This is a correction of a rating action commentary published on April 3, 2023.

It adds Valaris Finance Company LLC as the second lien notes co-issuer and updates the notes amount to $700 million from $600 million to reflect the upsizing of principal.

Fitch Ratings has assigned a 'B+' first-time Long-Term Issuer Default Rating (IDR) to Valaris Limited. The Rating Outlook is Stable. In addition, Fitch has assigned a 'BB-'/'RR3' rating to the $700 million second lien secured notes co-issued by Valaris Limited and Valaris Finance Company LLC, Valaris's FinCo. The proceeds will be used to repay all of the existing debt and for other general corporate purposes.

Valaris' ratings reflect the expected sharp decline in leverage in 2024 as the currently strong floating drilling rig day rates feed into the company's next year's contract prices. Valaris' credit profile benefits from one of the largest fleets of offshore jackups and floaters, short-term revenue visibility due to presence of contracts with minimum prices and volumes, and healthy liquidity.

Valaris' profile is negatively affected by high volatility in day rates and rig utilization combined with asset-heavy business model and high operating leverage, which together result in considerable swings in EBITDA depending on the industry cycle. Valaris completed a debt restructuring in April 2021, dramatically reducing its gross debt.

Key Rating Drivers

Leader in Offshore Drilling: Valaris owns 16 floating rigs, including 11 drillships and five semisubmersible rigs, and 36 jackups. Its offshore drilling fleet is the largest globally by number of rigs. Valaris operates in all major offshore oil and gas basins, such as the Gulf of Mexico, Brazil, Middle East, West Africa, the North Sea, Southeast Asia and Australia. In late February 2023, the company had a $2.5 billion contract backlog, up from $2.4 billion as of February 2022 and $1.0 billion at end-2020. Valaris expects to convert around 54% of February 2023 backlog into revenue in 2023 and 35% in 2024.

Rebound in Floater Market: As long-term forward oil prices started to increase in 2021, market day rates for floaters began growing at a fast pace and almost doubled between end-2020 and end-2022. Floater utilization has also been improving. Fitch does not assume any significant growth in market day rates in 2H23-2H24 and expects rates to decline in 2025 based on its oil price deck. The number of contracted floaters has been largely stagnant worldwide in 2017-2022, and Fitch expects this number to increase in 2023-2024.

Stacked floater rigs number peaked in early 2017 after oil prices collapsed in 2014. More than half of stacked rigs as of early 2017 exited the market by end-2022. Six of Valaris' 16 floaters are currently stacked, and this share of stacked rigs is roughly in line with total market numbers.

Jackup Fleet Improves Stability: Valaris' jackup business enhances stability of its cashflows. Jackup day rates are not as volatile as those for floating rigs and global jackup utilization fell less dramatically than floaters utilization in 2017. The higher resilience of the jackup market is underpinned by shorter payback for shallower offshore upstream projects. Valaris generated most of its EBITDA from jackup segment in 2022. Fitch expects this share will decrease in 2023-2026 as the company's floaters move away from lower legacy day rates. Valaris also benefits from stability of its other businesses, including bareboat charters to its JV with Saudi Arabian Oil Company (Saudi Aramco; A/Positive) and rig management services.

Envisaged Decline in Leverage: Valaris' rating is based on a sharp reduction in its gross leverage that Fitch forecasts in 2024. Valaris exited chapter 11 restructuring in April 2021, eliminating $7.1 billion of pre-petition debt and raising a $550 bond. However, its EBITDA leverage was 6.7x at end-2021 and 3.7x at end-2022 due to subdued EBITDA generation driven by muted demand for offshore drilling services over the last several years leading to oversupplied market.

Fitch projects Valaris' EBITDA to improve to approximately $200 million in 2023 from $147 million in 2022 and reach approximately $500 million in 2024 as Valaris starts realizing higher day rates on the 2023 contracts from rig reactivations and active rig contract rollovers. EBIDTA leverage is expected to decline to 3.1x in 2023 and 1.1x in 2024 given that Fitch projects a stable gross debt amount. Fitch expects that the company's EBITDA will start declining in 2025 based on falling oil price assumptions.

