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Tidewater's management on the offshore inflection $TDW (podcast #146)
The management team from Tidewater Offshore (TDW) comes on the podcast to discuss Tidewater and why we could be at an inflection point for the offshore space.
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Transcript begins below
Andrew Walker: Hello and welcome to Yet Another Value podcast. I'm your host Andrew Walker, and if you like this podcast, it would mean a lot if you could follow, rate, subscribe, and review it, wherever you're listening to it. With me today, I'm happy to have the management team from Tidewater, the CEO Quintin Kneen, and the CFO West Gotcher. Guys, how's it going?
Quintin Kneen: Hey, it's going great. Quite frankly, I'm feeling better now than I've probably felt in 5 to 7 years.
Andrew: Well, I know this interest you when you fall.
West Gotcher: Going well. Happy new year.
Andrew: West, how's it going?
West: I guess, I could say happy new year, happy to be on.
Andrew: Really happy to have you guys on. First podcast in the New Year, so Happy New Year to you guys and all the guests. Let me just start this podcast with a quick disclaimer just to remind guests nothing on this podcast is investing advice. Obviously, we've got a management team on. We're just going to be talking about the company, the industry, and everything overall. But people should do their own work, and consult a financial advisor. This isn't financial advice.
Anyway, the reason I'm having you guys on is the offshore space. It seems to be hitting an inflection point. It's been a very popular space and thesis in the value investing, and devalue investing circles over the past year, I've been spending a lot of time on it, and I wanted to have you guys on because a lot of value investors looking, they see offshore boats. They remember how bad the last cycle was.
They say, "These say are commodity assets. You always get burnt just when you think it's going on. So, it's a really interesting story. I wanted to have you guys on to talk about the industry overall, Tidewater specifically, and maybe help investors think about why this time might be different even though these our famous last words. So, I've rambled a little bit, I'll pause there, and just if you guys want to do the high-level Tidewater thesis and then we can go into lots of different parts of it.
Quintin: Yeah, absolutely, and we're very mindful of Sir John Templeton towards there because we are in a cyclical business, and it's always nerve-wracking when you here at this time, it's different. The reality is it's not different in the sense that the business is no longer cyclical, but there are factors that are different this time that we should consider as we go through it. Maybe while I'll step back, even back to 2014, and talk a little bit about what the industry's been through so that could help set up what the industry is going to be going through over the next several years.
So, if I go back to the end of 2014, there's a large build cycle. It really started in 2009 with a bunch of easy money coming into the world post, the great financial crisis. You saw a lot of building coming in out of Asia, principally China, which was state-sponsored and really it was all driven because of the fact that both of our category made a tremendous amount of money in the run-up between 2006 and 2008. There hadn't been a build cycle really since the late 80s. So, as a result there's a lot of money going into our vessels in that timeframe.
There was a little pause in the great financial crisis, but it was quickly eradicated by just the envelope of money. Then we saw another build cycle, it started in about 2011. So, it's just a lot of boats on order and have been slowly building even throughout the 90s. There hadn't been a serious correction in our industry. As we got to the end of 2014, what we saw was that there were more boats on the water and on order than the industry could absorb, even before the industry took a dive in 2014.
So, going into the the downturn that started call it November 2014, we were already on oversupply mode, and we had 20% of the fleet on order. So, we just had this massive crash that happened beginning in 2015. It took a while to get to really hit the industry participants because of the dynamic that was in place at the time, you can still walk up boats in 2013 for 5 years and even in 2014 at decent rates. Decent rates at that time were about $22,000 a day. So, you can deliver a new boat prior to work for $22,000 a day for 5 years. That was a good deal at the time. So, the industry slowly began to crash because I had a little bit of backlogged cover. You saw a crash in the 2016-2017 timeframe. Most of the businesses went through chapter eleven restructuring or some form of restructuring in 2017-2018.
Then slowly just started to wean through all of these long-lived assets. They are long-lived assets and they just take a long time to correct. Meanwhile, the rig industry, which is a factor in our demand, we talk about the demand equation shortly, but the rigs were more diligent about scrapping than the boat companies were. As a result, they scrapped more rigs than we scrapped boats' proportion. So, we were just always under the curve from an oversupply standpoint, if you will. As a result, it's taken us a long time to get back into a place where we feel that we are in balance from a supply and demand standpoint.
Now, go back to 2015 there hasn't been a boat ordered since 2015. I mean it's something I delivered in 2015 and 16 that was kind of emotional most of the way through their construction process, and the crash occurred in 2014, but as a result it has anything on order. We've been very good about attrition in vessels and put into to the scrapyard, a lot of participants in our industry, the holding cost for a boat isn't that significant, but these boats have been deteriorating for 5 or 6 years. These boats are designed to be constantly maintained. So, when you don't have them on the water and being constantly watched at by mariners, and everybody turning valves increasing, but increasing valves, and all the good stuff that is necessary to keep a boat in good repair, they begin to really accelerate their depreciation.
So, we've seen that begin to really take hold, and as a result, the supply of finally gotten down to a point where , "All right, we're seeing traction in all of the regions, and then all the vessel categories. Now, when you get down to search on Templeton's warning about it's different this time, but it's not different in the sense that you can change the forces of supply and demand in this industry. There's just too large for any one particular company, but you could play into it.
So, what's happened is because there's been this large underinvestment in vessels, and now the industry is turning, and they're trying to bring you the offshore industry back to life which they are, what we're finding is that there's not enough of the supply chain. Some of it is the pandemic supply chain problems, but a lot of it is the fact that shipyards have gone away. Most of the people that are attending to our type of vessels have moved on to other types of vessels. So, as a result, there's no infrastructure left to rebuild this industry at the pace that the offshore activity levels are increasing.
So, if I wanted to order a boat today, one, is that there's not that many yards. These yards, I was talking about in China, a lot of them have consolidated and gone away. They're out looking to build our vessel again because they got burned so bad, But even the the major yards in Europe or here in the United States, it's 2 and 1/2 to 3 years before I could get something delivered. So, the lead time on what to deliver is much more significant than it's been in the past, but there's other factors too. Because of the energy transition, there's a real question in boat owners and building ship so where's lines as to what is the right vessel to build? These are long-life assets or 25-year assets, and so if I'm going to build something with propulsion technology today that involves a heavy hydrocarbon output, it could be absolutely much faster than we've seen in the past.
