S&P Downgrades Seadrill Partners (SDLP) to 'CCC+/C'; Outlook Negative

October 20, 2016 10:52 AM EDT

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S&P Global Ratings lowered its long- and short-term corporate credit ratings on Seadrill Partners LLC (NYSE: SDLP) to 'CCC+/C' from 'B-/B'. The outlook is negative.

At the same time, we affirmed the issue-level rating on the company's super senior revolving credit facility (SSRCF) at 'B'. We revised the recovery rating to '1' from '2' on the SSRCF, indicating our expectation of very high (90%-100%) recovery in the event of a payment default.

We also lowered the rating on the company's term loan to 'CCC+' from 'B-'. The recovery rating of '3' on the term loan is unchanged, indicating our expectation of meaningful recovery (now in the lower half of the 50%-70% range, from the higher half previously) in the event of a payment default.

We removed all ratings from CreditWatch negative where we had placed them on March 30, 2016.

The downgrade reflects our expectation that market conditions will remain depressed at least into 2018, which will make obtaining new contracts for ultra-deep-water vessels challenging. Seadrill Partners announced in May the termination of the West Capella contract and recently announced the receipt of a notice of force majeure for the West Leo contract. These events are currently common in the industry and not specific to Seadrill Partners, which retains very high economic utilization on its contracted units. But they illustrate oil and gas companies' intention to continue seeking opportunities to reduce costs, particularly on their costly deep-water offshore contracts.

We assume that securing new contracts will be difficult, even more so at profitable terms, given the currently oversupplied market and low oil prices, which have reduced the number of possibilities for employment as oil and gas companies have cut their investments in deep- and ultra-deep-water projects. This underpins our view of the market and our decision to lower the rating. Despite our view of limited risk for a liquidity crisis in the coming 12 months, we believe that Seadrill's capital structure is unsustainable in the long term, in the absence of a favorable oil price development and consequent oil and gas offshore capital expenditure.

The parent company, Seadrill Ltd., remains in discussions with its stakeholders regarding refinancing and recapitalization plans; however, we understand that Seadrill Partners is currently not part of these discussions. But, given the close links between the two entities, any repercussions could potentially have a material effect on Seadrill Partners and could lead to a further downgrade below our current 'CCC+' rating. Nevertheless, we note that a positive outcome from the funding plans at Seadrill Ltd. could ease the threat of exceptional negative intervention from the parent.

Despite a current liquidity position that looks solid and a contract backlog that remains sizable, we believe there is a chance of a downgrade in the coming 12 months. This could occur in the case of a further rapid deterioration of the contract structure, notably through contract cancelations, given the company's high debt burden. Weak market conditions also increase risks of distressed exchanges in our view, which is also reflected in our negative outlook.

We could revise the outlook to stable if Seadrill Partners' credit measures stabilize, such that we believe the company will be able to extend its upcoming 2017 and 2018 debt maturities without a distressed transaction. New contracts amid improved market conditions and continued cash preservation discipline would support such a scenario.

We could lower the ratings on Seadrill Partners by one or more notches if we believed the cross-default risk with Seadrill Ltd. had heightened. This will depend on the progress and result of ongoing discussions between Seadrill Ltd. and its lenders. We could also lower the ratings if Seadrill Partners were to engage in a distressed exchange offer or debt repurchase, or if liquidity worsened as a result of major operating shortfalls, such as multiple cancelations and a steep drop in backlog.

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