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Why Rowan & Ensco's Merger Deal Is Flawed: Canyon's View

Zacks Equity Research

Rowan Companies plc’s RDC merger with its bigger rival Ensco plc ESV recently witnessed strong opposition from its shareholder Canyon Capital Advisors LLC, a Los Angeles-based alternative asset manager. Canyon owns 6.3% of Rowan’s outstanding shares (more than 8 million), valued at $82 million at the close of market on Jan 7. This makes Canyon one of Rowan’s biggest shareholders.

Following the news, the stock rallied around 7.9% in the last session.

Canyon’s Take on the Deal

Per Canyon, the recent oil market volatility has made offshore assets less attractive. With oil prices plunging more than 30% in the last few months, expensive deep-water drilling projects have become less profitable, leading to a tough business environment for offshore drilling service providers like Rowan.

Moreover, based on the following factors, Canyon thinks the merger can undervalue Rowan’s assets and performances, which will affect the company’s operational and financial profile:

Balance Sheet Superiority: While one-third of Rowan’s$2.5 billion long-term debt will not mature until 2042, Ensco’s $5.2 billion long-term debt comprises $3.6 billion obligation due to mature in the next 10 years. Moreover, Rowan’s cash balance of more than $1 billion is much higher than Ensco’s $630 million. Additionally, the completion of the merger deal will likely lead to debt maturity of more than $4.5 billion between 2024 and 2027, of which $3.6 billion is attributed to Ensco.

Better Assets: Rowan expects the merger to create a “uniquely positioned offshore drilling company with capabilities across all water depths.” However, Canyon anticipates Ensco’s older and less reliable assets to reduce the quality of the combination’s overall asset base.

Rowan’s premium jack-ups primarily capitalize on shallow-water projects with less risk. Moreover, its joint venture with Saudi Aramco provides it a low risk asset base, which leads to cash flow predictability. Contrarily, Ensco’s focus on costly midwater and deep-water projects with lower profitability can dampen results of the combined entity in a volatile oil price environment.

Undervalues Rowan Shares: For each Rowan share, shareholders will get 2.215 Ensco shares. On completion of the merger, Ensco and Rowan shareholders will own about 60.5% and 39.5% of the outstanding shares of the combined entity, respectively.

While Rowan expects the all-stock deal to maximize its shareholders’ value, Canyon argued that the transaction does not provide enough premium, which can offset the rising risks associated with Ensco’s business.

Due to the reasons stated above, Canyon intends to vote against the merger, which can potentially create a leading offshore driller based on fleet size, geographic presence and customer base. Per Canyon, even if the merger deal gets voted down by shareholders, Rowan will still be able to provide shareholders significant value.

Price Performance

Houston, TX-based Rowan has lost 39.8% in the past year compared with 41.9% collective decline of the industry it belongs to.

Zacks Rank & Stocks to Consider

Currently, Rowan has a Zacks Rank #4 (Sell). If you are interested in the energy sector, you can opt for some better-ranked stocks. These include

Houston, TX-based Shell Midstream Partners, L.P. SHLX is a midstream energy company. For 2019, its bottom line, which has witnessed two upside revisions over the past 60 days, is expected to grow 18.8% year over year. The company currently sports a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Tulsa, OK-based Helmerich & Payne, Inc. HP is a drilling service providing company. For 2019, its sales are expected to grow more than 21% year over year. The company currently carries a Zacks Rank #2 (Buy).

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Shell Midstream Partners, L.P. (SHLX) : Free Stock Analysis Report
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