Capex, Reactivations Weigh on FCF: Fitch expects Valaris will boost capex to accommodate strengthening demand for offshore drilling services. Fitch projects its annual capex including a purchase of one new build drillship to average roughly $400 million in 2023-2024, doubling the size of 2022 capex. These numbers also assume several rig reactivations. Valaris aims to reactivate floaters when it can secure a contract that provides a sufficient return on reactivation costs. Part of the reactivation costs is subtracted from its EBITDA. As a result of elevated capex and reactivation costs, Fitch forecasts Valaris's FCF to remain negative until 2026.

No Dividends, Limited Buybacks: Fitch does not project any dividends to be paid by Valaris in the medium term. The company has an approved $100 million share buyback program and Fitch assumes it will be fully executed in 2023. Fitch does not expect Valaris to pay any significant dividends until its key markets recover sustainably.

Growing JV with Aramco: Valaris has a 50% stake in an equity method-accounted JV with Saudi Aramco called ARO. ARO is an offshore drilling company that has contracts with Aramco. Fitch expects ARO to be in an expansionary stage in 2023-2027 and does not expect any dividends from it. At the same time, Fitch expects the company to fund its capex through FCF generation and standalone debt without any cash calls from the partners. Valaris has $0.4 billion notes receivable from ARO due 2027 and 2028. Fitch does not forecast notes principal repayment in 2023-2026, but expects the company to receive $25 million-$30 million of annual interest.

Bond Recoveries: The $700 million notes' 'BB-'/'RR3' rating is one notch above Valaris's IDR. This is based on substantially better recovery prospects for the notes than what was achieved by the unsecured bondholders during the bankruptcy two years ago. The rating for the new notes assumes significantly lower total drawn debt consisting of the fully drawn $375 million RCF and the $700 million notes.

Derivation Summary

Valaris's peers include Noble Corporation plc, Precision Drilling Corporation (B+/Stable), KCA Deutag Alpha Limited (B+/Stable), CGG SA (B-/Positive) and Nabors Industries, Ltd. (B-/Stable). Valaris is similar in scale to Noble, but experiences lower margins due to its current contract structure and higher concentration of jackups. Noble is expected to generate more consistent FCF than Valaris given the recent recovery and higher margin profile for floaters, which results in modestly lower leverage, especially in the near term.

Fitch expects Precision and KCA Deutag to generate significantly lower revenue than Valaris and have comparable EBITDA margins in 2024-2025. Their leverage is projected to be higher, but they are involved in the onshore drilling segment, which is more stable than the offshore one.

Nabors has modestly larger scale than Valaris and a more diversified and less volatile cash flow profile. Gross debt and leverage are higher than Valaris and Nabors is subject to meaningful near- and medium-term refinancing risks. CGG, an offshore seismic data processing and equipment manufacturing company, is also exposed to the volatile offshore oilfield services market and also completed a debt restructuring in 2018. It has higher maintenance capex requirements than Valaris and higher expected leverage.

Key Assumptions

Brent oil prices of $85/bbl in 2023, $75/bbl in 2024, $65/bbl in 2025 and $53/bbl thereafter;

Revenue growth of 15% in 2023, 30% in 2024 followed by declines thereafter;

EBITDA margins growing to 10% in 2023 and into the low 20% range in 2024-2025 while decreasing thereafter;

Capex, including newbuilds, averaging $400 million in 2023-2025 and falling toward $150 million thereafter;

Stock buybacks of $100 million in 2023 and no dividends paid.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Sustainably stronger offshore drilling market fundamentals, including high day rates, longer contracts and growing backlog and rig utilization;

Track record of conservative financial policy that keeps gross debt in check;

Midcycle EBITDA leverage below 2.0x.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Deteriorating market fundamentals such as decreasing day rates and offshore rig utilization;

Significant increase in gross debt;

Weakening liquidity;

Midcycle EBITDA leverage above 3.0x.

