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APRIL 2012
Story continued on page 4, see Default FEDS OPERATION TWIST Tony Murphy
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ating deck high above the oceans surface. Traditional moored semisubmersibles operate at depths of 5,000 feet, but new dynamically positioned semisubmersibles can operate at depths up to 10,000 feet. Semisubmersible rates can be between three to five-times more expensive than those of jackups. Finally, drillships operate like very large ships fitted with drilling capabilities in the middle of the hull. They are very mobile and can operate in ultra-deepwater segments of 10,000 feet and deeper. As they represent the most versatile class of rigs, drillships carry with them the highest day rates in the market. Catalysts for Growth and Emerging Trends Global energy demands will only continue to increase in the future, driven by newly industrializing countries such as China and India, which are expanding their automobile markets. This fuels greater oil production, greater crude oil prices, and greater demand for offshore drilling companies. Lately, day rates in the industry have been steadily increasing, with ultra-deepwater rigs approaching $550,000 per day and premium jackups in benign environments exceeding $130,000 per day. Meanwhile, successful oil exploration activities continue to provide drilling companies with more opportunities to tap. Last year, 23 oil discoveries were announced at average water depths of 6,200 feet, the sixth consecutive year of 20+ announced discoveries. These wells must be drilled eventually, further driving demand for offshore drilling. For example, Petrobras announced in February that it would lease 26 rigs from Sete Brasil and Ocean Rig, both for fifteen years each. Gulf of Mexico activity is expected to surpass pre-BP Macondo levels as the drilling moratorium has lifted. Finally, the key industry trend will be the shift towards ultra-deepwater rigs. Despite the expensive construction costs of ultra-deepwater rigs, demand for these rigs is in an aggressive growth phase, expected to represent more than a third of all of offshore drillings production by 2020. Companies that are positioned to take advantage of this industry trend will be able to reap the increases in revenues and profits that the industry will see. Conclusion Moving forward, the offshore drilling industry represents a strong growth sector. To take advantage of the growth, one could long a market basket of various drilling companies or evaluate specific companies. Due to the cyclical nature of the industry, one should be cautious when using traditional P/E ratios and instead utilize EV/EBITDA for a less deceptive valuation metric. Finally, like any investment opportunity, there are risks that must be evaluated. In addition to government regulation and sensitivity to oil commodity prices, another key risk is overcapacity: as day rates continue to rise and companies continue to commission new rigs, the market could reach a saturation point. However, rig construction is a lengthy process, and over the next one to three years, market demand for offshore drilling should continue to increase at healthy levels.
off-SHoredrIllInG
By Teddy Xiong
With the global demand for oil seemingly ever increasing and onshore oil wells quickly depleting, the offshore drilling industry seems primed to capture increases in revenue and profit. By 2020, offshore drilling is expected to account for 34% of the worlds oil production, up from 25% in 1990, and persistently high oil prices have driven increases in oil exploration and production. Although the most challenging and expensive means of accessing oil and gas reserves, offshore drilling yields substantial amounts of high quality crude oil and generates healthy profit margins for firms that can front the high capital required for drilling. As companies are currently experiencing record backlog for drilling contracts, it is important for the savvy investor to understand operation basics and ways to identify value. Operation Basics Offshore drilling companies secure drilling contracts from oil and exploration companies through a competitive bid basis. As a result, price competition becomes the leading factor in determining which firm secures a contractalthough quality of service, safety and operational performance, equipment suitability, and reputation also play key roles. Unlike land drilling, where a large number of firms compete for contracts, offshore drilling is characterized by a small number of firms due to the high capital barriers to entry for the construction, maintenance, and global transportation of expensive rigs. Once a drilling company has secured a contract, its future revenues will be determined by its day rates and utilization. A day rate is the amount of money a company receives for one days worth of drilling, increasing as demand for drilling services increase. Newer rigs generally command higher day rates than older rigs, and more specialized rigs also command a market premium. Utilization refers to the percentage of time that a rig was actively running and earning money during the time period and is a function of market supply and demand. Not surprisingly, revenues are heavily tied to crude oil prices: as the price of oil increases, demand for drilling increases, and both day rates and utilization increase. Types of Rigs There are three basic types of rigs that a company employs. Jackups are the most common type of offshore drilling rig and see the most volatility in day rates. They have a central barge section that floats on water and holds drilling equipment with multiple legs that extend to the sea floor. Since they physically touch the bottom of the sea floor, jackups are used in shallow water areas, typically at a depth of 400 feet, although highspecification jackups can be contracted at a premium for harsher conditions. Semisubmersible rigs operate at greater depths, floating on submerged pontoons that support an oper-
aPrIl 2012
Shortly before the acquisitions announcement, Zynga stock shot up 6% on rumors the deal would go through. The acquisition strengthens Zyngas portfolio of games that already includes Farmville, CityVille, CastleVille, Zynga Poker, Empires & Allies, and Words with Friends. It also helps to increase Zyngas presence in the mobile market, which is an increasingly important segment amongst consumers. Draw Something is also an inherently social game, which is well-aligned with Zyngas other offerings, specifically the ones that use Facebook as a platform. Draw Something also allows Zynga to continue the process of slowly distancing itself from Facebook, or at least gives the company more diversity and less dependency on Facebook as a platform. Zynga currently derives more than 90% of its revenue from Facebook. Draw Something and Words with Friends provide revenue for Zynga that is not linked to Facebook, which investors on Wall Street would like to see more of moving forward.
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[CredITS]
Kevin Goldfarb Editor-in-Chief
Vice President of Financial Analysis
Karl Helmold
Former Vice President of Financial Analysis
Shruti Shah
Design Editor
Jasmine azizi
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alejandro Villero
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Tony Murphy
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Teddy Xiong
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