Northern Ocean Bond Maturity Threatens 90% Shareholder Dilution

Northern Ocean Ltd. faces a September 2024 deadline on a US$200 million senior unsecured bond. The deepwater drilling contractor, listed on the Oslo Børs, operates two high-spec drillships. If bondholders choose conversion over cash repayment, existing shareholders could face dilution of more than 90%, according to an analysis published by the Good Investors blog.

The bond carries a conversion price of NOK 6.18 per share, roughly US$0.41 at current exchange rates. Shares trade near NOK 5.30, so conversion is slightly out of the money. The conversion price was set at a premium to the stock price at issuance. The shares have fallen since, making conversion unattractive for bondholders unless they expect the stock to rise, the blog noted. The bond's conversion price represents a premium of about 17% to the current share price.

The company had negative equity of US$259 million at the end of 2022, with cash and equivalents of US$64 million. Repaying the bond from cash flow looks unlikely, the blog argued. The company's negative equity and low cash position suggest it is burning cash.

A conversion of the full US$200 million bond would add roughly 485 million new shares at the current conversion price, versus the 34 million shares outstanding. That would dilute current holders by more than 90%. The Good Investors blog argued that most bondholders would convert if cash repayment is not available, given Northern Ocean's weak liquidity position.

Northern Ocean's two drillships, the Deepwater Mira and Deepwater Atlantis, are contracted in West Africa and the US Gulf of Mexico. Dayrates have climbed from the pandemic lows to around US$80,000 to US$100,000, a level the company said in a February 2023 presentation is close to breakeven on operating costs. The market for deepwater rigs is tightening, with supply of high-spec vessels limited. That gives the company some pricing power, the blog noted. The Deepwater Mira is contracted with Occidental Petroleum through October 2023, with a one-year extension option. The Deepwater Atlantis is working for BP until December 2023. Both contracts provide visible revenue but not enough to cover the US$200 million bond.

Beyond the bond, Northern Ocean carries US$391 million in long-term debt, much of it from related-party loans and shipyard financing. The company's largest shareholder, Hemen Holding Ltd., has provided subordinated loans. The company also pays interest on its high-yield debt, which consumes cash. In its Q4 2022 presentation, management said it aims to refinance the bond and extend maturities. No deal has been announced.

The company could sell one of its drillships. Sale prices for deepwater rigs are uncertain. Another option is a negotiated exchange of the bond for a longer-dated note. The outcome hinges on the willingness of bondholders to hold the paper and on the trajectory of dayrates, according to the Good Investors blog. If rates continue rising, Northern Ocean could generate enough cash to service new debt.

Northern Ocean's parent, Northern Drilling Ltd., has its own financial strain. That limits the possibility of a capital infusion from the group. The Good Investors note highlighted that the company is a possible multibagger if dayrates spike significantly. The base case involves survival with heavy dilution. The shares trade near NOK 5.30, giving a market cap around US$20 million, a fraction of the bond value.

Before the September 2024 deadline, the company will report first- and second-quarter results. Those prints will show whether cash flow is improving. The next major catalyst is any announcement on refinancing.