So, there's been a real hesitancy to put anything into build mode at this point. So, we're watching other shipping industries to see how they handle it. Our boats are different in the sense that they don't go for a long straight voyages, if you will. They're not going from point to point from China to the United States or other places in Europe. As a result, they're quick on quick, off boats, and they don't lend themselves to easily to LNG because of where they're located. They don't lend themselves to any other alternative technology at this point. So, as a result, the impetus for ordering new ships is very low. We haven't seen any even in the recent build up in activity in the offshore. So, I'll stop there for a second, Andrew, and just see if you want [crosstalk]
Andrew: I was just going to say, I guess I quickly out of that, is beyond some of those I guess, physical, limitations or obsolescence limitations. The economic rationale that's still quite in there yet, right? So, the underlying economics of what a new build would require today were not even back as strong as the markets been through 22, and kind of where we sit today and kind of what we're hopeful for moving forward. The rates still aren't even back to where they need to be in order to justify that new build. So, that's an additional kind of obstacle. Beyond that, the capital formation piece isn't really there.
So, I think historically, there had been a state sponsored entities that would help finance vessel build-outs either it was just kind of in their DNA or it was some sort of national strategic imperative or something that nature and that's kind of vanished. Beyond that, the traditional bank markets aren't very supportive. The capital markets are there to an extent for us, but we're quite large. So, when you add up a varieties of factors between some of the physical and technological limitations in the financial and capital limitations, there's just a lot of headwinds that we think are kind of prohibitive to new vessels entering the market in any foreseeable time frame.
Andrew: No, that's perfect. So, I guess that there's a lot to hear you guys covered a lot of the questions, but there are a lot there that I want to dive into a little bit later. So, I think we did a nice overview of the supply side, and I guess I should have mentioned at the beginning that this is basic economics, right? Like boats are pretty much a commodity, you've got supply and demand, and if demand is really high and supply is really low, rates have to tick up quite a bit to eventually, incentivize, as you said, eventually the rates have to go high enough to, hopefully, incentivize some new builder or something. But if it takes 2 and 1/2 half years for the new builds, if it takes 3 years like rates quite high in the meantime.
Now, if we're in a 2018, oil prices are low. Lots of boats out there, not a lot of exploration. Lots of supply, no demand; rates will be low. So, we're kind of talking about the supply-demand picture of the supply, very tight, very limited right now. Seems like it's going to be the way, and we've just had over the past year, if you've been following the energy markets, everyone knows oil prices have gone up. Supply demands really tight. Oil prices remain around 75-80 despite 400 million barrels of SPR going offline. So, I think we've covered supply for a little bit. I want to I'm going to come back to a lot of that, but why don't we start talking about demand? Demand here is offshore drilling everything, and I'll just flip it over to you, what are you guys seeing on the demand side?
Quintin: Okay, So, let me walk through the demand equation as we see it, and then we can talk about those factors as well that we're just routed to the micro [inaudible]. So, the largest part of what we do is really just production-oriented support. So, there's 5,000 points out there on the ocean somewhere, there are platforms or other installations they need visiting on a regular basis. The ship will go out there. They'll do maintenance. They'll repair items, and if there are demands, they'll bring supplies and so forth. As a result, a big part of what we're doing is just a milk run. We're just going around the offshore oil, field dropping, off supplies, and helping people administer maintenance on the existing assets that letter out there. Maybe you call that the install-base people.
Then that's probably 60 to 70% of what we do, depending on where we are in the cycle, but what really drives us to PQlization, and therefore, peak day raise is the drilling activity. So, everybody watches the drilling activity, and there's observable metrics, the number of drilling rigs working and there were boats working, people always correlate them. But if you don't consider the you know that alpha component of okay, there's a base level of activity, you'll end up over shooting on the demand side both up and down. So, I just frame the demand equation on that one.
So, as we were going through, call it 2,000, so things we're taking a long time to correct, right? So, I'll take you back in 2019, and then I'll go through the pandemic, and then talk about where we're at today. So, end of 2019, I started to see a little bit of increase in daybreak utilization, right? The things that had attrition long enough where you were starting to get some pricing leverage in certain geographies. So, in both classes that are in demand, so the larger vessel. So, let me stop here and say, generally people prefer larger vessels. They're commoditize, of course, but the same time, bigger is better. You have more option value. They're usually the most modern vessels. They often have the most safety equipment. They're more fuel-efficient. They are more carbon efficient. So, people just generally like new or assets. They're more reliable, right?
So, for all those reasons, people like newer boats. Newer boats cost more, but in the downturn, when everything went to cash flow breakeven as the equation works out, it matters if a bigger boat or a smaller boat, they're all going on with essentially the same price. So, "Well, I'll take a bigger boat. So, everybody sort of gets used to using a larger vessel, and so that the larger vessel was the format that always went to work, and maybe you didn't get the day rate you wanted, but you don't have to worry about utilization. It was a smaller boat for you. You really had to worry about utilization, and whether they are going to deteriorate the pipe.
To my point earlier, if the boat is working as being constantly maintained, and therefore the likelihood that it's going to live, it's full 25 to 30 years, it's more likely to have. So, all those good things for the larger boats. So, as we went through the end of 2019, I started to see the rates really begin to take up on the larger boats, to the point where people were starting to look at the next class of boats called the 800-square deck boats. So, the large boats called 1000-square meter deck was going down to 800 square meter. It's start to see those prices increase.
Now, as we get into the first quarter of '20, the pandemic hit, and it just felt like all bets were off. Then it was just literally any port in the storm, right? You just had to get your boots off higher. Well, you have to move higher. You had to get them to a port. You had to get the people that are on the boats off hires getting term set your salary costs down. So, the '20 and '21, largely was just about restructuring, and getting the boats off higher. Getting them into a port. Getting them put into a lay up state, and then getting them relocated to where they need to go once the industry recovers. Well, yet later in the '21, and then really in the first part of '22, people started coming back to life. The oil price was rising, and people were who had deferred maintenance.
