21 June 2018 ( Lagos ) : Depthwize, through its vehicle – Depthwize Funding Company Plc, seeks to raise N20 billion via series 1 of its N30 billion program. The company intends to use the proceed to finance its maturing commercial syndicated loan and finance ongoing business operations. Analysts believe that Depthwize is an improving credit story driven by both organic growth in earnings and ongoing deleveraging exercises. 

The proposed refinancing as well as analyst’s expectation of higher earnings points to a lower leverage ratio in coming years. Based on analyst’ analysis, finance charge is expected to decline by 65% over 2018, reflecting the 5-year moratorium offered by its lessor, Megadrill Service. Farther out, whilst finance charge will track higher on the back of its bond issuance, the expected jump in earnings—given the revival of 2 key rigs - will see coverage ratio expand. 

Analysts project expansion in interest coverage ratio to 3.0x (2017:1.0x). Furthermore, its improved earnings should translate to higher free cash flow, as management guides to no major capital expenditure in sight. Depthwize is an indigenous oil and gas servicing company, providing marine, drilling, and other related services. The rig business contributes the largest portion of revenue (65%).

Risk to Outlook. The company remains sensitive to crude oil prices and volumes, though, its operation in shallow waters, mode of contract, and relative peace in the region, provides a buffer should crude oil prices touch $40-$50/bbl. and some stability in cash flows. Elsewhere, despite healthy cashflows, analysts note the increase in receivables, with a high proportion of it categorized under ‘existing customers with some default in the past’. 

Also, on the positive side, the planned refinancing of dollar loan to Naira sizably moderates its exposure to FX risk. Also, the bond issuance is fully guaranteed by Megadrill Service Ltd – the lessor of the oil rigs to Depthwize Ltd. Programme

Investment Highlights

Depthwize has recorded impressive earnings growth, from a low of N439 million in FY 12 to N3.4 billion in FY 17, with its shareholder’s fund expanding five-fold over the period to N12 billion in FY 17 (2016: N8.8 billion). Though Debt to equity ratio improved from 11.7x in 2012 to 1.1x in FY 17, leverage ratio ticked up to 4.2x relative to 5-year average of 3.0x, following its $100 million (N20 billion) syndicated loan the company got in 2013. To add, its coverage ratio barely matched up in prior year with the EBITDA of N3.2 billion being 1.0x interest expense of N3.2 billion as at FY 2017.

Going forward, analysts expect improved fundamentals. First, earnings are expected to improve sizably on the back of increased activity in the oil industry even as the three oil rigs are now active compared to 2017 when just one was active.

Elsewhere, analysts see lower finance cost going forward. This is hinged on the 5-year moratorium offered by its lessor—Megadrill Services Ltd—on both interest and principal payment of the lease obligation in order to relieve the finance cost burden resulting from the planned bond issuance. Furthermore, with about N1.1 billion expected as interest payment on the existing debt1 – syndicated commercial loan of $100 million, finance cost should therefore decline 65% to N1.1 billion in 2018 given that there is a six- month moratorium on the new debt issuance. 

Beyond 2018, analysts have assumed a premium of 200bps to FGN bonds on the planned debt issue, which implies a finance cost of N3.1 billion2 per annum. Thus, they see finance cost declining relative to prior period.

Based on analyst’s estimated funding cost, they expect coverage ratio of 3.0x over 2018 (2017:1.0x) with leverage ratio declining sizably. In addition, they expect the improved earnings to translate to higher free cash flow with no major capital expenditure in sight.

Business Overview

Depthwize is an indigenous oil and gas servicing company, providing marine, drilling, and other related services. In the drilling business segment, the company operates three rigs (Majestic, Imperial, and Monarch). Also, Depthwize has in its fleet four turgo boats and associated newly built badges to support its drilling services. The three rigs are currently active. The company operates majorly in shallow water drilling. The company currently has one contract with Muni Pulo Limited and two contracts with Belbop Nigeria Limited.

The three oil rigs are on a finance lease from Megadrill Services Ltd. The company entered a finance lease agreement with Megadrill Services Limited for the lease of the Majestic and Imperial rig on March 1, 2012 and January 1, 2013 respectively. The agreement for the newest rig—Monarch was effective on May 1, 2015. The lease period for each rig is 20 years, with interest on the lease rentals payable at an annual rate of 9.5%.

As at FY 17, the rig business contributed the largest portion of revenue (65%, up from 62% in FY ‘15), followed by Marine spread revenue which came in at 27% (from 22% in FY ‘16 and 15% in FY ‘15). From earnings perspective, rig operation is the largest in the bucket followed by the marine business. Aside staff costs (~30% of total expenses), other major component of the Company’s cost is its depreciation cost (~16% of total expenses) and Insurance (~7% of total expenses) cost due to the high capital expenditure structure and riskiness of the business.

