Fitch Affirms Offshore Drilling Holding S.A.'s IDRs at 'BB-' & Sr. Secured Notes at 'BB'

CHICAGO--()--Fitch Ratings has affirmed Offshore Drilling Holding, S.A.'s (ODH) foreign and local currency Issuer Default Ratings (IDRs) at 'BB-'. The Rating Outlook is Stable. Fitch has affirmed company's USD950 million of senior secured notes due 2020 at 'BB'.

Key Ratings Drivers

ODH's ratings reflect the company's solid commercial relationship with Petroleos Mexicanos SA (Pemex, IDR 'BBB+') as well as the relatively stable cash flow generation resulting from its contractual agreements. The ratings also reflect the nascent nature of ultra-deep water exploration in Mexico as well as the company's moderately high leverage, partial structural subordination and contract roll-over risk. The company's expansion plan is considered aggressive and adds to risk.

Solid Commercial Relationship with Strong Counterparty:

ODH's ratings reflect the company's, as well as its shareholder's, strong commercial relationship with Pemex. ODH and its shareholder provide off-shore drilling services, as well as other energy related maritime services, to Pemex. ODH currently owns three ultra-deep-waters sixth generation dynamic positioning drilling semisubmersible rigs. The company charters its assets to three operating affiliates that in turn lease the drilling rigs to Pemex's exploration and production subsidiary at day rates ranging from USD489 thousand to USD565 thousand. ODH is part of Grupo R, a privately held conglomerate of companies that have been providing drilling and oilfield services to Pemex for over 25 years.

Nascent UDW Exploration Phase in Mexico's Gulf Cost:

Although oil and gas production in Mexico has been concentrated offshore with approximately 75% of production during recent years, this has been mainly in shallow waters. Pemex has only recently focused in deep water and Ultra Deep Water (UDW) exploration, mainly given the need to incorporate new reserves to offset declining production from matured fields. Pemex has drilled only a limited number of deep-water wells in its operating history. Development of possible reserves in this sector might be challenging as Pemex has limited experience in deep water oil and gas exploration. A shift back to only shallow and mid-waters exploration at the expense of UDW exploration could negatively impact demand for the UDW drilling rigs the company owns.

Energy Reform Could Support Demand: The passing of the energy reform in Mexico in recent months is expected to generate significant interest from international oil and gas companies and increase exploration activity in the Mexican side of the Gulf of Mexico (GoM). ODH stands to potentially benefit from this expected increase in activity given the company's experience in the country and to some extend could have a first mover advantage by having readily available assets in place should Pemex opt not to renew the existing contracts. The deep water market is one of particular interest for the country to open to new entrants.

Moderately High Leverage:

ODH's leverage ratio for the last 12 months (LTM) ended June 30, 2014 improved to 4.3 times (x) from 5.2x as of the LTM June 2013. This improvement in leverage was included in the initial rating and resulted from a full year of operation of La Muralla IV, which only reported nine months of operations during 2013 and Centenario only operating an average efficiency of 37.8% during the 1st quarter of 2013. ODH's EBITDA as of the LTM ended June 2014 amounted to approximately USD364 million.

Going forward, total leverage is expected to range between 4.0x and 4.5x with the exception of years when the company adds financial debt to fund acquisition without reporting a full year of operational revenues for the new assets. ODH's total debt of USD1.57 billion as of June 30, 2014 was composed of USD950 million rated bonds due 2020 and the balance relates mostly to an amortizable bank loan guaranteed by La Muralla IV. In the future, the company expects to add approximately USD950 million of debt to finance expansions, namely the acquisition of five jack-ups that are expected to be delivered in 2015. The company is currently analysing different funding alternatives for the new debt, which could be issued under the same or similar conditions to those of the existing bonds.

Partial Structural Subordination:

The company's senior secured notes are guaranteed by certain ODH's restricted subsidiaries, including Rubicon Drilling Services and Utileduci subsidiaries, which own the Centenario and Bicentenario drilling rigs, respectively and have no debt. The notes benefit from a 12 months interest reserve account. The notes are currently structurally subordinated to approximately USD460 million of project-finance like bank debt related to La Muralla IV, which amortizes through 2018 and has a small balloon payment. Upon repaying all of La Muralla IV related debt, this asset will also guarantee the debt issuance together with ODH's other subsidiaries.

Contracts Roll-over Risk and Adjustable Day Rates:

The company is exposed to contract renewal risk given that the three UDW drilling rigs have contracts that expire before the maturity of the notes. The rating incorporates the expectation that Pemex will re-contract these drilling rigs shortly before the contracts expire at average or marginally below average market day rates for similar assets. As these UDW rigs are considered important assets for exploration of new oil fields in Mexico. The debt services reserve account mitigates contract roll-over risk as it would allow ODH time to relocate the assets if required. The contracts for Centenario and Bicentenario rigs have fixed day rates for the first two years and are then adjusted annually with average market rates for the remaining three years. La Muralla contract, the third and last UDW drilling rig to enter commercial operation, has a five-year contract with Pemex at fixed day rates for the duration of the contract. The company's cash flow stability and predictability will benefit if contracts were to be renewed at fixed day rates for periods of five years or longer.

Aggressive Speculative Growth Strategy:

ODH's ratings incorporate the expectation that the company would continue to add offshore drilling equipment without increasing its leverage on a sustained basis. Currently, the company has construction orders for five shallow waters drilling rigs, or jack-ups, for which ODH is yet to sign contracts with Pemex. The company expects to sign contracts with Pemex for this equipment before the shipyard delivery. Although the company has been operating this way in the past, this risk adds to cash flow uncertainty and high carrying cost should Pemex not contract the rigs and ODH is forced to find alternative markets for the equipment.

Rating Sensitivity

A negative rating action could be triggered by a combination of the following factors: ODH's consolidated leverage increases in a sustained basis to above 5.0x, contracts are not rolled over within six months after expiration, and/or the company faces delays of six months or greater contracting new equipment after it is delivered.

A rating upgrade could be considered under a combination of the following factors: ODH's leverage decreases below 3.5x in a sustained basis, and/or the company contracts all its drilling equipment under long-term contracts of no less than five years under fixed day rates and with very limited to none out-clauses.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (Aug. 8, 2012).

Applicable Criteria and Related Research:

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=859955

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Contacts

Fitch Ratings
Primary Analyst
Lucas Aristizabal
Senior Director
+1-312-368-3260
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Cinthya Ortega
Director
+1-312-606-2373
or
Tertiary Analyst
Miguel Guzman
Associate Director
+52 (81) 8399-9100
or
Committee Chairperson
Daniel R. Kastholm, CFA
Managing Director
+1-312-368-2070
or
Media Relations
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Lucas Aristizabal
Senior Director
+1-312-368-3260
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Cinthya Ortega
Director
+1-312-606-2373
or
Tertiary Analyst
Miguel Guzman
Associate Director
+52 (81) 8399-9100
or
Committee Chairperson
Daniel R. Kastholm, CFA
Managing Director
+1-312-368-2070
or
Media Relations
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com