So, okay, the other thing that happens is any time there's a downturn, people start deferring maintenance. So, that the milk run that I was talking about, people just like, "Okay, we're not going to do this, that or the other. We're just going to save as much as we can. We need a boat, but maybe we're not going to spend as much money on equipment and repairs. So, you have go visit it, but don't do bring it over any supplies. Don't spend any time there. What we got into doing was just kind of visiting and inspecting assets channel.
As things begin to come back to life, and the oil price begin to rise in the latter part of '19, so this was before the Ukraine conflict, people were like, "Well, crap, these prices, let's get everything working." So, you start to go out and visiting these production-oriented facilities and begin to optimize them. So, if a generator had gone offline or something else had broken over the last few years since 2014 sometimes, well, you go get that fixed, and then you enhance the production capability of those particular assets, and you start generating more money.
So, a big part of the activity levels that we first saw, even in the beginning of '20 and the '19, but also kind of in the end of '21 and '22 was just this increased level of maintenance activity, and kind of catching up on deferred repairs and maintenance, right? So, all of that began to increase at the end of '21 and into '22, oh man, now it's not just the big boats that were in short supply, it was the 800-square-meter decks. You start to see rates in all the region starting to increase. We're like, "Okay. Well, now we're getting back to where we were pre-pandemic."
Then we have the conflict in Ukraine, and there was a real mind shift when that occurred in the first part of '22 where people got focused on energy security again. So, they're like, "Okay, where we're going to go?" Throughout the end of '21 and into '22, there was a unique phenomenon. Most of the time, when the oil price begins to rise, the first that go back to work or the majors and super majors. So, Exxon, BP, Shell, and others, they are usually the most reactive. So, the most reactive areas are in the north sea in the US gulf of Mexico. We didn't see that this time. What we saw where the majors holding back, and I attribute that to the bit more capital discipline on their side, perhaps a little bit more focus on renewables, and as a result, we saw the NOCs dive in.
So, we saw Saudi Aramco. We saw Petrobras. They'd early in '20 and in the 21, continued to an activity level increase. As a result, those areas of the world really began to utilize more vessels more quickly. So, they had been rising, and then as we get into 22, and the energy security theme really took hold, everybody started jumping in. So, all the geographies started to put boats back to work, and put rigs that work as well. As a result, activity levels have been increasing nicely ever since. So, we're in a nice position as we come into the end of 22, and beginning into 23 that really, we haven't seen in over 7 years where people used to be - all right, just to give you an example - used to be, we'd have boats of the dock that we'd worked. Nobody would want a boat long-term because why lock a boat long-term when you just call out a boat as necessary.
Now, people are trying to put folks to work, 5, 7, and 10 years even. As a result, the EMP companies whether they're NOCs or major, super majors, are worried about not having a vessel. So, the vessel scarcity is a real issue today. So, that has the effect of people holding onto boats longer which further tighten up the market, right? So, we're in this nice phase of as we go into 23, virtually, all of our boats are working. West, you're going to have to correct me, but there may be 5 or 10 that are working.
West: Yeah, and we have a few still held for sale, but essentially.
Quintin: Yeah. So, bringing us, all the boats are working. The day rate acceleration has just been phenomenal, quite frankly, but as excited as I am about the performance of the business in '22, we're still not earning our cost of capital. I still couldn't justify building a new vessel today. I'm just much better off than I was previously, and so, relatively speaking, we're in a good position. [crosstalk]
Andrew: Perfect. West, did you want to add anything on the demand picture West, or I know we'll be talking about the EBITDA number in a second, which I'm sure you'll be jumping in.
West: Yeah, no problem. One thing that we look at, and I think plenty of market observers have watched this part, I guess, look at is what the expectations for offshore spending is going to be, and we follow that through a variety of resources. As Quintin said the rate movement in 2022 was pretty astounding. We saw rates move within a quarter what we typically would have expected them to move over the course of the given year, okay? So, really substantial moves, but when you look at what offshore capital commitments announced capital commitments are over the next few years, 2022 was a nice year, but the expectation is that as we get through 23 and 24 offshore capital come ins are nearly expected to double. Okay?
So, if you're in this kind of supply constraining environment, and you talked about the two curves meeting earlier, and you have that demand curve really move out, then there's only one way to kind of satisfy that imbalance in that sort of price. So, when we look at what's been announced, and what's interesting, if you look at some of the numbers put out by some of the larger kind of industry research folks out there, they actually don't even include substantial spending activity that's expected to occur in the Middle East.
I think that's just definitional in terms of how they captured these expected dollars, but it's a substantial move up over the next few years. I think that's driven by just the late economics of where commodity prices are. The energy security construct that's happening. Frankly, I think a capital rotation back away from onshore back to offshore that I think a lot of these companies have traditionally been engaged in, and that they're organizationally set up to pursue. So, that piece of the main story is pretty exciting.
Andrew: Perfect. Okay, so I think we've covered the supply and demand story. Hopefully people see, supply is limited right now, demand appears to be increasing, and you kind of get like almost, I don't want to say parabolic, but maybe an exponential thing. When utilization for industry goes from 50 to 60, you're not really going to see rates stick up 6 to 7 years. But as things get tighter and tighter, the rates are really creeping up because, look, if you're drilling offshore you're all-in cost of a barrel is probably 20 to $30 per barrel. If oils at 70, if you're going on a boat, if you're going to know us from 15K per day to 20K per day, that's pretty much a rounding error in the grand scheme of things.
So, as things get tight, you can really start paying up for these vessels. So, I want to talk earning's power real quick, and I think that valuation earnings power will be great. So, as we're talking January 4th, the stock price is about $34 per share, that's about 1.8 billion market cap. You've got a little bit of net debt about 50 million at the end of Q3. So, you can call it 1.8, 1.85 billion market cap, whatever people wouldn't do. Q3 earnings are 50 million average. We've talked about rates have been going up a lot, utilization be going up.
