OREANDA-NEWS. October 13, 2015. Fitch Ratings has placed Russia-based Eurasia Drilling Company Limited's (EDC) Long-term foreign and local currency Issuer Default Ratings (IDR) of 'BB' on Rating Watch Negative (RWN). The RWN follows EDC's announcement that it received an offer for a potential merger with the intention of taking EDC private. A full list of ratings actions is available at the end of this commentary.

We aim to resolve the RWN once the offer either fails, or, on the assumption it does not, when we obtain clarity on EDC's post-deal financial policies, specifically on dividend payouts and leverage. We expect this to take place over the next four-to-six months. Furthermore, we will assess the impact of the proposed de-listing from the London Stock Exchange on EDC's creditworthiness, ie, on its financial transparency and timeliness and completeness of information disclosures.

On 8 October 2015 EDC announced that its board received an offer of USD10 per share, following the failure of the proposed transaction with Schlumberger Limited announced at end-September 2015. We understand from the company that certain of EDC's management and core shareholders plan to take the company private, in order to undertake significant rationalisation of its business.

Should the proposed transaction be completed, higher-than-anticipated dividends may be up-streamed from EDC by shareholders to help service the shareholder debt raised for the buyout, or EDC may potentially assume or guarantee the debt itself. As a result, EDC's financial metrics may exceed our guidance for a negative rating action. At present, there is significant uncertainty around the deal structure and its effect on EDC's financial profile.

KEY RATING DRIVERS
Weaker 2015 Performance
In January-August 2015, EDC's horizontal metres drilled increased 29% yoy, while the vertical footage declined 32% yoy, on weaker orders from PJSC LUKOIL (BBB-/Negative), EDC's main customer. EDC's total revenue from drilling and related services was down 41% in 1H15 yoy to USD918m, on weaker rouble and lower total drilling meters.

LUKOIL accounted for 63% of EDC's total 1H15 revenues, down from 72% in 1H14, while JSC Gazprom Neft (BBB-/Negative) accounted for nearly 14% of EDC's total 1H15 revenues, up from 7% in 1H14. We have incorporated lower 2015 onshore drilling volumes into our rating case for EDC and do not expect any pressure on EDC's ratings from weaker 2015 operating results.

Leading Russian Onshore Driller
With a 21% market share in January-August 2015, EDC is one of Russia's leading drilling companies by onshore metres drilled. Despite competitive pressures, we expect EDC to remain the largest onshore driller in the country over the medium term. Its ratings are constrained in the 'BB' category due to high customer concentration and limited geographical diversification. LUKOIL contributed 75% to EDC's revenues in 2014, up from 66% in 2013, while the share of OJSC OC Rosneft, EDC's second-largest customer in 2013, fell to 6% in 2014, from 19%.

KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for EDC include:
-USD480m buyout transaction consideration.
-EDC will either significantly increase dividends and potentially provide substantial financial guarantees, or assume the acquisition debt after the transaction.
-Drop in onshore drilling volumes in 2015 and moderate increase thereafter.
-Increases in RUB-denominated onshore drilling tariffs in line with changes in Russia's producer price index.
-The share of offshore drilling volumes increasing to 11% in 2016 from 7% in 2014.
-Stable EBITDA margin averaging 25% in 2015-2018.
-Average annual USD/RUB exchange rate of RUB60/USD in 2015, RUB60/USD in 2016 and RUB55/USD and RUB47.5/USD thereafter.
-Capex for 2015-2018 in line with the management guidance adjusted for RUB/USD exchange rate forecasts.

RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to a resolution of the RWN and stabilization of the rating outlook:
-Failure of the buyout offer.
-Confirmation of the status quo for EDC's post-transaction dividend and leverage policies.
-FFO adjusted net leverage below 2.5x (2014: 1.0x) and FFO interest cover above 8x (2014: 13.9x) on a sustained basis.
-Positive free cash flows from 2015 onward.
-Better diversified customer base.

Negative: Future developments that may, individually or collectively, lead to a Negative rating outlook or a downgrade to 'BB-':
-FFO adjusted net leverage above 2.5x on a sustained basis due to high dividend payout, M&A or weak operating performance.
- Material weakening of corporate governance or transparency to a level worse than that of the average rated Russian company

LIQUIDITY
Strong Mid-Year Liquidity
At end-June 2015, EDC's cash balance of USD370m covered its total short-term debt of USD323m. Rouble balances accounted for 55% of EDC's cash at that date, with US dollars accounting for the rest. For 2015, we forecast EDC to generate free cash flow of USD32m and we estimate that it will be able to maintain sufficient liquidity over the medium term.

Large Repayments Over 2015-2017
As of 31 December 2014, EDC needed to repay or refinance USD511m in 2015-2017, including payments for long-term liabilities for fixed assets and excluding interest, or 46% of its borrowings, of which USD126m falls due in 2015 and another USD248m in 2016. It then has negligible repayments until 2020 when its USD600m eurobond is due.

While EDC's currently low leverage and strong track record mean it should be able to refinance or repay its obligations when due, a possible escalation of Western sanctions on Russia may hamper its refinancing activities or make new borrowings significantly more expensive, while Russian banks and capital markets provide only limited liquidity options.

FULL LIST OF RATING ACTIONS

Eurasia Drilling Company Limited
Long-term foreign and local currency IDRs of 'BB': placed on RWN
Short-term foreign and local IDRs: affirmed at 'B'
National Long-term rating of 'AA-(rus)': placed on RWN

OOO Burovaya Kompaniya Eurasia
Senior unsecured rating of 'BB': placed on RWN
National senior unsecured rating of 'AA-(rus)': placed on RWN

EDC Finance Limited
Senior unsecured rating of 'BB': placed on RWN