Beleaguered Balance Sheet

McDermott International’s Restructuring Dissected

By Lori Musser

On Jan. 21, McDermott International, one of the world’s largest engineering, procurement and construction companies, filed for Chapter 11 protection in Houston and announced a financial restructuring.

It was a pre-packaged approach, with prior support from two-thirds of the company’s creditors, according to the firm’s media release on the filing. The plan brings US$2.8 billion in operating cash and eliminates half (more than US$4.6 billion) of the company’s debt, via equitizing most of its funded debt.

How did this come about? The purchase of CB&I was the tinder. McDermott’s massive US$6 billion purchase of CB&I in 2018 brought with it opportunities, synergy-related savings and pecuniary economies. The company’s project backlog was and continues to be quite stellar – at the end of the third quarter of 2019 it was US$20.1 billion and growing.

Only a year ago, on a Feb. 25, 2019 call with analysts, McDermott President and CEO David Dickson was optimistic: “We are confident in our future as a combined company, and that confidence continues to be validated by the solid performance of the vast majority of our offshore and onshore portfolio and a rebounding market that we believe will allow our company to grow.”

That optimism still prevailed when Dickson said to Breakbulk in May 2019: “Our savings from CPI proceeded at a rapid pace that exceeded our original expectations … we ended up raising our targeted savings to US$475 million. We have successfully completed our integration efforts and achieved the full actioning of US$475 million of annualized cost synergies.”

Cash Flow Crunch

But his optimism was misplaced. McDermott’s stock price fell in late 2018, and again in the second half of 2019. Despite regular announcements for new contracts and progress on current ones, the company’s stock price was on a downward trajectory. Then there was an unsolicited approach to buy Lummus Technology, McDermott’s shining star and reliable cash flow generator.

In October, the company announced a US$1.7 billion financing agreement with lenders, essentially a tranched bridge loan, which Dickson said signaled confidence in McDermott’s underlying business. But Dickson also said: “We continue working with [lendors] to achieve a long-term balance sheet solution …”

Then McDermott chose to miss a Nov. 1, 2019 debt payment on senior notes.

In early November 2019, as McDermott’s CFO walked out the door, a third-quarter net loss of US$1.9 billion on revenue of US$2.1 billion walked in. By comparison, in 2018, the company reported third quarter net income of US$2 million on revenue of US$2.3 billion.

The company attributed the loss primarily to US$1.5 billion in non-cash charges “related to impairments of goodwill and intangible assets and US$256 million of changes in project gross profit on specified projects,” which boiled down to having acquired assets that were not expected to generate the cash flows previously anticipated, heavy debt from the acquisition of CB&I, and a tough cash flow situation.

In the same third-quarter loss report, McDermott cited “unfavorable changes in cost estimates” for EPC work on its Gulf Cameron and Freeport liquefied natural gas, or LNG, projects, among others. Dickson described the bright spots in the company’s future as a “continued strong backlog, with several significant customer project awards, including the Ichthys Phase 2a Gas Field Development Project in Australia … as well as a large LNG tank project on the U.S. Gulf Coast. We also achieved solid operating results in our MENA, Asia-Pacific, Europe, Africa, Russia and Caspian, and Technology segments.”

However, the true albatross round McDermott’s neck was that its capital structure continued to be “pressured by certain legacy CB&I projects,” according to Dickson.

Buttressing the Balance Sheet

With no single panacea for its beleaguered balance sheet, in late January McDermott outlined a six-pronged restructuring plan:

• Robust debtor-in-possession, or DIP, financing facility of US$2.81 billion.
• All operations continue in normal course.
• Customer projects continue uninterrupted on a global basis.
• Employee wages and benefits to be paid in normal course.
• Suppliers to be paid in full.
• Court confirmation of plan expected within two months of Jan. 21 filing.

Proceeds from the sale of Lummus Technology are expected to repay the DIP financing. After restructuring, McDermott anticipates US$500 million in debt and US$2.4 billion in secured letter of credit commitments. “With the majority support of our lenders, we will emerge a stronger, more competitive company with a capital structure that matches and supports the strength of our operating business,” according to the firm’s investor outreach page.

McDermott provided reassurance to suppliers in a Jan. 21, 2020 letter that said: “Importantly, we expect that all suppliers will continue to receive payments and be paid in full.” That includes suppliers all along the supply chain.

Analysts speculated that vendor concerns about section 547 preference claims may be partly to blame for escalated problems. Chapter 11’s Section 547 deals with demand letters for partial repayment of money paid to vendors and creditors in the 90-day run-up to bankruptcy filing. If vendors were switching to cash on demand credit terms, it may have fueled the cash crunch, according to WYCO Researcher on financial content service Seeking Alpha.

The Focus Project Problem

During the Feb. 19, 2019 investor call, Dickson was optimistic, but did point out, since the merger with CB&I in 2018, “the market’s view of the underlying rationale of the transaction has understandably been colored by the charges we have taken on focus projects,” which were impacted by increased labor costs and hurricanes, among other factors.

For the Cameron LNG project, Dickson said: “I’ve said before, many of the difficulties that have been experienced along the way are attributable to the fact that this was a serious bid miss from the onset.

“We knew that these projects were going to be challenging when we made the decision to pursue the transaction, and while the magnitude of the financial impact has been greater than we anticipated, we also believe[d] then and have since confirmed: firstly, that CB&I’s problems were limited to those projects; secondly, that the rest of the portfolio is sound; and, thirdly, that under our management the mistakes made when these projects were bid will not be repeated,” Dickson said.

Fixed-price contracting with small margins on massive developments may be a big part of the problem.
Nevertheless, given a US$20.1 billion backlog and a revenue opportunity pipeline that weighed in at US$89.1 billion in November, and a plan to address debt and cash flow issues, McDermott may soon see the tail end of problems largely triggered by the CB&I combination, and be back on track for growth.  

Image credit: Sempra

Based in the U.S., Lori Musser is a veteran shipping industry writer.