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Fitch Affirms QGOG Constellation's FC and LC IDRs at 'BB-'; Outlook Stable

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Fitch Affirms QGOG Constellation's FC and LC IDRs at 'BB-'; Outlook Stable
Fitch Ratings
October 22, 2013 11:47 AM
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Fitch Ratings has affirmed QGOG Constellation S.A.'s foreign and local
currency Issuer Default Ratings (IDRs) and USD700 million senior
unsecured notes due 2019 at 'BB-'. The Rating Outlook is Stable.

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Key Rating Drivers

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Constellation's ratings reflect the company's high consolidated leverage
and structural subordination to its operating subsidiaries' project
finance debt, which at times may limit cash flow disbursements from the
operating subsidiaries (Opcos) to the Holdco depending on various
financial covenants. Positively, consolidated leverage is expected to
rapidly decline as the project finance debt at the operating companies
amortizes. Constellation's ratings also reflect the stable and
predictable cash flow generation of the company's OpCos' offshore
drilling assets, which are supported by long-term contracts with
investment grade rated Petroleo Brasileiro S.A. (Petrobras; IDR 'BBB').
The ratings also incorporate the favorable demand prospects for oil and
gas services in Brazil driven by Petrobras' aggressive capital
expenditure program as well as new exploration and production entrants
to the market.

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High Initial Leverage and Adequate Liquidity


The company's consolidated leverage is considered high for the rating
category and is expected to decrease over the near term as the debt at
the OpCos rapidly amortize to levels more consistent with the rating
category. As of the last 12 months (LTM) ended June 30, 2013, leverage
as measured by total debt to EBITDA was approximately 6.0x. Fitch
expects the company to lower its consolidated leverage ratio to below
4.0x within the next few years, which is more in line with the assigned
ratings. Total debt as of June 30, 2013 reached approximately USD3.2
billion, while EBITDA was USD535 million. As of June 30, 2013, debt at
the OpCo level amounted to USD2.4 billion, out of approximately USD3.2
billion of total consolidated debt.


Constellation's liquidity is supported by a 12 months debt service
reserve account and the company's cash on hand, which somewhat mitigates
possible disruptions of cash flow to the Holdco from the OpCos due to
debt restrictions at the OpCos. As of June 30, 2013, cash and cash
equivalent amounted to USD421 million, of which approximately USD229
million were at the holding company level and the balance was at the
operating companies. Also a positive factor for the company's liquidity
was the equity injection of approximately USD300 million from its
shareholders during September 2013, which the company expects to use to
partially fund its approximately USD200 million equity contribution for
a new ultra deep water (UDW) drilling rig it ordered in November of 2012.


Structural Subordination to Operating Companies' Debt


The potential retention of cash flows after debt service at the OpCo
level makes cash flow to the Holdco somewhat less stable and
unpredictable than the cash flow from operation of its subsidiaries.
Most of the project finance debt at the OpCos have cash sweep provisions
and minimum debt service coverage ratios (DSCR) (e.g. 1.2 or above) that
must be met before cash flow distributions are allowed to be made to the
Holdco. Specific assets (Lone and Gold Star) are not permitted to
distribute excess cash to the holding company until all project finance
debt is repaid.


Cash distributions to Constellation are sensitive to the operating
performance of the OpCos' (the rigs') uptime performance. For example,
in the case of the Alaskan-Atlantic operating assets, a decline in the
uptime rate to 95% or below from the combined 15 years historical
average of 96.3% will likely prevent these assets from distributing cash
to the Holdco. Gold and Lone Star financing are not expected to
distribute any cash to the holding company until Gold Star is released
from the associated financing and Lone Star until all debt is paid off,
which is expected to fully amortize by 2017. Under Fitch's base case
assumption of an average uptime rate of 95%, net cash flow distributions
to Constellation from its OpCos is expected to average between USD50
million and USD70 million over the next four years. Net distributions to
Constellation are expected to notably increase beyond 2017 as some
project finance debt is fully amortized and should increase if uptime
rates are higher than projected.


Predictable Revenues and Strong Backlog


Constellation's consolidated revenues and cash flow from operations are
stable and predictable, reflective of its long-term contractual
structure, for the most part with Petrobras. The company provides
onshore and offshore oil and gas drilling services through its different
subsidiaries. The average remaining contract life for its existing
majority owned offshore drilling assets is approximately three and a
half years. The company currently operates eight offshore drilling units
under long-term contracts with Petrobras and has placed an order to
build a new 100% owned UDW drillship yet to be contracted, which adds to
risk. The company also operates nine onshore rigs, which are, for the
most part, contracted with Petrobras. The bulk of the holding company's
cash flow comes from its offshore services.


Constellation's current contract backlog, excluding contract renewal
options, of approximately USD10 billion bodes well for the company's
credit profile as it supports cash flow predictability. Of the company's
current backlog, approximately half relates to the offshore drilling
assets where the company has majority participation. The balance of the
backlog relates to other assets without majority participation as well
as its onshore assets.


Strong Demand for Drilling Rigs in Brazil


Long term demand prospects for oil and gas services in Brazil, including
demand for offshore drilling rigs and production equipment, are strong.
Driven by a government initiative to increase the country's oil and gas
production, Petrobras has embarked on an aggressive capital investment
program of up to USD236 billion over the next four years. Further, the
government has implemented requirement that a high percentage of the
work and materials provided for these expenditures be from 'local'
sources in order to boost economic activity. The combination of higher
demand and the local content mandate for oil and gas related services
support long-term demand prospects for the company as well as its
ability to renew contracts at favorable rates.


Rating Sensitivities


Considerations that could lead to a negative rating action (Rating or
Outlook) include:


--Failure to lower leverage to 4.0x or below; or


--An overly aggressive growth strategy that could pressure credit
metrics (somewhat mitigated by the issuance's covenants).


Considerations that could lead to a positive rating action (Rating or
Outlook) include:


--Injection of new capital into the company, depending on how it invests
the new funds and the lead time required for the new investments to
generate cash flow from operations.


Additional information is available at ' www.fitchratings.com '.


Applicable Criteria and Related Research:


--'Corporate Rating Methodology' (Aug. 8, 2012);


--'Parent and Subsidiary Rating Linkage' (Aug. 8, 2012).


Applicable Criteria and Related Research:


Corporate Rating Methodology: Including Short-Term Ratings and Parent
and Subsidiary Linkage


http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715139


Additional Disclosure


Solicitation Status


http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=805735


ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND
DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING
THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS .
IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE
AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE ' WWW.FITCHRATINGS.COM '.
PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS
SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS
OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES
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RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY
CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH
WEBSITE.


Security Upgrades & Downgrades Finance Fitch Ratings offshore drilling Petrobras
Contact:
Fitch Ratings Primary Analyst Lucas Aristizabal, +1 312-368-3260 Director Fitch Ratings, Inc. 70 W. Madison Street Chicago, IL 60602 or Secondary Analyst Bernardo Costa, +55 114504-2607 Senior Director or Committee Chairperson Sergio Rodriguez, +52 81 8399 9100 Senior Director or Media Relations: Elizabeth Fogerty, +1 212-908-0526 elizabeth.fogerty@fitchratings.com
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