Valaris Limited ("Valaris")
5847 San Felipe
Suite 3300
Houston, TX 77057
Attn: The Directors
30 May 2023
Dear Directors,
Lodbrok Capital LLP ("Lodbrok") has been a long-term investor in Valaris (NYSE: VAL) since our inception in 2017, with funds and accounts managed or advised by Lodbrok holding more than 3% of the shares in Valaris. We served on the investor committee in the recent financial restructuring, during which we supported the business with new capital at a challenging time. Our history with Valaris makes us one of the longest-standing shareholders and our continuous involvement predates all members of the current board and senior executives.
We are writing this letter because we believe the board of directors of Valaris (the "Board") has failed to achieve its key objectives since the company emerged from bankruptcy two years ago. Valaris' share price is currently down more than 20% in recent months, and year-to-date it is trailing the average performance of its six closest international peers by close to 30%. We believe (i) that the Board needs to be reduced in size, (ii) that the company should immediately initiate a separation of its jackup and floater fleets in order to explore strategic options to maximise the value of each of these, and (iii) that the company should immediately return any excess cash to shareholders. In our view, such actions are necessary to close the large valuation discount to fundamental asset values and listed peers that the current share price implies.
Performance review
Our letter from July 2022 stated our position that it is critical for shareholders to have a board focused on the objectives of a) closing the significant trading discount to fundamental values and listed peers and b) implementing a best-in-class return of capital policy. We highlighted jackup divestments and normalization of an excessively defensive balance sheet as means to achieve this. In our opinion, the Board has failed to achieve both objectives.
Balance sheet remains overly defensive
We estimate that Valaris had close to $1.4bn of cash available as of Q1 2023 pro forma for the refinancing and assuming the RCF was fully drawn, with a significant net cash position, leaving an excessively defensive and highly inefficient balance sheet. The liquidity equates to almost 1/3 of the market capitalization and highlights the strong potential to increase shareholder distributions: Illustratively, we estimate a dividend of c. 30% of the market cap, assuming no positive share reaction, would despite the recent poor share performance imply around 25% net-debt-to-EV pro forma, which we believe the company's investors would consider more appropriate leverage.
Increasing valuation discount
We estimate that Valaris' current market value implies less than $200m per 7G floater, or <2x EV/EBITDA at the rig level based on leading day rates for such assets, which we estimate correspond to c. $100m of annual EBITDA per rig on multiyear contracts in a sector with marketed utilization above 90%. We attribute any stock price appreciation in Valaris over the last year to general sector performance, and we estimate that both the main peers and physical assets continue to trade at significant premiums and that these premiums recently have expanded.
Failure to take any material strategic or corporate action
Since Valaris re-listed in 2021, its main competitors have been able to execute on many strategic transactions: Seadrill has acquired Aquadrill, divested Paratus and sold the majority of its jackup fleet; Noble has acquired and integrated Pacific Drilling and Maersk Drilling, while also divesting a significant amount of its jackup fleet; and Transocean has recently acquired a stranded asset at the yard, has diversified into exploration of seabed minerals, and has been publicly reported to have bid for another large rig operator. Such strategic actions stand in stark contrast to the inactivity and lack of direction we have seen under the current Board of Valaris.
We believe Valaris' $150m share buyback commitment, corresponding to c. 11% of estimated liquidity and c. 3% of the market capitalization after the share price has declined more than 20% in recent months is indicative of an excessively defensive board that lacks the required decisiveness needed to steer the company at this point. Valaris' motto of boldly first is not apparent from any action taken so far by its directors.
What investors need to see:
1. A leaner board that is more effective in making shareholder-oriented decisions. We believe Valaris' post-restructuring Board has not evolved with the organization and is too large. In addition to the two shareholder representatives, the CEO and the chair, we think only one further director is warranted, for a total of five board members. Our voting at the upcoming AGM will reflect this position. An even number of board members is sub-optimal in our view, and, as we consider the current structure to have demonstrated an inability to take action, we believe a board of seven directors will be worse placed than one of five directors to create value for shareholders.
2. Separate the jackup and floater businesses and explore strategic options to maximize values. We see no reason for keeping the floater and jackup businesses together that would possibly justify the conglomerate discount of a mixed fleet. This is a conclusion that the industry reached a long time ago, and we struggle to understand why the Valaris Board is taking so long to arrive at that same conclusion. Given the large discount of the floater assets compared to certain listed peers and asset transactions, we believe the floater fleet could attract immediate strategic interest from several parties in potentially mutually attractive transactions, and we would be happy to receive equity consideration in any listed major peer as part of a deal. For the jackup business, given its geographical footprint, we believe the company should launch a process to list this company in the Middle East, where local peers like ADNOC Drilling and ADC have been able to obtain attractive valuations, while also running a dual track process to explore strategic options. We estimate that Valaris' jackup assets are trading at large discounts to Middle Eastern and international peers, which could facilitate potentially mutually attractive combinations. If there are any such deals available for the floaters or the jackups, we believe the Board has a fiduciary duty to all of the company's shareholders to actively pursue such outcomes.
3. An immediate return of excess cash through buybacks and dividends to demonstrate the Board's commitment to increasing shareholder value.
In our view, the offshore drilling sector is poised for continued strong recovery after years of rig supply contraction and underinvestment in the industry, with the revitalized capital structures and evolving industry dynamics providing further resilience against any macro weakness. We continue to believe Valaris is uniquely positioned among the leading offshore drillers with the lowest asset valuations, the highest operating leverage, and balance sheet flexibility that allows for a best-in-class capital return policy.
Although no meaningful action to address shareholder concerns has been taken by the Board to date, we see significant opportunity to rapidly remedy this with the steps we have outlined above. We hope the Board will recognise their responsibility to maximise shareholder interests and take immediate action.
Sincerely,
Mikael Brantberg
Chief Investment Officer
Lodbrok Capital LLP
Joachim Bale
Partner
Lodbrok Capital LLP
Please note that this letter is intended to provide transparency on our perspectives as shareholders, and as we want to remain unrestricted and public, we do not seek any direct feedback on its contents. This communication does not constitute a solicitation of any proxy, vote or approval. Do not send us your proxy card. Lodbrok is not able to vote your proxy, nor does this communication contemplate such an event.
View source version on businesswire.com: https://www.businesswire.com/news/home/20230530005304/en/
Contacts:
Lodbrok Media Contacts
Nepean
nepeanlodbrokteam@nepean.co.uk
