We think Noble found an excellent and value-creating use for its excess cash, as we estimate the firm purchased Frontier Drilling for about the replacement value of its assets and five times 2011 EBITDA. Frontier was looking for an exit, as it was struggling with covenant violations and construction payments for the two Bully rigs. While a significant source of EBITDA, the Frontier Driller rig was subject to the Gulf moratorium, and the potential loss of EBITDA under a force majeure declaration would have been a death knell for Frontier. The deal increases Noble's deep-water exposure at a reasonable cost and adds $2 billion in backlog during a period of significant uncertainty for the industry. Noble expects to close the merger by the end of July.
The Royal Dutch Shell agreements are contingent on the merger's successful close and deepen the relationship with Noble. Shell has agreed to contract Noble's under-construction Globetrotter on a 10-year contract for $410,000 a day for the first five years. During the second half of the contract, the day rate will be based on a market index for similar rigs and adjusted every six months. Shell also agreed to similar terms for a second new build that will be delivered in the second half of 2013. It appears that Shell prefers to deal with an established contractor and take a later delivery date than contract one of the available rigs from a speculative player that would have been available a year earlier. The $410,000 day rate on both contracts does lower the current market day rates for ultra-deep-water rigs to $410,000 from prior contracts in the $450,000-$500,000 range. However, Noble traded a lower day rate for a longer 10-year contract, as more typical deep-water contracts are for five years. Furthermore, the second half of the contract is linked to market day rates, which we would expect to be higher.
Finally, Noble's agreements with Shell to address the Gulf moratorium are a good model for future moratorium agreements. The agreements let Shell suspend the rig contracts of any rig operating or anticipated to operate in the Gulf during the moratorium, if needed. In exchange, Noble will earn a reduced day rate that will cover its operating costs and allow the rig to be quickly returned to duty. The term of the contracts will be extended at the original contract day rate to reflect any suspension period. From Noble's perspective, the agreements eliminate the uncertainty associated with the moratorium and the possible force majeure declarations that could have sent its rigs back on a market with as little as 30 days of day rate in compensation. We believe the rest of the drilling industry must be thrilled to see such a strong agreement emerge with very little financial downside for the drillers.
Stephen Ellis is an equity analyst with Morningstar.