So, I don't want to focus on the last 12 months number. I think some people do that, and you'll you'll see a higher valuation, but if I just analyze Q3 you'd be trading about eight and a half times EBITDA, about 50 million EBITDA so 200 million annualized. So, in half time, that's not that expensive. These actually free cash flow nicely, but what I really want to focus on is kind of where the puss is going, where earnings can go.
You guys have a great slide. The last investor deck, you'll publish was September. I'm looking at that. It's slide 12. You guys start talking about, "Hey, if we can get to an 18 and 1/2 thousand dollar per day, day rate, that would get us to 666 million in annual EBITDA. So, again, EBITDA translates really nicely into free cash flow. We're talking about 3 times EBITDA, maybe three-and-a-half times free cash flow at these levels, if you can hit that rate.
So, I want to pause there. West, I probably toss to you. Quin, you can jump in, but walk me through that valuation number. Why the 666 Million number can get in there, the assumptions behind that 18 and 1/2 thousand day rate, and that EBITDA number?
West: Yeah, sure. So that, and we can talk about this separately, but that was an exercise we went through after we acquired Swire Pacific Offshore in April of '22, which again, we can talk too, separately. That's been a good transaction. Some really nice boats, larger boats, newer boats in the part of the world, or in two parts of the world that we're excited about primarily West Africa and Southeast Asia. But we put, and again, we've talked about that separately, but we put that together and say, "Look, we're coming off of a period, and you're kind of alluded to it earlier, looking backwards in a cyclical industry, sometimes has its limitations right? If you're on the precipice of a recovery and looking backward is a terribly instructive as to what the earnings power, in our case, have given fleet can do, or of our fleet can do.
So, we said," Okay, let's look at this combined fleet. We contemplate the synergies that we identified through the Swire acquisition that we periodically updated the market on, and said, "Let's look at where the vessel, where our fleet is from an OpEx perspective, what we expect to bring out of the system both from NGNA and OpEx perspective on the synergies. Given that fixed cost base, because I think there's one important element to note of our business is what I think people typically think of as variable costs of labor and things like these, are really fixed for us, and that if a vessel is 50% utilized or 100%utilized, we're paying our crews the same, now, you can have some incidental repair maintenance, and so on and so forth, but conceptually speaking, we're 100% operating, leverage business.
So, let's take that fleet where we were at that time, and it's instructive still, and apply different day rates to it. So, we looked at kind of $1,500 a day increments, and the reason for that is historically, that was what we generally expected to achieve over the course of a given year. I mentioned earlier that we saw day rates expand more than that. I think in Q2 of this past year, our day rates expanded by $1,900 a day, right? So, again, speaking to the amplitude of right expansion.
So, we kind of staggered it that way to say, if it had given utilization level and the given day rate, what our earnings look like? For each incremental move in day rate, how does that drive our earnings capacity? The way the kind of the math worked out of our fleet of just under 200 vessels, in those kind of utilization and day rate scenarios is for every $1,500 a day of day rate movements, it's about 100 million dollars of incremental EBITDA. The reason why we kind of stopped it, if you will, at about 18 and 1/2 thousand dollars a day was that was what kind of the peak day rate that we achieved back in 2014. It was actually a touch closer to 19,000, but round numbers that's about the peak we were at.
So we said, "Okay, look, we'll show that they're kind of putting perspective of what Tidewater at that time generated. So, that kind of puts out this 670 million. It was kind of by having sense that was 666, of I don't know if there's anything [crosstalk]
Andrew: I saw yours. I was like, "I don't know if you want to put that number into [inaudible] especially something that's been as scarce as offshore for this long.
West: Right. Maybe I should talk and have it round up a little bit, but in the event, that's the math. But what's interesting is I mentioned, that's what Tidewater at the time did. So, since that time, almost a decade ago now, there's been a variety of things that have happened to the fleet. What is it, is we've sold a lot of older, smaller vessels that at that time, or just even now, just generate a lower day rate. Now, they may have lower costs and things like that depending on where they are and so forth, but just nominally had a lower day rate.
Also since that time, we've kind of shrunk the fleet or kind of optimize the fleet for the larger newer vessels that Quintin talked about earlier. Additionally, since that time, we've acquired new vessels namely through the shire acquisition that are larger and bigger, and more equipped. So, I guess the best way to say it is, the fleet today is not the fleet in 2014. We would argue that we have a much higher spec on average, much larger on per vessel basis, much larger vessel. We think that the average day rate in a similar market environment would be meaningfully higher than 18 and 1/2.
Again, for purposes of that presentation, and for that analysis, we wanted to just kind of put it in something that people could sink their teeth into to say, "Okay, they did this back in 2014. Let's put it there, but the
fleet is not the same now as it was then. So, we are much more positive on kind of like the aggregate day rate power, if you will, the fleet now, than we would have been as compared to where we were in 2014.
Andrew: I want to go into a couple different components, and again people can go look at this as the September - what is it, the Pareto deck that you guys did? It's on the Tidewater website.
West: Yeah, it's there. Yeah.
Andrew: I just want to dive into obviously the day rate. I think people can get used to that, but there is one other part, which we don't have to spend too much time, but just so, there's two things people are going to look at. A; there's a big utilization uplift number, and again, I think that's mainly just normalizing kind of the dead time, but you just want to talk to the utilization you assume, and why that's a reasonable assumption in there.
West: Yeah, and all that, Quintin, jump in here as well, but at that point in time, again, this was done in, I guess would have been in early Q2 of last year. We still have a lot of vessels that we were selling. So, we had kind of total utilization, and active utilization. Active utilization is our utilization for non-laid up vessels. So, we had a variety of vessels laid-up at the time, and we've pretty well worked all those out. So, I guess, at this point in time, it's useful to think of just utilization, just at writ large where I just kind of your normal utilization number.
At that point, our utilization was lower. It has certainly come up throughout the course of '22, as you can see in our public filings. So, it was to say, "Look, we think whether it's probably a realistic utilization level in a strong market is around 90%. We were somewhere in the high 70s at the time we said, "Okay, we're showing this growth scenario. It's not just going to be day rate because you point out earlier, the utilization kind of has to come up and work for day rates to come up. So, we said, let's take that to 90%. That's probably not are fully maxed utilization.
