Description

Archer Ltd (ARCH NO, MC: 1.45bn NOK, 20d ADV: 10m NOK)

Archer Ltd is a Norwegian listed oil services company that recently underwent an extensive re-organization following years of over-leverage. The frail balance sheet disallowed the company to reinvest and grow its business. Fundamentally. Archer runs a collection of attractive assets but suffered from its balance sheet, which finished 2022 with $506m of net debt at 5.3x effective leverage. Archer previously had an old credit facility with six banks, of which five were Nordic. Due to ESG pressures and commodity price volatility, some of these banks sold their exposures at a discount to par, which created a tougher dynamic to roll this debt owing to different risk preferences and motivations amongst creditors.

Archer decided to replace the financing structure with something more robust, including a 1st lien credit facility with banks that had a more substantial relationship as well as a 2nd lien bond placed with strategic investors, all rounded up by a primary injection of equity struck at 1 NOK per share which represented a meaningful discount of 80% relative to the unperturbed price.

Pricing and term for these capital structure instruments was contested but fair considering a still constrained environment for OFS capital.

Archer priced the 1st lien note at a spread to SOFR of 300-550bps, depending on leverage for a four-year tenor with a minimal amortization schedule. Archer issued a 2nd lien note at a 10% margin, half in kind, or else at 12% all in kind at the issuer's option with a similar tenor as the 1st lien. Archer raised $100m in primary equity, nearly quadrupling the outstanding shares. However, John Fredriksen and affiliates supported a quarter of the capital raise and directed his affiliate Paratus to take up its pro rata shares. Thus, Fredricksen's holding company invested $25m in the equity, Paratus $20m, and both investors collectively invested $50m in the 2nd lien. Through his galaxy today, Fredricksen owns 44.6% of Archer equity and suggests strong support from one of the savvier OFS industrialists.

Despite the math of the dilution from 5 NOK implying a fair post-recapitalization equity value of 1.5 NOK, Archer's share price has remained under pressure, trading far below, which is confounding given the recapitalization brought down leverage by about 1.5x turns and termed out the maturity schedule which should have created equity value from theta alone. There were no pre-emption rights that offended Archer's primarily retail shareholder base. Furthermore, the brokerage coverage of Archer doesn't exist as the company suffered from perceived permanently impaired equity. The most reasonable explanation is psychologically driven selling borne of frustration, impatience or the trigger of stop-losses.

Archer has three main business lines:

Platform Operations enjoys a 50% market share in the North Sea, operating and maintaining fixed, modular, and mobile drilling facilities. Archer boasts over $1.2bn of backlog for a business that offers 9-11% EBITDA margins with limited capital intensity. Archer services across the lifecycle of fields, which helps mitigate cyclicality due to demand for P&A activity in the North Sea.

Well Services offers solutions to help ensure good integrity and performance. Archer recently bought an operationally geared asset from Baker Hughes, and the segment has eclipsed Platform Operations regarding group earnings contribution.

Finally, Archer's Land Drilling business includes 11 drilling rigs and 33 workover rigs in Argentina. This business has 5-6% solid margins and an estimated replacement value of $207m with a robust $650m backlog, providing over two years of visibility.

I and/or others I advise hold a material investment in the issuer's securities.

Archer should produce $120-130m in EBITDA into 2024, which will continue to drive deleveraging. Assuming capex equal to depreciation yields a >20% free cash yield to equity, and equity value should accrete even considering a flat EV as debt gets paid down, forcing up the equity value.

Every half turn of EBITDA implies a 50% increase in equity value, implying significant leverage to reflating OFS dynamics. There is no near-term debt maturity, which implies a slow theta decay to equity option value

Catalyst

• Archer's net debt is more than covered by the value of its platform division, which is an under-appreciated cash generator with solid visibility, a good market position, and operates in an oligopoly
• The other businesses are geared into oil and gas expenditure, which remains robust in an environment of recovering E&P spend and high commodity prices
• The land drilling segment is ignored due to fears of Argentina as an investment jurisdiction, but shifting political sands could help create a re-rate as investors seek out idiosyncratic in-country exposure
• After recapitalization, Archer still needs to be better covered and is largely retail-owned and traded. As the company executes and continues to prove it can swiftly deleverage, institutional interest may return and help quell share price volatility, which today may preclude investment