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Sufficient Liquidity: Valaris pushed its debt maturity from 2028 to 2030 with the bond refinancing. The company's combined negative FCF, including capex and working capital cash outflows, will reach $400 million in 2023-2025, according to projections. This can be covered by $724 million of cash at end-2022 and the $375 million long-term committed RCF. Valaris should have sufficient liquidity if it maintains a disciplined approach to discretionary cash spending.

KEY RECOVERY RATING ASSUMPTIONS

The recovery analysis assumes Valaris would be reorganized as a going-concern (GC) in bankruptcy rather than liquidated;

Fitch has assumed a 10% administrative claim.

Going-Concern Approach

Valaris' GC EBITDA estimate reflects Fitch's view of a sustainable, post-reorganization EBITDA level, upon which the agency bases the enterprise valuation. The GC EBITDA assumption for commodity price sensitive issuers at a cyclical peak reflects the industry's move from top of the cycle commodity prices to mid-cycle conditions and intensifying competitive dynamics.

The GC EBITDA assumption of $155 million equals EBITDA estimates for the mid-point between a distress year and near-term EBITDA expectations. This represents an emergence from a prolonged commodity price decline. Fitch stress case assumes for Brent oil prices are $45/b in 2023, $35/b in 2024, $45/b in 2025 and $48/b for the long term. These prices could lead to a marked difference in the company's cash flow generation given the impact a period of prolonged oil prices could have for day rates and rig utilization.

The GC EBITDA assumption reflects a loss of customers and lower margins than the near-term forecast, as E&P companies cut their costs. The EBITDA assumption also incorporates weak offshore drilling market fundamentals and Valaris' charters to Aramco, as well as overall high rig supply, but improving demand.

The assumption reflects the material decrease in the company's liabilities as well as the material write down in the value of the company's PP&E following the company's debt restructuring. Valaris eliminated $7.1 billion of pre-petition debt from its balance sheet after exiting bankruptcy procedures in 2021. During the restructuring process, the company also wrote down the book value of its PP&E from $10 billion to approximately $900 million.

An enterprise value multiple of 5.0x EBITDA is applied to GC EBITDA to calculate a post-reorganization enterprise value. The choice of this multiple considered the following factors:

The historical bankruptcy case study exit multiples for peer energy oilfield service companies have a wide range with a median of 6.1x. The oil field service sub-sector ranges from 2.2x to 42.5x due to the more volatile nature of EBITDA swings in a downturn.

Fitch used a multiple of 5.0x to estimate the enterprise value of Valaris due to concerns of a downturn with a longer duration, a high exposure to offshore drilling rigs that can see meaningful volatility in demand and continued capital investment to reactive rigs.

Fitch also assumed a $50 million value from its equity stake in ARO and notes payable to Valaris by ARO.

Liquidation Approach

The liquidation estimate reflects Fitch's view of the value of balance sheet assets that can be realized in sale or liquidation processes conducted during a bankruptcy or insolvency proceeding and distributed to creditors.

Fitch assigns standard discounts to the liquidation value of the company's ?ash, accounts receivable, and inventory. Fitch is using a 30% liquidation value to the company's book value given the high uncertainty of assets valuations during a downturn.

The $375 million first lien secured RCF is assumed to be fully drawn upon default and is the most senior in the waterfall.

The allocation of value in the liability waterfall results in recovery corresponding to a recovery rating of 'RR3' for $700 million second lien secured debt issuance.

Issuer Profile

Valaris provides offshore drilling services to oil and gas companies across the globe. It owns the world's largest fleet of offshore rigs, including jackups and floaters. Valaris is incorporated in Bermuda and headquartered in the U.S.

Date of Relevant Committee

10 March 2023

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

ESG CONSIDERATIONS

Valaris has an ESG Relevance Score of '4' for Waste & Hazardous Materials Management; Ecological Impacts due to the risk that a possible offshore oil spill may affect the drilling company. This factor has a negative impact on the credit profile, and are relevant to the ratings in conjunction with other factors.

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.

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