I think practically speaking across a fleet of 200 vessels or so, that we have when you when you think about dry docks, and just frictional employment and between contracts, downtime for repair maintenance, the practical utilization that we could probably achieve our fleets are on 92, maybe 93%. Okay, so not quite fully utilized of full effective utilization, bidding closed, right? So, we said let's put it there because we're showing this market upload scenario. So, that was kind of the concept is that, we're not saying we're just full bore, just totally sold out, but a very strong utilization environment that would I think support these rate increases that are contemplated on that page.
Andrew: Obviously, you guys are getting close to. I'm just looking at Q3 total utilization 78%, active utilization, 84%, and that's going up from everything I've seen in the industry. So obviously, you're already starting to get to that utilization.
West: Yeah. As I look at you, and I think we talked about in last call as you know, the difference there between that total and active is we did have a handful of vessels that were still assets held for sale or otherwise laid up. So, that's the Delta there. It's kind of these non-active vessels. Shortly, we should expect as we talked on the last call, we should expect that total inactive utilization to converge as we basically just have our kind of go forward fleet that we're happy with, and that we're going to work moving forward.
Andrew: Perfect. Quin, did you want to add anything there, or I just want to talk about free cash flow?
Andrew: Go ahead.
Quintin: Yeah, let me add a few things about just the psychology of the market to give you a little bit of background on how the industry operates. Then we can go into free cash flow and all those other good things. I get that question sometimes that's along the lines of well, supply and demand is so tight. Why don't you just push all the data rates up to $30,000 a day or something like that? Unfortunately, the nature of a highly fragmented industry especially one that's been kind of abused over the past 7 years, you've got to get all of your industry participants to be pushing at the same time, right?
So, what I am encouraged about is, what was alluded to, which is the acceleration in day rates that we're seeing in this up cycle is much faster than what we've seen in previous up cycles. You mentioned the Pareto conference, the groups of Pareto and Clarksons, and a group called Westshore as well, they all have available online spot and term day rates for our types of vessels, right? If you look at the current term rates where vessels that are going to work in like the Southern Caribbean and some sometimes in the North Sea as well, you'll see that they are approaching or even higher than the peak day rates in the last cycle already. But it's just going to take a while for everybody to adjust to that, and all of the vessels, our 200 vessel fleet to kind of get remarked up.
So, it's just going to take some time in order to do that, and so, I bring that out just because it does vary by by geography. For example, in the US Gulf of Mexico, where the larger boat companies are probably 4 or 5 of the large boat companies, they can push boat rates a little bit higher here in the US Gulf of Mexico than you can in areas like Asia where it is much more fragmented. But even in areas like Africa, which is I would say, a mid-level of fragmentation, they're all still relatively high, but just mid-level live. In Africa, we're starting to see day rate of acceleration that is exceeding our expectations. So, very excited about the piece of increase. It's just going to take a couple of years in order to get everything normalized. Unfortunately, just takes that time.
Andrew: Perfect, and then I just want to ask, look, the investors are familiar with offshore, anything capital-intensive, anything that touches energy, basically, right? Like the EBITDA number can be great, but a lot of times there's a lot of CapEx behind that number, and obviously, we talked about how we're nowhere close to new build incentives. We'll probably dive into that a little bit more, but people are going to think, "Oh, these are big boats, dry dock expenses, maintenance CapEx, keeping them up."
I want to talk about if people go look at the deck, 666 million of EBITDA, you say at that level we have a 91% free cash flow conversion. So, talking 600 million, what's going into that? What can people think of a maintenance cutbacks number? What's going in? What's behind generating so much free cash flow on these?
West: Yeah. So, I mean, Quin, I'm happy to - I don't know if you want to [crosstalk]
Quintin: Yeah, come on. Yeah, go ahead. Thanks.
West: Yeah. So, when we think about we do have dry docks, and that is generally speaking, our largest kind of cash, not OpEx cash spend. I guess for those who aren't as familiar with the vessel industry, that is effectively what you would consider maintenance CapEx, right? Every 5 years, and generally speaking, about every 2 and 1/2 years, but really every 5 years, the vessels have to go into a dry dock, which is where the vessels are lifted up, and a series of inspections and repairs, maintenance, and so on and so forth, goes on. That usually is anywhere from 30 to 45 days out of work, and anywhere from depending on the size of the vessel, a few hundred thousand dollars to a couple million dollars, okay?
Again, that's just like clockwork. You got to do it every 5 years, if you're going to work that vessel. So, that's generally, the timing of the dry dock is generally driven by the age, assuming that vessel's been working the whole time however, if it's been laid-up, and so on. Maybe it gets kind of out of cage, so to speak, but generally speaking, it's driven by age. So, the reason why I say that is because it's easy to say, "Okay, if you just kind of prorate your fleet every 5 years that's how much you should expect to expend.
Unfortunately, it's a little lumpier than that. Not all vessels were ordered uniformly across years, and so on and so forth. So, there are some lumpiness in there, but for a fleet our size, and kind of the complexion we have, that spend is probably somewhere in the neighborhood of 60-ish million dollars a year. Again, with the lumpiness that can come through. So, that's kind of our biggest cash, again, non-OpEx kind of cash item is the dry dock.
So, for conversation purposes, call that kind of 60 million dollars a year. Beyond that, we do have some outstanding debt. We did a bond offering in the Norwegian public debt markets. It's a little over a year ago, and the cash interest on that. It was 175 million dollar bond issue at 8 and 1/2%. So, we do have about 15 million dollars a year cash interest expense. We do have some, what I'd call, non-vessel CapEx that just generally related to IT, and technology projects. Now, as we kind of move forward, some projects are on batteries, and things like this. That's called 5 to 10 million a year, just depending on what we have going on.
