Oil Stocks

After the BP Spill, Small Drillers Are Merger Bait


Two years ago, Seahawk Drilling (HAWK) was plotting to expand its fleet of rigs worldwide. Now that BP's (BP) well explosion in the Gulf of Mexico has thrust the industry into a regulatory limbo, Houston-based Seahawk may sell itself. "If we can't be more diversified, I would rather sell the company to somebody else and let them try to do it," says Seahawk Chief Executive Officer Randall Stilley.

Mergers and acquisitions among offshore drillers are likely to accelerate as bulk becomes a matter of survival in an industry that Simmons analyst Ian Macpherson now pegs at $125 billion in size. Intensifying government scrutiny and rising customer demands may crank up costs so high that only the largest companies can compete, bankers and analysts say. There were $5.3 billion worth of deals involving drillers last year, more than triple the total in 2009, data compiled by Bloomberg show. "What you have to do these days to get a contract if you're a driller is going to get tougher and tougher," says Mark Bentley, who advises on energy mergers and acquisitions at Greenhill (GHL) in London. "This means the industry will increasingly rely on larger companies."

Oil giants ExxonMobil (XOM), Chevron (CVX), and Royal Dutch Shell (RDS.A) are demanding that drillers have the highest-quality equipment and the most experienced rig workers, says Global Hunter Securities analyst Brian Uhlmer. Meanwhile, U.S. regulators still refuse to issue permits in the Gulf of Mexico, and the Interior Dept. is returning applications with requests for more details about how the companies are meeting environmental and equipment rules imposed by the government since the April BP disaster.

That's put a squeeze on drillers. "The drillers have to scrap, upgrade, and modify because of environmental concerns and to meet new requirements," says Bjarne Skeie, who last year sold his stake in Skeie Drilling & Production to Houston-based Rowan (RDC).

"New regulations, stricter permitting/certification procedures, and higher insurance costs could push small-caps with limited operating experience into the arms of stronger players," Citigroup (C) analyst Robin Shoemaker wrote in a Jan. 11 report, which cited Ensco of London, Rowan, and Houston-based Pride International (PDE) as potential targets. Ensco, with a market value of $7.7 billion, trades at 13 times earnings as of Jan. 18, while Rowan has a price-earnings ratio of 13.1, lower than the 14.5 average among drillers, Bloomberg data show. Rowan and Pride declined to comment. Ensco did not respond to requests for comment.

Other potential takeover targets include the drilling unit of Greece's Metrostar Management and Houston-based Vantage Drilling, says Uhlmer, who names Transocean (RIG), Diamond Offshore Drilling (DO), and Seadrill (SDRL) as possible acquirers. Representatives for Metrostar, Vantage, Transocean, and Diamond Offshore declined to comment. Seadrill didn't respond to requests for comment.

Seadrill, controlled by Norwegian billionaire John Fredriksen, has been the most acquisitive driller since 2006, announcing 11 transactions worth $4.96 billion, according to Bloomberg data. The company, which has a market value of about $14.7 billion, agreed on Jan. 3 to buy two ultra-deepwater rigs from Lloyds Banking Group (LYG) for $1.2 billion.

The bottom line: With operating costs rising in the aftermath of the Gulf oil disaster, many smaller drillers will be acquired by larger companies.

Wethe is a reporter for Bloomberg News.
Simmons is a reporter for Bloomberg News in Paris.

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