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January 5, 2015

Oil Crash Contagion Hits Hedge Funds

By Wolf Richter at Wolf Street

It started a few weeks ago. I’d hear from guys here or there in the oil patch who’d just been laid off. That contrasts with the prior anecdotes of hiring binges. A trickle of anecdotal evidence that something has changed, but not enough to pin down credible trends. Then suddenly, something happens – and it turns out that the trends might be worse and might be developing faster than imagined. 

Afterhours Monday, Dec. 29,  between the holidays during a shortened workweek when everyone was supposed be on vacation and when no one was supposed to pay attention, Civeo, which provides workforce accommodations for oil fields and mines in Canada, Australia, and the US announced its Initial 2015 Operating Guidance. And what it said about the oil industry was a doozie.

Civeo is one of the many peculiar creations of Wall Street’s financial engineering shops. When it was still a unit of Oil States International, David Einhorn’s hedge fund Greenlight Capital and Barry Rosenstein’s Jana Partners clamored vociferously for a spinoff, because spinoffs were the new hot thing to make a quick buck. So by early June, Civeo was spun off. It had over 4,000 employees and housed over 20,000 “guests,” as it said on its website. The price of oil was above $100 a barrel. It was the absolute peak of the junk-bond bubble, particularly the energy junk-bond and IPO bubble. Nothing could go wrong.

The shares surged from $22 to $28 by mid-June. Wall Street talked about a 50% upside. In August, when Einhorn let it be known that his hedge fund had acquired a stake, the stock jumped 11% afterhours. Now he was clamoring for the conversion of Civeo into a REIT. But the price of oil was already declining, and shares had backed off to the $25 range, when Civeo announced on September 29 that it would not convert to a REIT but instead move its headquarters to Canada. Over the next two days, its shares crashed 54% to $11.61.

But Greenlight didn’t get caught with its pants down, Forbes reported:
An Oct. 9 filing with the Securities and Exchange Commission shows that Greenlight Capital was a large seller of Civeo stock heading into the company’s announcement that a REIT conversion would be unworkable. Between Aug. 13 and Friday, Sept. 26, Greenlight Capital sold 1.65 million Civeo shares at an average price of $25.25, trimming its stake by 25%.
After the crash, Einhorn “made some smartly-timed trades to increase his clout,” as Forbes described it, paying an average price of $12.55 a share and raising its stake to 9.9%, which made his hedge fund the third-largest shareholder, behind Jana Partners and Fidelity. And now he wanted to oust the CEO, push the company to take on yet more debt, and embark on an “aggressive program” to send this money to shareholders via dividends.

The excitement lasted only briefly before shares got caught in the maelstrom of the plunging price of oil.

And yesterday afterhours when Civeo announced a dose of reality about the oil patch, the stock plunged. During regular trading today, it plunged further, closing at $3.93, down 52.5% for the day, and down 82% since it was spun off six months ago.

Civeo was one among a number of impeccably-timed energy spinoffs that cost gullible buyers of the new shares a large part of their investment in just a few months. Other success stories in 2014 include North Atlantic Drilling, spun off from deepwater drilling company Seadrill in January; its shares are down 80%. Or Paragon Offshore, an offshore driller spun off from Noble in early August; its shares are down 84%. Wall Street engineering at its finest.

So in its Initial 2015 Operating Guidance, Civeo said that the plunge in the price of oil and its projected persistence caused “major oil companies” to slash their 2015 capital budgets. Particularly hard hit were the development and expansion plans of oil-sands operators, a “major driver” of Civeo’s business in Canada.

Just how bad is it in Canada? Baker Hughes’ latest rig count, released on Monday, shows that US drillers reduced their rigs that are drilling for oil by 37, to 1,499, while increasing gas rigs by 2 to 340. But in Canada, oil rigs plunged by half from 190 to 94; and gas rigs dropped by 19% from 201 to 162. The Canadians aren’t dilly-dallying around. According to Civeo, tar-sands operators have been just as aggressive as drillers in cutting operating costs and capital expenditures.

Going into 2015, Civeo has about 35% to 40% of its lodge rooms contracted in Canada, “down from over 75%” a year ago. That’s down by about half!

In an all-out effort to cut its operating costs, it has been slashing headcount, in its Canadian operations by 30% and in its US operations by 45%. It’s closing facilities and is going after capital expenditures with a big axe, chopping them from $260-$280 million in 2014 to $75-$80 million for 2015. That would amount to a cut of about 70%!

And it said that it would likely muck up its income statement and balance sheet with write-offs of various assets, including goodwill, that it is carrying at inflated values.

So, given these consequences of the plunging price of oil that coincided with the consequences of Wall Street engineering, it would suspend its dividend and other forms of “returning capital to shareholders” and would instead try to deal with its debt. In other words, it’s trying to hang on.
Civeo is a thermometer into jobs in the oil and gas industry whose erstwhile boundless boom was funded to a large part by debt. It pushed the economy forward through big capital expenditures and massive job creation. Now capital expenditures are being cut with mindboggling speeds, and the job-creation machine has shifted into reverse. The effects will ripple through other industries.
We already heard from Texas on Monday, where the oil price plunge is starting to permeate the suppliers to the oil and gas industry. The Dallas Fed’s Texas Manufacturing Outlook Survey mentioned some of the anxieties in its Comments. An executive in Fabricated Metal Manufacturing lamented, “The drop in crude oil prices is going to make things ugly … quickly.”

An executive in Machinery Manufacturing complained that a lower rig count would “reduce the market for our products.” An executive in Chemical Manufacturing worried about the adverse impact on margins. An executive in Electrical Equipment, Appliance, and Component Manufacturing saw that low oil prices would “negatively affect our business.” Even an executive in Wood Product Manufacturing worried “about the service sector.”

What Civeo is doing, other companies in the oil patch have already started to do, or will do soon: cutting capital expenditures not with a scalpel but with an axe while slashing headcount and other operating expenses. These companies gorged on debt during the greatest credit bubble in US history. The Fed encouraged them to. Investors closed their eyes and held their noses and handed them the money. Wall Street made sure they did. And now that debt sits on their shoulders and will have to be dealt with, even as the price of oil has plunged by half. It’s going to be very, very tough.

Courtesy Wolf Richter at WolfStreet.com (EconMatters archive HERE)

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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