Valaris has Dramatically Underperformed Peers Despite Having Some of the Best Assets and Most Diversified Fleet in the Offshore Drilling Industry
Stock is Down 97% over Past Ten Years; More than $11 Billion in Shareholder Value Destroyed over Past Five Years
Luminus Details Company’s History of Operational, Strategic and Governance Failures – Including Mismanaged Marketing, Value-Destructive M&A and Poor Capital Allocation Decisions
Significant Board Changes Are Needed Now to Reverse Valaris’ Chronic Underperformance
NEW YORK–(BUSINESS WIRE)–Luminus Management LLC, the investment advisor to funds (together with certain of its affiliates, “Luminus”) and accounts that own approximately 18.7% of the equity of Valaris plc (“Valaris” or the “Company”) (NYSE: VAL), today issued a letter to Valaris shareholders expressing grave concerns regarding years of persistent strategic, operational and governance failures at the Company and the immediate need to upgrade the Board. Luminus expressed its view that Valaris’ stock could be worth more than four times current trading levels if the Company was appropriately governed and shareholders had renewed confidence in its future direction.
The letter is available at www.RevitalizeValaris.com and the full text is below:
December 4, 2019
Dear Fellow Valaris Shareholders:
Luminus Management, LLC (together with certain of its affiliates, “Luminus” or “we”) is the largest shareholder of Valaris plc (“Valaris” or the “Company”), owning approximately 18.7% of the Company’s stock.
Luminus was founded in 2002 and is primarily focused on investing in the energy and power sectors. We have substantial experience evaluating and deploying our capital in the offshore drilling industry across the capital structure. We have continuously owned Valaris, or one of Valaris’ predecessor companies, since 2013.
As long-term oriented investors, we have been watching Valaris’ current Board and management team underperform peers1 year after year. The Company is one of our largest investments as a firm because—despite Valaris’ poor track record—we believe a revitalized Valaris can create substantial value for its owners going forward. In fact, we believe if Valaris were merely valued on par with its peers, its stock could be worth more than four times current trading levels. If Valaris employed the strategies we have recommended, it would increase shareholder returns by an additional 300%.
This re-valuing of Valaris will not happen without change at the Board level. After all, the responsibility for Valaris’ litany of failures lies with the directors. Shareholders cannot expect Valaris to be fixed by the very people who are responsible for its decline.
The Crisis: Over $11 Billion of Shareholder Value and $3 Billion of Bondholder Value Destroyed
Despite a superior asset base, a robust liquidity profile, and access to secured debt markets, Valaris has underperformed on both an absolute and relative basis over almost every relevant time period.
Over the last twelve months (through November 22nd, 2019, the last day before we filed our Schedule 13D), the value of Valaris’ stock has declined 85%. Over the last five years, the Company has destroyed more than $11 billion of shareholder value, and over the last ten years the stock is down 97%. Remarkably, over the last thirty years, even as oil prices have tripled and the global economy has boomed, the stock has declined 84%.
Yet, the Company owns superb assets and has plenty of liquidity:
- Valaris Has Best in Class Assets: Valaris owns and operates some of the best assets in the industry. The Company has the largest jackup fleet—including an attractive joint venture with the world’s most significant jackup customer, one of the largest and highest-specification drillship fleets, and a presence in every key offshore market.
- Valaris Has Limited Near Term Capital Needs: We estimate that Valaris will only need an incremental $1 billion to fund operations and debt maturities until 2024, using conservative dayrate and balance sheet assumptions.2
- Valaris Has Significant Access to Capital: Valaris’ bond indentures (which were largely put in place when the Company and its predecessors had investment-grade credit ratings) provide the Company with substantial flexibility to raise structurally senior debt. The Company’s high-quality asset base can backstop well over $3.53billion in incremental structurally senior debt based on recent market comparables and current trading prices.
It is unfathomable that a Company with such a high-quality asset base and abundant liquidity would trade as if a restructuring or default were imminent. Nevertheless, Valaris’ near-term bonds (with maturity in June 2022) are trading with a yield above 26% and the Company’s long-dated bonds trade at levels that imply creditors expect either bankruptcy, further value destruction, or both, over the next twenty years.
This horrific underperformance is also apparent on a relative basis. Valaris’ stock and bonds have underperformed those of its most notable peer, Transocean, over almost any time frame. Today, for example, Transocean’s 2022 bonds yield less than 8% and Transocean’s stock is down just 32% this year through November 22, compared to Valaris’ shares which have plummeted 72%.
Simply put, investors value a drillship owned by Valaris at a level substantially below a comparable drillship owned by almost any of the Company’s competitors (after adjusting for contracted backlog). If Valaris simply traded at asset valuations equivalent to those implied at its peers, the stock could be worth more than four times current levels. This discount is unprecedented in our investing experience.
