of $426 million, and the roughly $327 million the company is expected to generate this year.

There's no question Falcon's climb back to profitability will be arduous. Falcon is projected to lose 31 cents this year and a penny next year before returning to profitability with projected earnings of 94 cents in 2001, according to

First Call

.

And the $1.6 billion figure, based on peak rental rates in the industry from late 1997, seems quite rosy. Rental rates for many classes of rigs have been halved since then. Worldwide rig utilization stands at 73%, down from 90% a year ago; rates typically won't move north until utilization moves above 80% or 85%. Ofner stresses the $1.6 billion isn't an actual projection, offering it merely as an illustration of earnings potential.

But investors who believed in Falcon months ago are now reaping rewards.

Steve Schwartz, research director at

Circle T

, a New York-based hedge fund, was well aware of Falcon's problems but started buying in earnest after management laid out its plan for the next two years. His fund now owns about 300,000 shares, purchased at an average price of $7 and change.

He likes Falcon's prospects in the Gulf of Mexico natural-gas drilling market, which is expected to boom in coming quarters.

Not everyone is convinced.

Erik Gustafson, manager of the

Stein Roe

fund, says he's more comfortable owning Diamond Offshore and

Schlumberger

(SLB) - Get Report

. Falcon's management always downplayed the significance of its leverage, he says, and if oil prices stay where they are, the company will get bailed out. But if oil prices dive, Falcon's debt will come back to haunt it.

Credibility questions may resurface as well if Falcon falters again in its construction or if it fails to finalize its two project-finance deals before the quarter's end. Despite the change in attitude, Falcon still has a lot to prove.