Valaris: Speculating On The Warrants

My Newest Purchase Is A Leveraged Bet On A Long Offshore Bull Market

Summary

• Valaris is another company in the offshore sector, with a mixed fleet of deepwater rigs and jackups.

• I recently bought a small position in the warrants, which expire in April 2028 with a strike price of $131.88.

• I lay out three scenarios with the warrants that I will be considering moving forward.

• It’s a small position for me, but for offshore bulls, I think the Valaris warrants are more compelling than the common stock.

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I have written several times about offshore, so most readers should be familiar with my bullish arguments on the sector. I will provide a quick recap before diving into my most recent trade, which was buying Valaris VAL 0.00%↑ warrants. Offshore is a cyclical industry, with long investment cycles. After the last cycle, there has been consolidation and bankruptcies that cleaned up balance sheets across the sector. Many of the stocks in the sector still trade well below the replacement cost of their assets. One of the companies that was reorganized in 2021 was Valaris. I think we are in the second or third inning of one of these cycles, with day rates approaching $500k.

I think we hit $500k in 2024 at the latest, but I think we still have a long way to go for patient investors. One of the reasons for the supply and demand mismatch for offshore is that there are basically no new builds (so no new supply for offshore rigs). I have seen a couple estimates ($850k or $1M) on how high day rates will need to go to incentivize new builds, but I don’t need to be a rocket scientist to assume that day rates will continue to go higher over the next couple years. As day rates continue higher, companies in the sector start to become much more profitable, as most of that revenue increase flows straight to the bottom line.

Eventually we will see new builds, but the companies in the sector will be printing cash at higher day rates for years. The new builds will take anywhere from 3 to 5 years to complete and they will probably cost $1-1.5B depending on material costs. Overall, I’m very bullish on the sector and I’m expecting stocks in the sector to double or more as the offshore bull run gets going over the next couple years. I’m always looking for asymmetric opportunities in the market, whether it’s in stocks, options, or like today’s post, warrants.

Warrants

For some quick background, warrants are the right to purchase shares at a certain price. They are basically a leveraged bet on the underlying stock. I recently purchased a tiny position in Valaris warrants for my main portfolio, and I think they will outperform the common stock, which should perform well in an offshore bull market.

The Warrants are exercisable from the date of issuance until 5:01 p.m., Eastern Time, on April 29, 2028, at which time all unexercised Warrants will expire and the rights of the holders of such Warrants to purchase Common Shares will terminate. The Warrants are initially exercisable for one New Common Share per Warrant at an initial exercise price of $131.88 per Warrant (the “Exercise Price”).

The simple explanation is that the Valaris warrants are like a super long dated call option. For Valaris, their warrants give investors four and a half years for the investment thesis to play out. While I prefer other companies in the sector, I think that the setup for Valaris warrants is very asymmetric. For me, there are three potential outcomes for this trade.

Worst Case Scenario

The worst case scenario is that the Valaris warrants turn out to be worthless. Whether the offshore bull market fails to launch, or something goes wrong with Valaris, it is possible that the stock doesn’t go higher from here. In this case, I either sell at a loss, or hold until the warrants go to zero. I think this scenario is highly unlikely, which is why I put on the trade.

Middle Case Scenario

The next two scenarios are more bullish, but depend on what I decide to do with the warrants. If we get the offshore bull market that I’m expecting, Valaris stock is a bargain today and trade at much higher levels in the next couple years. If this happens, the warrants will outpace the shares. If there is an opportunity that looks more attractive in a couple years, or I just want to lock in profits, I will sell the warrants to reinvest elsewhere.

Best Case Scenario

The best case scenario starts off similar to the previous scenario. The difference is when the time comes to make a decision on what to do with the warrants. In this case, I will exercise the warrants to buy the shares. Management will have to prove themselves over the next couple years, which have been frustrating for some Valaris investors with some of their contracting missteps. If Valaris goes to $250 or $300 a share (hypothetically of course) in the next four and a half years, then I will still be able to purchase shares at $131.88. I bought the warrants for $14.00, so the cost basis would be $145.88. It seems expensive now, but if shares are as undervalued today as I think they are, it could turn out to be an interesting trade.

Conclusion

This position is very small for me today at less than 1% of my portfolio, but it could become a larger position in the future if my thesis on offshore is correct and Valaris executes over the next couple years. Valaris is already buying back stock, and I think we could see a dividend from the company in an offshore bull market. Valaris’ assets have them well positioned for the next couple years, and as their contracting position improves, I’m expecting a dramatic increase in cash flow, and in turn, a much higher share price.

Hopefully management will prove themselves over the next couple years and I can exercise the warrants and hold onto the shares past 2028. If this offshore cycle lasts as long as I think it could, this is a definite possibility. If I find something more attractive than Valaris, I would consider selling, but that is a decision I don’t think I will have to make for several years. I am going to stick with a small position for now, but I’m not against adding in the future if the warrants get cheaper. The Valaris warrants are a speculation worth considering in my opinion. If you are an offshore bull like I am, the Valaris warrants give investors an opportunity to leverage the potential upside.

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Disclaimer

I own Valaris warrants (ticker VAL-WS or VAL/WS). You should do your own research before making any investment decisions. Different investment strategies have different risk/return profiles which should be considered before making any decisions.