So, those are kind of the main cash items that we have or cash outflow items that we have. So, when you look that earnings scenario, and you don't have big dollars that are being used for new builds, and again, you have kind of a fixed operating cost base, you take out those kind of cash flow items. That's why we have such high cash conversion because we do have the maintenance CapEx that, I think any oil field services investor, energy investors probably used to sing, but because we have a 20-year, 25-year asset versus a 3 to 5-year asset, if you're talking about a frat later of something of that nature. You just don't have the velocity of capital spending needs that you do in other silos of the oilfield services space, which is what allows us frankly to generate that kind of free cash. I think that's kind of the beauty of this business, and why ultimately people have gotten into it over time is because of that free cash generative capability.
Andrew: Then you mentioned, look, again, at that back end of the lives, obviously, people are going to have, if the company is going to have terminal value, eventually you're going to have to replace the boats. But the nice news for investors is, the fleet is in really good shape. This is a 11-year-old fleet right now, so you've got 10 plus years till you have to start worrying about the average boat kind of retiring. Obviously, they'll be replacement cost in there, but in the near term, the medium term of the cash flow is going to be incredible.
Okay, so I think that's great. Let's talk. We said, 600 million even though we've gone through free cash flow and everything, I want to talk day rates right now. What you guys are seeing the market? At the Paredo conference, you said they 18 and 1/2 half thousand day rate was the EBITD number. I'm looking at the slide. Slide 17 says, "Leading edge contracts, the average day rate is kind of 17,000. For the biggest boat, it's over 23,000. The last time you guys gave an update was the Q3 call where I think leading edge rates, for some sectors, were in excess of $25,000 per day.
So, people might have heard that 18 and 1/2 thousand, 666 million EBITDA number and said, "Oh, that's an ideal scenario." I would kind of, say, "No, obviously, the boat needs to be priced, and we can talk, we haven't talked about how you guys have structured your contracts and everything, but it seems like we're already there." So, what are you guys seeing for leading edge rates right now?
Quintin: Well, it does vary by region, all right? Certainly very viable class, and again, there's public published data out there that I'm going to lean on because I don't want to talk too much for real, I don't talk to you for until it either keep going.
Andrew: No, yeah, absolutely.
Quintin: So, what you'll see when you look at data like from Westshore or from Clarksons or even from Pareto. You're starting to see that every quarter, those rates continue to complete much faster than they'll up in the past. So, there's definitely a market data out there that suggests that the larger boats and the tighter regions are going out for more than $30,000 a day per term work. This is work longer than a year. So, that's another $5,000 leap on top of what we said on our call in Q3. It varies by vessel size too.
So, that's definitely in the large class of vessel. So, 1,000 square meter deck boat, modern vessel, but even in the older vessels and the smaller vessels, you're starting to see significant increases. So, movements or 2 to $3,000 a day ahead of where they were at. So, the momentum and day-rate acceleration is continuing to increase and continuing to maintain. So, we are very encouraged by the day-rate environment around the world, and all of the vessel classes.
Andrew: I don't think it would be quick... go ahead, Quin. Go ahead, West.
Quintin: Yeah. The other thing I was going to say is a little bit of what we were talking about before, which is the whole scarcity of vessels is getting into the mindset properly of the EMP companies because they realize now that they just can't call out a vessel. So, they're not letting vessels go, which is tightening up the market, but they're also willing to pay more for vessels in order to ensure that they got them available throughout the year.
So, we're getting back into a full market scenario where a lot of the ability to negotiate or the power of the negotiation is largely in the vessel owner's position and we're continuing to push price. We're also pushing term rates - I mean, sorry - the terms of the contracts. There's a lot of non-day rate terms that do have an impact that we're pushing back on to. So, everything right now is very bullish for the vessel launch.
Andrew: West, did you want to add anything?
West: No. I didn't mention anything.
Andrew: I mean, look as an investor, I look at that and I say I won't put it into your mouth, but I look at the leading edge rates, and we'll talk how you guys have set up the structure of your contracts in a second, but I look at them and say, "Look, they had a 666 million EBITDA number. I think they could get about 600 million in free cash flow number on that. I look at leading rates, and I say, by the end of 2023, I wouldn't be surprised if they're beating that number in generating even more free cash flow with this lead or something.
Maybe it would take to get into 2024, but kind of on a run rate. So, I look at that and say, "My God, the free cash flow generation these guys can do, when we talked about the supply-demand, and how a supply response is probably 2 and 1/2, 3 years or more outs. You just look at that story, and my gosh. So, I just want to talk how you guys have structured the rates because if people have looked at any of the offshore drillers especially, they're going to look and they're going to say, "We've already talked about how you guys all have almost the whole fleet active. You looked at offshore drillers, a lot of them have cold stacked or warm that can takes months and months to get those. A lot of them have contract links that can run years.
So, they might have struck a four-year contract in 2021. It's great that rates for semi is going to $400,000 per day now, but they struck a four-year contract in 2021, at $200,000 per day. So, it's going to take 5 years for them to get that. I want to talk about how, you guys have kind of turned out the book to take advantage of these because I do think it's unique in kind of the offshore space to front run the answer to be as open as you guys are.
Quintin: Yeah. No, absolutely, especially for the larger boats. So, the larger boats more modern part of our fleet, we're going as short as possible. We're just taking advantage of the day rate accelerations. So, just repricing every time the vessel turns over. Because of the psychology that we were talking about, you just got to turn the boat over a couple times with your customers before you can start really pushing the day right up, and we're starting to see that.
Now, with a fleet of 200 boats, not every boat in a 200 boat fleet is the best boat the world, right? We definitely have high grade the fleet by getting rid of a lot of whole lower spec vessels, but we still have some lower spec vessels in our fleet. We will more likely lean to locking up those types of boats just because they're a little bit more marginal. I'll take a good day rate, and run with it for a good distance, but it will take us a few years to replace the entire fleet just because of that pitch rhyme. But I have not seen a pace in the history of this industry that has been as quick to replace as this one is. But we also have never started from a deficit as low as we were.