Higher oil price to grease earnings

Depthwize has remained resilient in the past years despite reduced activities witnessed in the oil and gas industry between 2015 and 2016, as a result of the crash in oil price and incessant pipeline vandalism. As an oil servicing firm with its business linked directly to oil explorers, revenues dipped between 2015 and 2016 at an average of 6.6%. Prior to this period, the company maintained a topline average growth of 47%. However, EBITDA has maintained an upward trajectory over the review period, rising by a CAGR of 60% between FY 12 and FY 17 (-2.0 YoY).

In 2017, major support to earnings came from interest income (FY 16: N285k, FY 17: N3.8 billion) of which the management attributed to the modification of the repayment terms on its finance lease obligation. For context, Megadrill Services Ltd, the lessor to DepthWize gave the company a 5-year moratorium in order to relieve the interest payment burden of its planned debt issuance. Accordingly, interest expense also declined by 33% YoY majorly from interest payment on finance lease. Following the recede in finance cost, EBITDA/Interest Expense printed at 1.0x from 0.68x in the previous year.

Going forward, analysts see earnings improve sizably. First, improved oil price typically means there will be more exploration activities in the oil industry. In addition, the incessant pipeline vandalism witnessed in the Niger Delta region has reduced drastically which has further boosted production activities. In terms of composition of revenue, analysts see the rig business retaining its major share even as the three rigs are fully active compared to 2017 when just one rig was active.

The five-year moratorium given by Megadrill Service will drive finance cost lower over the coming years. With no major capital expenditure in sight, increased EBITDA should translate to improved positive free cash flow.

Key Risk/Catalyst

One key risk to monitor is the high portion of its receivables (95% of total receivables – N16.7 billion) categorized under ‘existing customers with some default in the past’. With the fact that Depthwize is still in business with the client creates further risk.

Other risks to monitor is the sensitivity of Depthwize business to oil prices and militant activities in the Niger-Delta area considering it operates majorly in shallow water drilling. Lower oil price will cause a reduction of activities in the oil industry, thus limiting the company’s earnings. Also, a blow-out of militant activities like what was witnessed in 2016 could see business operation decline.

However, analysts see some mitigating factors. First, the bond issuance is fully guaranteed by Megadrills Service Ltd – the lessor of the oil rigs to Depthwize Ltd. In addition, the planned refinancing of FCY loan to LCY debt creates an opportunity to avert foreign exchange risk.

Bond Offering

The Company is seeking to raise N20 billion in a N30 billion series program. The company intends to use the proceeds to refinance its maturing commercial syndicated loan and finance ongoing business operations.

Bond Structure

ISSUER:             Dephtwise Funding Company Plc.

SPONSOR :        Depthwize Nigeria Limited

GUARANTOR:   Megadrill Services Limited 

SECURITY:        The Bonds issued under the Programme will be secured by an All Assets Debenture by Depthwize Nigeria Limited and a mortgage security over the rigs operated by the Sponsor, provided by Security Megadrill Services Limited

STATUS    :         The proposed Bond will be repaid over three years from a sinking fund to be established by the Issuer on behalf of Bondholders. The Sponsor shall on an annual basis, for as long as the Bond remains outstanding, pay 60% of its reported Free Cash Flow (FCF) to the Issuer for the benefit of the Sinking fund till principal amount is complete.

Company Background

Depthwize Nigeria Limited was incorporated on 29 July 2011; the registered address of the company is at Block 42, Plot 11A, Rasheed Alaba Williams (Road 13), Lekki phase 1, Lagos state. With the object of the company being to:

To carry on business as contractors for the lease, purchase, and operation of offshore drilling rigs and to carry out all associated marine operations.

To carry on business as contractors in all matters associated with offshore drilling contracts including installing rigs, laying infrastructure, erecting structures, and providing all things necessary petroleum and gas supplies for the oil rigs.

To build, construct, supply, import, export, lease, act as agents for the sale, purchase, and lease of drilling rigs and marine vessels of all kinds.

Ownership

The authorized share capital of the Company is N25,000,000 divided into 25,000,000 ordinary shares of N1.00 each.

The Company is majorly owned by the Chairman, CEO who holds sixty percent shareholding with 15,000,000 ordinary shares while the remaining forty percent (10,000,000 ordinary shares) is held by Dwize LP, a limited partnership. The partners of Dwize LP are Mr. Uche Dimiri and Mr. Olumide Akpata

Source: Analysts from ARM Securities Limited.