R&B Falcon's Cash Crunch Threatens Drilling Plans

Falcon's cash flow may not cover working capital needs and other obligations.
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A persistent cash crunch threatens to ground

R&B Falcon

(FLC) - Get Report

just as it seeks to complete its deep-water expansion and join the nascent recovery in shallow-water drilling.

The Houston-based contract driller pulled off a $1 billion bond offering in March and sold $300 million in preferred stock in April, garnering breathing room and much-needed cash to fund its construction of seven deep-water rigs. Falcon figures its construction program will cost $1 billion.

But in a filing last week with the

Securities and Exchange Commission

, Falcon said its cash flow from operations and borrowings still won't be enough to fund working capital needs and other obligations, including lease payments and debt service.

Falcon's management says the onerous language in the filing was to some degree boilerplate to satisfy the SEC's strict disclosure regulations. It's confident it will have enough cash. But its debt load of $2.7 billion puts it in a precarious position. Falcon, like other drillers, still faces possible contract cancellations from oil companies that contracted rigs before the industry downturn at rates higher than current rental rates. In addition, there's the threat that the recent rise in oil prices won't hold.

Falcon's long-term debt-to-capital ratio stands at 58%, according to

First Call

, which towers over offshore driller

Transocean Offshore's

(RIG) - Get Report

29% ratio and

Diamond Offshore's

(DO) - Get Report

18% ratio.

"I have a lot of respect for management, and I think there is going to be a turnaround" in the shallow-water market, says Bryan Dutt, founder and principal of

Ironman Energy Capital

, a Houston-based hedge fund. Falcon's shallow-water fleet, which contributed about 40% of last year's revenue, will benefit from any rental-rate upswing. But Falcon "is on a financial precipice," adds Dutt, who holds no position in the company. "I think it is still touch-and-go whether they are going to make it."

Falcon's financial situation, coupled with its diverse, attractive drilling fleet, have added to speculation that it's a takeover target. Falcon's management indicates it's amenable to an offer -- at the right price. Shares of Falcon have doubled since February, to 10 1/2 Monday.

But Falcon also contends that it can survive through this tough period, "no matter how extended," says Charlie Ofner, a vice president. The company is finalizing the sales of some surplus equipment, he says, which could bring in $50 million to $100 million. And it plans other noncore asset sales that could raise another $300 million.

In addition, Falcon is still working on

two project financings that will capitalize on the value of two new rigs, Ofner says. The first should be completed by the end of June, he says. Falcon will net $235 million through its financing of the state-of-the-art floating rig

RBS 8M

. The second financing project will be triggered when Falcon secures a contract for the drill ship

Deepwater Frontier

, which will be challenging due to weak conditions and declining rental rates in the deep-water market.

Oil companies are not jumping to book rig time in deep water. In fact, they're using any excuse possible to wriggle out of contracts, says Dutt at Ironman. Falcon and other drillers already have been hit with

several cancellations this year.

Of immediate concern is the possible termination of a contract by

Petrobras

of Brazil for the

Falcon 100

semisubmersible, or floating, rig, which is behind schedule. Under the contract, Falcon is subject to late-delivery penalties of $26,500 per day; a significant delay could result in the contract's cancellation.

In addition, it needs to rent out two and one-half years of time for the rig

Deepwater Frontier

, which Falcon built through a joint venture with

Conoco

(COC)

. Conoco plans to use the rig for the other half of the five-year contract. If Falcon can't contract out its allotted time, it will be stuck paying the rental rate of $165,000 per day. The company only says it is hopeful it will get a contract.

On the plus side for Falcon is the expected resurgence in shallow-water natural-gas drilling later this year and into 2000 in the Gulf of Mexico. Utilization for the industry's 180-rig gulf fleet stood at 62% at April 30, up from 60% a month ago but still well below the year-ago 95%. As oil and gas exploration companies become comfortable with current prices, drilling will pick up; once utilization hits 85% or 90%, rental rates will rise.

Also driving the shallow-water market is the high depletion rates for natural gas wells. Falcon has "enormous operating and financial leverage" with its large fleet of shallow-water rigs, says Matthew Conlan, who follows the offshore drilling group at

Prudential Securities

in Houston. Still, he has an accumulate rating on the stock since the risk that "any disappointment from the company could be much more devastating than it was when we went into the slump," he says. Prudential has not done underwriting for Falcon.

Indeed, the Gulf of Mexico activity hasn't been fully appreciated, says Arvind Sanger, an analyst at

Donaldson Lufkin & Jenrette

. "In the next two years, the domestic business could contribute an incremental $1 per share," he wrote in a research note Friday. In 1998, Falcon earned $91 million, or $1.10 a share, on revenue of just over $1 billion. R&B Falcon is currently Sanger's top pick; DLJ has been an underwriter for Falcon.

"We believe we're down to blocking and tackling here to get us through," says Ofner at Falcon. That is "largely based on the resilience we see in the domestic gas industry."

But as Dutt at Ironman points out, Falcon's missteps began when it used debt to finance projects at the top of a cyclical industry. Now, everything has to go right for it to emerge intact and unscathed.

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