The Company’s woeful track record of value destruction – one of the worst of any company listed on the NYSE today – is a function of Valaris’ repeated self-inflicted wounds across strategy, operations, capital allocation, M&A and governance. Moreover, the trading levels of Valaris’ securities are, in our view, an indication of the market’s expectation that this pattern of poor decision making will continue.
Despite this, we are convinced that Valaris possesses the assets and the financial flexibility to create a significant amount of value for its stakeholders. We believe there are actions that a revitalized Valaris can take to increase its stock price well above the level implied by the valuation of its peers. What Valaris desperately needs, though, is change.
There is no indication that shareholders will regain confidence in the current Board or changes implemented at its direction any time soon. Nor should they. Instead, to realize Valaris’ full and fair valuation, and to optimize the Company’s strategy, operations and governance, we believe Valaris requires immediate changes that investors can trust.
A Pattern of Self-Inflicted Wounds
Valaris’ stark underperformance and the destruction of billions of dollars of shareholder capital was not inevitable. Nor was it simply the result of industry cyclicality. Instead, the vast majority of the Company’s problems were self-inflicted by what we believe has been suboptimal strategy and consistently poor decision-making. There are dozens of examples, but a few will suffice to illustrate the point:
- Floater marketing efforts have been suboptimal: Ensco—Valaris’ predecessor—did not prioritize marketing, relying instead on its operational track record and a decentralized and “reactive” marketing team. This strategy was passable in an undersupplied market, when customers were actively searching for a contractor with spare capacity. Today’s more challenging market conditions lay bare the short-sightedness of this approach, as competitors (who actively marketed, forged strategic partnerships, centralized data collection, etc.) have gained market share. Valaris has the largest share of warm 7th-generation drillships that are not working, an extremely low ratio of long-term contract wins to assets and dayrates that are widely regarded as lagging peers. Valaris has even lost lucrative contracts recently such as Inpex Ichthys, despite being the incumbent provider.
- Asset management and capital allocation have been poor: Valaris’ legacy Boards committed large amounts of capex (in total more than $10 billion) to construct rigs at the peak of the cycle without long-term contract visibility. Many of those rigs continue to sit idle, with some having not generated any meaningful earnings. Following the Atwood acquisition, Valaris led investors to believe it would sell assets to help repair the balance sheet; the Company, however, has not monetized a single asset to a third party since that time, other than for obsolescence. Legacy Rowan made the strategic decision to hold its drillships off the market in the early years of the market downturn; it backtracked in early 2018, speculatively investing to re-activate rigs for short-term work it only won by bidding below operating cost. Valaris has destroyed billions by investing at the peak of the market and failing to monetize any part of its fleet.
- The Rowan directors (several of whom are now Valaris directors) agreed to an underpriced merger with Ensco: The Ensco-Rowan transaction was so poorly negotiated by Rowan that two large and vocal shareholders had to intervene two times to obtain better value for Rowan’s equity holders. If not for the intervention of these shareholders, the Rowan board would have been content to monetize Rowan’s assets at an exchange ratio 24% below the level Ensco was ultimately willing to pay. And even with the required intervention, the deal received weak shareholder support.4
- Poor ability to predict near-term earnings: In the Company’s January 2019 Proxy for the merger vote, Valaris’ management provided estimated 2019 EBITDA projections of $313 million for the combined Ensco-Rowan. Just months after the vote, the Company reduced its projections materially, sending security prices tumbling. Now it is clear that the Company will miss its 2019 EBITDA projection by more than 50%. The fact that Valaris so quickly abandoned the initial projections it used to justify the merger, coupled with such a drastic earnings miss damages the Board’s credibility.
- The Atwood Oceanics acquisition was poorly structured and overpriced: It was clear to us at the time of the Atwood acquisition that Atwood was heading for bankruptcy and Ensco was overpaying. Several Ensco shareholders (including us) noted this at the time, and one publicly challenged the acquisition. (The vote to approve the deal received extremely low shareholder support.5) Despite distressed bond pricing at Atwood, Ensco structured the deal in a manner that allowed Atwood bondholders to exercise a change-of-control put option at 1% over par, putting additional pressure on Ensco’s own balance sheet. Marking Atwood’s assets to market at today’s values, the Atwood transaction destroyed almost $800 million in value while adding significant leverage to Valaris and limiting the Company’s other options. Additionally, four of Atwood’s five jackups are currently cold stacked and not generating any revenue.
- The Atwood acquisition failed to position Valaris in the Australian market: A major selling point of the Atwood acquisition was Atwood’s “long-standing reputation in the Australian market.”6Yet the pro forma entities’ combined market share in Australia has actually declined since the transaction closed.
