Investment Thesis:
April 4, 2017, will be remembered as the “big fall” for Seadrill (NYSE:SDRL) and its subsidiary North Atlantic drilling (NYSE:NADL) and in a somewhat lesser extent Seadrill Partners LLC (NYSE:SDLP) — in which Seadrill owns a minority stake just under 50%.
The question is what happened yesterday and why?
Everyone has a theory, of course, and as the theory goes, we can always extract some shreds of truth hidden in these assumptions and conjectures used to build it.
Often, analysts come with a “simplistic” theory, not really a “simple” theory and assuming they can come up with a theory in the first place.
Let’s face it, most of the analysts and authors, here and there, are not really familiar with what drives the market engine — No disrespect, this is why they are “struggling” analysts and not taking care of a fund, isn’t it? — The “fuel” is money — a lot of it — and trading decisions at the millisecond pace using advanced tools and algorithms.
What I have read today is that the “analysts” community in general interprets this sell off mostly wrong, and using straight reasoning from continuity while we were witnessing a technical breakout.
In short, Seadrill management warned many times, during the past several months, about the risk of a significant shareholder dilution. However, this time, all of a sudden, oh! divine clairvoyance, it is “more precise” and the “market finally got it, this time”. Give me a break.
M. Carl Surran from Seeking Alpha is doing a very good job at getting us an important clue of what is the common “street” interpretation and wrote:
While SDRL already had warned shareholders that they face dilution in a restructuring deal, the latest statement is “an even clearer sign from the company that the value for existing shareholders will be lower than what is priced in the equity market,” says SpareBank 1 Markets analyst Vidar Lyngvaer.
What really does it mean? The market is a “slow minded” listener that needs repeated warnings about his impending demise before it realizes that it is going to collapse?
Some sort of long-neck dinosaur that needs several minutes to effectively die, because of the time it takes for the body to send the last signal to the far fetch and tiny brain? Come on! Who can even think it is the right explanation?
Technical analysis and trends rule the market. Seadrill and the “confirming sign” of a negative breakout.
The market is very good at spotting a trend and go with it. A trend comes in many sizes, long-term, intermediate-term, short-term and ultra-short-term. Yesterday, was a perfect example of the latter.
Let’s look at the chart and comment on what we see in terms of Technical analysis.
As indicated in my preceding article, SDRL describes a falling wedge pattern (I would say “described” after yesterday). The falling wedge is a generally bullish pattern (low performance rated 20 out 23 by Bulkowsky), which means that under normal circumstances the breakout is potentially more likely to occur on the positive side at about two to one. No certainty in predicting future events of course.
On April 3, 2017, the stock was testing the trend line resistance and for a moment I thought that it was the positive breakout anticipated. However, a breakout is confirmed by high-volume and we had only a minimum volume that day. I interpreted this situation as a “sell” signal, which I posted on Seeking alpha.
Then, yesterday we heard the news, and the stock traded sharply lower in pre-market, but within the falling wedge pattern, which means a range between 0.95-1.05. However, when the normal US market began, volume increased and the trend line support was crossed, confirming a negative breakout in process and the “snowball effect” experienced afterwards was unavoidable.
This situation triggered a huge automatic response translated by a new reversing trade from long to short. It was plainly evident when analyzed through the tiny-time-duration chart.
Thus, I replaced my long bets to short bets immediately and estimated the breakout length, which is about the distance between the two trend lines right above the breakout point at a ratio of about ~40% (empirical), which indicated 0.72-0.73 (we reached 0.65). It was my basic covering strategy. It worked perfectly this time but it is not easy and demand control and willingness to change or adapt constantly.
Conclusion:
Hundred of million dollars have been lost and made yesterday on nothing more than a semantic interpretation. I wrote yesterday:
Sounds like a broken record, triggering the same “evergreen” market reaction.
SDRL 4Q’16 conference call transcript Seeking Alpha. [Click here]
M. Mark Morris, CFO, said it honestly in the conference call:
Regarding our restructuring, our objective is to find a solution that bridges us to a recovery in the sector, achieves a sustainable capital structure, and protects value for our stakeholders. We’ve been engaged in extensive discussions with our lenders and potential new investors, including Hemen, regarding the terms of a comprehensive restructuring. These discussions have also included the ad hoc committee of bondholders. While the ad hoc committee is not presently restricted, they have indicated a willingness to become restricted again in the future.
We currently believe that material additional amendments to the terms of the proposed bank amendments will be necessary to raise the new capital. Feedback from stakeholders and potential new inventors also indicates that a comprehensive and consensual agreement will likely require conversion of our bonds to equity. Under such circumstances, the new capital raise and any resulting debt conversion would likely result in substantial dilution to our shareholders and potential losses for other financial stakeholders.
Today, the company announced the following:
These extensions provide additional time for the Company to further advance the ongoing negotiations with its banks, potential new money investors, and the advisers to the ad hoc committee of bondholders regarding the terms of a comprehensive restructuring plan, which may include the infusion of new capital. While no definitive terms have been reached, based on stakeholder and new money investor feedback, as well as the Company`s existing leverage, we currently believe that a comprehensive restructuring plan will require a substantial impairment or conversion of our bonds, as well as impairment, losses or substantial dilution for other stakeholders. As a result, the Company currently expects that shareholders are likely to receive minimal recovery for their existing shares.
We expect the implementation of a comprehensive restructuring plan will likely involve schemes of arrangement or chapter 11 proceedings, and we are preparing accordingly.
Ok, wording is slightly different, a month ago, it was:
“likely result in substantial dilution to our shareholders“
and today we have:
“shareholders are likely to receive minimal recovery for their existing shares.“
Which is worse? Sounds the same to me and the risk of bankruptcy or out-of-court is still the same.
What will happen today and the next few months will be dictated by everyday news and rumors. I am sure it will be another exciting day or two… As technical analysis is concerned, we are now turning a blank page and the story starts today again.
My message is that SDRL is a trading tool nothing else, and it is not adapted necessarily to anyone who wants to make a quick buck. Trading and investing is a dangerous proposition that requires knowledge, professionalism and control. The risk is significant and always present, lurking in the shadows. You will have to deal with it, on a personal level and TAKE RESPONSIBILITY for your own actions. Do not incriminate John Fredriksen, me or the Pope for your losses, it is plainly unfair and unwarranted. Thank you in advance.
Important note: Do not forget to follow me on the offshore industry. Thank you for your support.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I day trade SDRL and the disclosure above is not adapted to describe my position. Read my article.
Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.
