An Ignoble Spinoff- Noble’s Insolvent Spinoff No Paragon Of Virtue

Last week, we noted a few examples of the ‘ugly spinoff’ phenomenon where really ugly looking spinoffs end up performing really well. These businesses often have dim growth prospects, low margins and are often initially larded up with debt or other legacy problems. Despite those challenges, the ‘bad business’ stocks often do well as the companies finally have dedicated management and the initial shareholders are usually rather negative on the business depressing the price. There is a fine line though in spinning off a ‘bad’ business and a ‘doomed’ business and crossing that line can lead to pain, lawsuits and of course, potential penalties. Think Verizon’s (VZ) Idearc spinoff which filed for bankruptcy shortly after the spin and led to claims trying to stick Verizon with the debt. The latest accusation of spinoff malfeasance stems from the 2014 spinoff of Noble (NE) standard spec rig business, Paragon Offshore.

Paragon filed for Chapter 11 (for the first time) in early 2016 and emerged with a restructuring plan in 2017. The legacy litigation trust of Paragon Offshore is arguing that its spinoff from Noble was a ‘fraudulent corporate spinoff’ and that Noble should be on the hook for damages to creditors that got hit in the restructuring. Their argument is that Paragon was insolvent at the time of the spin and was only able to obtain financing because Noble misled creditors about the health of the company and of its customers.

Noble was ‘disappointed’ with the filing, but vehemently denies the charges and will ‘vigorously contest the lawsuit’. At least that is always the posture in the very beginning. The company insists Paragon was properly capitalized at the time of the spinoff (and even has a solvency study to back it up) and only went down in flames due to the ‘arduous business conditions’ that ensued. Although oil prices have been climbing recently, it’s easy to forget how low they sunk at the time of the bankruptcy filing. It was a difficult period for the entire industry, producers and drillers alike.

This isn’t a legal opinion (no lawyers here), but it was pretty clear at the time of the spin that Paragon wasn’t the star of the show. It was full of Noble’s older and lower margin rigs and it even took on a bunch of debt in order to pay Noble a big, fat dividend. The locations weren’t great either. We quoted the Houston Chronicle discussing the spinoff saying that ‘older vessels drag down margins and increase expenses, while the newer fleets are more technologically advanced, have more deck space, and do not have as many preparation and maintenance issues.’

Sure, Paragon was a ‘bad’ business, but plenty of those end up being spun off and having happy endings for shareholders. Was Paragon a ‘fraudulent’ spin or a doomed business though? That is up to the courts to decide now. Should be interesting to watch.

Disclosure: Author holds no position in any stock mentioned and of course, is not a lawyer so don’t take any legal advice from this blog.