- Hiding reduced revolver availability: The Company buried the reduction of its credit facility capacity (viewed by some as an important lifeline) in a footnote to its third quarter 2019 10-Q, with no accompanying explanation, rather than proactively communicating to shareholders. Only after we publicly “asked” the Company to explain the reduction in availability (and after multiple private requests) did the Company communicate “openly” to shareholders about the reduced availability.
- Failure to communicate a dividend cut: Management renegotiated its revolver in early 2019. The amendments to the revolver’s covenants prevented the Company from continuing to pay its dividend. Yet, on its first-quarter earnings call – conducted weeks after finalizing the revolver negotiations – management neglected to communicate the elimination of the dividend. Most shareholders only found out about the dividend cut weeks later when the Company issued a press release finally updating its dividend policy.
Valaris’ recent bond tender destroyed hundreds of millions of equity value: One of the supposed benefits of the Ensco-Rowan merger was additional liquidity for the combined Company.7Yet, the Board decided to deplete that cash on hand through an ill-advised and poorly-executed bond tender that unnecessarily transferred significant value to bondholders. Consider the following:
Despite our written and verbal objections at the time,8Valaris:
- telegraphed its bond tender to the Street well in advance of its commencement, effectively giving investors the ability to “front-run” the bond tender; and
- paid an unnecessary premium on these inflated bond prices.
- When the tender was officially announced, the Company simultaneously stated that it would not be returning capital to shareholders, which also drove up prices for bonds both included and excluded from the tender.
- Against our strong objections, the company preferred “flying blind” 8 and did not secure long-term replacement financing.
- The Company then increased the size of the tender, despite our written advice not do so.
- Just weeks later, the Company reduced its cash flow forecasts which (predictably) sent bond prices down by more than 22%.
- Despite our written and verbal objections at the time,8Valaris:
That the Company executed the entire $724 million transaction without clarity on pricing of, or assurance of securing, replacement financing (which today would be much more expensive and restrictive to the Company) and was forced to draw on the revolver despite our express repeated concerns, is a huge blunder. The Company botched nearly every step in this bond tender and cost shareholders at least $278 million in value (35% of today’s market cap), based on today’s bond trading prices.
This Board and management team have made an astounding number of mistakes: they approved a suboptimal marketing strategy, built assets at the peak of the cycle, failed to monetize assets at the peak (or since), increased leverage to overpay for acquisitions, failed to properly negotiate a merger, mismanaged shareholder communications (on forecasts, dividends and liquidity), and completely botched a critical capital markets transaction.
Along the way, the Board has—on at least four separate occasions over a span of three years—fought input and objections from four separate, large and sophisticated investors. In the two prior situations with measurable outcomes, the shareholder turned out to be right and the unanimous Board decisions destroyed substantial value. Even more shocking, despite all these failures and a shameful history of antipathy towards shareholders, the Board is yet again choosing to spend money and distract leadership in order to fight its largest shareholder.
Change is Needed
It is clear to us that the Valaris Board lacks the experience, alignment and objectivity necessary to instill confidence in shareholders. There have been too many mistakes and too many refusals to heed the advice of owners.
If there were any doubt about the need for shareholders’ perspectives on the Board, one needs only to review Valaris’ stock price reaction to recent events. When Luminus filed its Schedule 13D, indicating an ownership level of 18.7% and highlighting its intention to call an Ordinary Meeting of shareholders to replace members of the Board, the stock jumped 12%.
The Board’s recent, reactive moves – adopting our suggestion of adding a Finance Committee and some new Board members – suggest that this Board does not recognize that it has lost the confidence of shareholders. These belated actions appear to us to be no more than reactive defense maneuvers enacted by an entrenched Board faced with a proxy contest from the Company’s largest shareholder. The Company’s obvious “strategy” here is to do as little as possible, as late as possible, while trying to appear to be proactive. The fact that Valaris’ stock declined when the Board announced its half-hearted efforts demonstrates that shareholders are not fooled by these tactics.
But no reactive measures can change the fact that this Board has failed shareholders time and again. Nor are the long-serving directors truly aligned with public shareholders—even now. Not one of the independent directors is a major owner of Valaris’ stock and none has bought any stock in more than five years, even at recent, depressed prices. Shockingly, it appears that only two directors have ever bought Valaris (or a predecessor company’s) stock in the open market. Throughout the entirety of the current cycle, directors barely opened their personal checkbooks, yet they were comfortable showing unanimous support to use shareholder funds to build an empire, levering up the balance sheet in the process.
Valaris has dramatically underperformed peers over almost any time frame, and its shareholders have lost billions of dollars. Self-inflicted wounds and wasted opportunities are responsible for much of this. It is clear that shareholders deserve better representation in the boardroom, and that the capital markets will continue to lack confidence in Valaris’ Board until substantial change occurs.