So, it's just going to take a number of years to get back to even earning our cost of capital as well. Then, of course, I think it will take them even a longer time for people to commit to ordering new builds just because it's not just the day rates. So, there's other technological factors and concerns about the long-term demand for vessels of people who are factoring in when they make an investment in a 25-year assets. So, I think supply will remain more unchecked this time.
West: I just had one thing in terms of the pace of kind of the fleets, the all-in fleets at a rate. We do still have some legacy contracts that we put in place in 2019, 2020 during the pandemic, or it was more about keeping the lights on. So, there are some of those legacy contracts to your point on the offshore rig, if you've locked up for 4 years then really matter what the prevailing day rate is you're getting what you get. We do have a few vessels like that, that are still getting what certainly below market rates that were contractually obligated to perform under.
Now, the good news is that a lot of those contracts kind of got work through last year, and we expect that by the late part of this year, all those called legacy contracts have kind of worked off. So, we'll have a lot more ability across the entirety of the fleet to kind of mark those vessels to market and kind of have the fully bloated, market rates with across the whole fleet.
Andrew: Perfect. I realize we're coming to the end of our calendar time. So, if you guys have to stop, you just let me know, and we'll stop it right there. But I'm going to keep asking questions until you guys tell me, you've got to stop. Obviously just tell me, you're public company CEOs, and CFOs, I'm sure you've got some stew. I do want to ask though, probably, everyone's hearing this. I think people are hearing how bullish I am. How bullish you guys are? I think there's a lot of free cash flow about to come in, but anybody who's been around the sector probably thinks, "Oh, there's always something that kind of breaks. They've got the, "What breaks the cycle?" question there.
I do look, and I try to be rational, and I went back and pulled. I don't think as we're involved then, but I went back and pulled Tidewater presentations from 2012 to 2013, the last full cycle, and you can find a lot of the language that is similar to this. I'm looking at one of them right now and they say, "Hey, yes, their stuff is under construction, but it's not enough to cover retirements, right? There's going to be this big retirement cycle, and they say, "Hey offshore drilling is going to come in hot."
It's a lot of similar language that the cycle is big. It's going to sustain high day rates. Obviously that cycle broke miserably, and we're, 8 years later, and we're just starting to talk about the cycle turning. Thanks to maybe in part, COVID shutting off supply, all of these other changes. So, the first question that people are going to have is, "Hey, why is this time actually different? I've heard this story before.
Quintin: Yeah, and I don't want to overuse the expression, 'This time was different", because it's still is a cyclical business, and I don't want to leave the impression that it is not cyclical, and very cycle breaks. So, it's not different from a cycle break. We just got to look for those points that indicate that you were getting to the top of the cycle or it's rolling over. Now, very often, it's either an over build or some macro event that impacts the cycle. So, we're certainly not an overbuilt. We are not building. In fact, we're still attrition on a net basis year over year.
So the industry, from where it was in 2013-2014 has shrunk almost 30% from where it was at that time. So, it's a smaller industry, and we have fewer vessels and we, at Tidewater, have a disproportionately better fleet. So, we shrunk our fleet, but also at the same time, trying to increase the overall earnings capability of the vessels that we have on an average basis. So, that's been our dynamic as we both passed 7 to 8 eight years.
Now, as we continue to think about what happens, in our industry. Certainly, if we start to see a significant amount of building that occurs around the world, we should be concerned, all right? Because even in 2013-2014 there were 400 vessels on work. So, you're looking back, and saying, "Okay, well, can the industry really absorb 400 vessels? Is the industry really going to attrition older vessels at that rate? No. Unfortunately, with a fragmented industry, people don't let go of vessels as quickly as economically suggest that they would. As a result, the groups are somewhat differentiated in the sense that you've got companies, like Tidewater that are just proportionally stronger, and more productive assets. Then you have other cold value or economic players that are just running smaller vessels.
So, each one of us has an incentive to keep our boats in play. As result, you don't see the attrition as fast, right? As I indicated before, we were, looking back on that part of the cycle in 2013-2014, we were oversupplied going into the downturn, right? Now, what caused that downturn was the crash in oil prices. So, to the extent that we see, there's two things that I worry about. One is an event similar to what we saw with Deepwater Horizon. Okay. When everything goes back to work suddenly, you've got a bunch of new employees. You've got a bunch of equipment that hasn't worked in a long period of time. You run the risk of something terrible happening. Of course, here at Tidewater, we're very focused on that potentiality, and very communicative with our groups, and making sure that we've gotten all the training, and making sure they were on top of it.
But I worry about something like that because that will shut down geography. It just doesn't shut down the world, but it'll shut down a particular geography for a long period of time. If it's in either the North Sea, or if it's in the US, then it's going to have a more pronounced effect because those industries are already under pressure. If there was something negative that happened, then you may see that it'd be more substantial than it has been in the past. I think the entry is very smart. This is on balance a very safe industry. People are very dedicated safety.
So, I bring it up because I think it's important to bring up, but my hope is that we don't have an incident like that, of course. Then the other element is just as quickly as this industry change, - this outlook that we talked about of people focusing on energy security that they came to, and called the spring of last year, maybe that change. Now, and I will say that even leading up to the conflict in Ukraine, and that the pendulum shift to energy security, we were still increasing our boat utilization and boat day rates. But as a shift, that put the world back onto a track of globalization, and harmony would certainly have a think a dampening effect on some of the activity that we're seeing out there today.
Andrew: If I could just follow up with a couple things to what you said. Just a few minutes ago, you mentioned in 2013, there were 400 boats on order. Just to put that in perspective, Tidewater is the largest player in the industry, and you guys have under 200 boats. So, we're talking about to Tidewaters on order, the global PSV fleet is 1400 boats. So, that 400 boats, just to put that number in perspective, that's a mass number.
Then on globalization I do hear you, that leads into my next question, right? Like, people are familiar, energy prices have been volatile. We saw a big spike in oil prices over the summer post Ukraine. Energy prices have been pretty soft recently. An offshore oil commitment is a billion dollar commitment. People don't care if the spot price is 80 versus 90. They're really looking, "Hey, what is oil for the next 10 years when we're making this investment? But oil prices, the out oil prices have come down over the past 6 months. So, the last thing that could kind of kill the thesis, we've covered the supply side, I think, it's the demand side.
