Ocean Rig UDW (ORIG) Ratings Affirmed by S&P Following Share Buyback from DryShips (DRYS)

Standard & Poor's Ratings Services said that it had affirmed its long-term corporate credit rating on Ocean Rig UDW Inc. at 'CCC+'. We removed the rating from CreditWatch with negative implications, where we had placed it on Feb. 19, 2016. The outlook is negative.

At the same time, we affirmed our issue ratings on:

• Drillships Ocean Ventures Inc.'s $1.3 billion term loan B facility at 'CCC+'. The '3' recovery rating reflects recovery expectations in the higher half of the 50%-70% range.
• Drill Rigs Holdings Inc.'s $800 million senior secured notes at 'CCC+'. The '3' recovery rating is unchanged, with recovery expectations in the lower half of the 50%-70% range.
• Drillships Financing Holding Inc.'s $1.9 billion term loan B facility at 'CCC+'. The '3' recovery rating reflects recovery expectations in the higher half of the 50%-70% range.
• Ocean Rig's $500 million senior unsecured notes due in 2019 at 'CCC-'. The '6' recovery rating is unchanged.

We removed all the issue ratings from CreditWatch.

The affirmation reflects our view that Ocean Rig's capital structure remains unsustainable in the long term and that its liquidity is currently less than adequate. We believe that customers' recent cancellations of rig contracts are a reflection of the rapid decline in oil prices and oil companies' consequent very high focus on reducing costs and capital expenditures (capex).

The removal from CreditWatch reflects Ocean Rig's purchase of all of its shares held by DryShips Inc. Therefore the uncertainty about potential negative intervention from the main shareholder is alleviated, in our view. However, other uncertainties remain, notably about cancellation fee payments from Total to be received and discussion with lenders concerning the debt facility attached to the Apollo rig. Specifically, a clause exists stipulating that if the rig is uncontracted 90 days after cancellation, then the company must make a prepayment within 180 days of contract termination. If this does materialize, it would further pressure Ocean Rig's liquidity position. Market conditions remain weak, in our view, and new contracts are difficult to secure. For the above reasons, we are assigning a negative outlook to the corporate credit rating.

Our view of Ocean Rig's business risk profile therefore remains affected by our view of the market conditions and Ocean Rig's inability to secure meaningful new contracts, leading to an anticipated deterioration in absolute profitability and increased earnings concentration as fewer rigs are contracted and working. Furthermore, the cancellation of three contracts since the beginning of 2016 clearly demonstrates the contractual termination risks and limited protection in place. We believe Ocean Rig's financial risk profile is deteriorating, reflecting the unsustainability of its capital structure.

The negative outlook reflects our view of Ocean Rig's increasing liquidity risks as it approaches debt maturity in 2017. It also reflects the uncertainty around receipt of termination fees and risks of debt prepayments, which could accelerate liquidity pressure. The negative outlook is also reflective of the weak operating environment, which could lead to further operating shortfalls not currently incorporated in our base case.

We would likely revise our outlook to stable if we saw substantial improvement in the company's operations and cash generation, supported by new long term contracts for its units, a situation we see as unlikely in the current market environment.

A downgrade would indicate specific default scenarios envisioned within the next 12 months, which could be the case when the 2017 bonds become due within 12 months in October of this year. This may also happen if the company does not receive fees for the canceled contracts, as well as if cash flow generation is cut by further contract cancelations.

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