There is only one way to ensure that shareholder confidence in Valaris is restored, in our view: shareholders must actively upgrade the Board with advocates who possess the skillsets and alignment required to ensure proper oversight of the Company’s operations, financial management, and governance. With a shareholder-backed and shareholder-aligned Board in place, Valaris will have the opportunity to attract new investors and achieve a fair valuation in the capital markets.
We intend to call an Ordinary Meeting of Shareholders for the purpose of allowing shareholders to elect a group of directors who possess complementary skillsets that are better suited to the challenges and opportunities facing Valaris.
We look forward to communicating with shareholders about the Ordinary Meeting and nominees in the weeks ahead.
Luminus Management, LLC (“Luminus”) is an investment adviser founded in 2002. Luminus employs a low net, relative-value oriented strategy that seeks to generate alpha via deep fundamental analysis and opportunistic investments across the capital structure of companies within the broader energy ecosystem. Luminus’ fund strategy has a general focus on opportunities within North America, and its coverage universe includes power, utilities, MLPs, E&P, drillers, refiners, engineering and construction, and coal/steel.
Luminus Management, LLC, Luminus Energy Partners Master Fund, Ltd. and Jonathan Barrett (collectively, the “Participants”) intend to file with the Securities and Exchange Commission (the “SEC”) a definitive proxy statement and accompanying form of proxy to be used in connection with the solicitation of proxies from the shareholders of Valaris plc (the “Company”) in connection with a general meeting of shareholders of the Company (the “General Meeting”). All shareholders of the Company are advised to read the definitive proxy statement and other documents related to the solicitation of proxies by the Participants in respect of the General Meeting when they become available, as they will contain important information, including additional information related to the Participants, their nominees for election to the board of directors of the Company and the General Meeting. The definitive proxy statement and an accompanying proxy card will be furnished to some or all of the Company’s shareholders and will be, along with other relevant documents, available at no charge on the SEC website at http://www.sec.gov/ and will be available upon request from the Participants’ proxy solicitor, Innisfree M&A Incorporated, by calling (866) 239-1763 (banks and brokers call collect (212) 750-5833).
Additional information about the Participants can be found on the Schedule 13D filed by the Participants on November 25, 2019.
This material does not constitute an offer to sell or a solicitation of an offer to buy any of the securities described herein in any state to any person. In addition, the discussions and opinions in this press release are for general information only, and are not intended to provide investment advice. All statements contained in this press release that are not clearly historical in nature or that necessarily depend on future events are “forward-looking statements,” which are not guarantees of future performance or results, and the words “anticipate,” “believe,” “expect,” “potential,” “could,” “opportunity,” “estimate,” and similar expressions are generally intended to identify forward-looking statements. The projected results and statements contained in this press release that are not historical facts are based on current expectations, speak only as of the date of this press release and involve risks that may cause the actual results to be materially different. Certain information included in this material is based on data obtained from sources considered to be reliable. No representation is made with respect to the accuracy or completeness of such data, and any analyses provided to assist the recipient of this presentation in evaluating the matters described herein may be based on subjective assessments and assumptions and may use one among alternative methodologies that produce different results. Accordingly, any analyses should also not be viewed as factual and also should not be relied upon as an accurate prediction of future results. All figures are unaudited estimates and subject to revision without notice. Luminus disclaims any obligation to update the information herein and reserves the right to change any of its opinions expressed herein at any time as it deems appropriate. Past performance is not indicative of future results.
1 Peers include Transocean, Diamond Offshore Drilling and Noble Corp
2 Assumptions include: 7 Generation Drillship day-rates increase to $250k/d beginning of 2022 and to $300k/d in mid-2023; similar level of conservatism assumed for other rigs; monetizes ARO note and SHI arbitration award for $525 million, cumulatively; no change in net working capital; no capture of debt discount
3 Assumes—at the very least—$120 million per surviving drillship (13), $45 million per modern jackup (36), $100 million per 6G Semi (2) and $50 million each for 3 surviving 8500 semisubmersibles
4 Only 80% of voting Rowan shareholders ultimately approved the deal, putting it in the bottom 3% of all M&A votes in the US/UK in the last five years
5 Only 65% of voting Ensco shareholders approved the deal, putting it in the bottom 1% of all M&A votes in US/UK in the last five years
6 Valaris investor presentation, August 13, 2017.
7 A joint investor presentation published on 10/6/2018 stated that “Strong liquidity and flexible capital structure enhances ability to navigate through industry cycles and generate shareholder value.” And current CFO Jon Baksht stated in the post-close 4/11/2019 press release, “We will have one of the strongest liquidity positions in the offshore drilling sector, giving us a competitive advantage as we move forward as a combined company.
Innisfree M&A Incorporated
Larry Miller / Gabrielle Wolf