So, I do think people think, "Hey, where does your oil have to go? Oil majors start looking and say, "Hey, that billion-dollar oil investment we're going to make." Maybe we don't make it because the oil prices might be below where our kind of risk adjusted return of capital is. What do you guys think about that, or what are you hearing from your customers on the kind of oil side?
Quintin: So, we have not seen any pullback whatsoever. In fact, we still see people picking up the drill bit and leaning into the cycle. So, from the standpoint of what we're seeing on the ground, and what we're seeing for 23, I don't see any pullback, but that dynamic of what you're talking about is something that we're always looking for, right? So, in Tidewater, what we're trying to have a disproportionately higher quality fleet. So, no matter what happens, if all the drilling goes away, they're still going to be significant amount of offshore of vessel activity work that has to happen. I want to make sure it goes to Tidewater vessels.
Andrew: There's ]inaudible] runs you talked about earlier, yeah?
Quintin: Exactly. Now again, if that were to happen, again, it is drilling that pushes us to those highest day rates and highest utilization periods, right? So, if that were to go away, we would have to normalize the fleet again. We'd have to shrink a little bit by cutting out the lower spec vessels in our fleet. But that's just what we do in our industry in order to match our fleet with the demands of the market.
Andrew: Perfect. Let's look at capital allocation real quick. I think your expectation is that there is going to be a lot of free cash flow pouring in this business. We talked a little bit earlier about you guys in the SPO acquisition earlier this year, which I think was great timing. I think it's been a home run so far, but capital allocation, you're going to have a lot of cash flow coming in. This is a business that historically has supported some leverage. You have a little debt outstanding, but net debt is basically going to be zero at the end of he year. I would think, close to zero.
So, capital allocation you could do M&A. You could leverage the business up. You can do by Bosch. You can do dividends. You could do a combination of all them. How are you guys thinking about capital allocation going forward?
Quintin: Well, as we release new builds, let's just take that off the table. Why? There's there's no sense in adding more capacity to this market at the prices that would take to build a new vessel. West is going to correct me here, but a new vessel was 65-70 million?
Andrew: There's a slide in the Pareto deck. Slide 21, if people want to see the economics, what you guys assume and find it. Again, it comes out to, you need a 38,000 day rate which even with this spike, were not even close to.
Quintin: For 20 years, right?
West: Right for 20 years, yeah.
Quintin: So, let's just think their builds off the table. A new capital going to new builds unless somebody comes to me when the contractor. There it's going to go, "Pay me the equivalent of $38,000.
West: "About 20 years later. So, then you look at, "Okay, certainly a value accretive acquisition so we could do it. That makes sense to do. I'm very interested in doing. If I can do another deal like Swire, I would do it. I don't think there's another deal like that quiet on the table, but there's going to be other deals that are out there.
So, if I could put more money to work and the returns that I think that were going to get on the SPO acquisition, I would do that. I think our shareholders would be very happy for us to do that, but I don't think enough of those deals to outstrip the amount of cash that we're going to generate, all right? So, we're going to have to give some money back to shareholders at one form or another. Now, the good thing is that negative carry is not as bad as it was 3 years ago, right? I mean, interest rates are going up a little bit, but that still doesn't convince me to hold on to the money.
So, I do need to make sure that there's enough liquidity in the business to withstand the vagaries of the cycles that we've all been talking about because it is business, and it's never lost on me that it looks like it's going to turn. So, I need to make sure that I've got a debt capital structure that can withstand the reasonable cycle. Right now, the capital markets aren't there for our company. So, we've been leaning on a cash balance just because we don't really have any other way to provide liquidity to the company.
But even with an adequate cash balance and spending money on acquisitions, we're going to have to return money to shareholders in the form of dividends or share purchases in the longer term. The board is going to be the ultimate determining of what that form is, but it's definitely going to be something that's we consider as we go through the next few years. Now, West, there's a restriction and the current debt that you should mention here again.
West: Yeah. So, when we did the public debt issuance and they're always in public debt markets last year, there is a provision that prohibits us from doing any buybacks, or distribution shareholders dividends for the first 2 years. Okay? So, we issued that November of '21. so in November of this year, that prohibition falls away. Then at that point, we're limited to 50% net income as what we can basically distribute out to shareholders. That's something we think about, and whether or not there are some sort of situation where we're seeing a lot of cash, and need to remedy that, is relevant. But as it currently stands, that's what kind of the limitations that were exposed to.
Quintin: Yeah. So, well, I guess how I would summarize it is I'm not looking to add capacity to the market, full stop. I am looking to consolidate existing capacity on the market, and leverage economies of scale to the extent that I think that it's value created to our shareholders. Even doing that, I don't think that we're going to outstrip the amount of cash that we generate. Then we're going to find ways to constructively return it to shareholders.
Andrew: Yeah, and I'll just note, Barbara Body is a major shareholder, and is on the board. He's kind of the one who turned me on to this, and got me started to talk to you. I trust Bob as at least one voice to be in the boardroom making rational capital allocations, decisions and everything there. So, that's great. Let's see. What else do I want? Look, I think we've covered most of what I wanted to cover actually. I think listeners can hear. I'm pretty bullish. I think you guys are pretty bullish. The cycle just seems great.
The cash flow is going to come pouring in, and it's just a really interesting story provided we're not looking at $20 oil prices for the foreseeable future again, but at any point. But yeah, look I really appreciate you guys taking time being so generous of your time. Any last thought you guys want to get out that investors should be thinking about or as they get to know the story or think through this business?
Quintin: No. I mean, I think we touched on everything that I would touch on in the discussion with the new investor.
West: I agree.
Andrew: Great. Well guys, I really appreciate you being so generous with your time. I really appreciate you being good stewards to my capital because this is a again, I'll disclose I've got a position in Tidewater. I think this is a great story. I'm looking forward to Q4 earnings, and I'm looking forward to catching up with you guys soon.
Quintin: All right. Take care. Thanks.
West: Thank you.
Andrew: Have a good one, guys.