Northern Drilling
Peter Bremner’s main goal should be to keep the business with Noranda while successfully winning both long-term specialized jobs for Mond Nickel Contract and buying 8 drills.
The Company
Northern Drilling is a profitable company (Exhibit 1). It was able to decrease its debt/equity ratio from 19,33% to 3,65% within one year (Exhibit 2) and at the same time managed to grow not because of its debt but because of its operations which underlines its financially sound condition. However, Peter Bremner is an ambitious person with a long history in the industry and he wants to secure Northern Drillings future growth.
Mond Nickel Contract
Because of the highly competitive Canadian exploration drilling industry especially for less profitable routine work, Northern’s growth strategy is to focus on long-term specialized work. A strong support for this strategy is, that Peter’s company has no further capacity in the deep diamond drills, however for all drill types the company only has a utilization of 75%. Therefore, the Mond Nickel Contract is the perfect opportunity to increase its infrastructure for and exposure to specialized work. Moreover it’s a great opportunity to diversify the company’s revenue sources. Currently, Northern is highly dependent on the revenues of Noranda Nickel (Exhibit 1). When comparing the different NPVs of the different options (Exhibit 3-6) and the respective income statements (Exhibit 7-10) assuming a depreciation of 10 years and a tax rate of 30%, the first important point is that financially not all of the projects make sense, with the 20% hurdle rate Northern benchmarks investment decisions. Taking these financials into consideration, only the projects where he renegotiates with Noranda Nickel and diverts 4 drills away from Noranda’s exploration sites and uses them on the Mond Nickel contract would make sense. However, Peter Bremners company is in a position to increase its usual GM of 30% and make some of the other options financially attractive as well. The two main reasons for this are:
1: He has a competitive advantage over the other competitors. Orbit is known to be a discount contractor. It lacks the technical experience and because they are a low price bidder it has probably not the financial resources and stability Northern possesses to bid for such a big project. Boart has previously lost its contract with Mond so that with its recent management issues and underperformance does not pose a serious threat to Northern. The competitive advantage over Major is that they will have a lower price because our cost basis should be lower since Northern is much smaller and do not have the overhead Major has.
2: There is no issue in sharing information between competitors in this industry. It is plausible that the real competition in this industry is to secure the drilling rights. Mond will contact Noranda and they will not only talk about the quality of Northern’s work, but also about it’s pricing. If Northern bids aggressively and perhaps even deviates from its 20% hurdle rate to get the contract, Noranda will reevaluate their relationship and ask herself if this relationship really was that good to begin with. The consequence would be that Northern sets itself up for a price battle with Noranda in the future risking the high margins on those specialized projects on which the company’s growth strategy is based or even the good relationship with Noranda as a whole.
As can be seen from reviewing the Income Statements (Exhibits 11-13) and NPV calculation (Exhibits 14-16) both the cases where Northern only wins the deep job and buys new drills for it and the case for winning both intermediate and deep job with all new drills have a positive NPV by increasing the bidding price by 3% resulting in a GM of about 32%.
Why should they increase the GM and bet on the option with the lowest NPV?
Even though the option in Exhibit 14 with an increased GM has a positive NPV, it is the option with the lowest positive NPV. Yet, it is the option Northern should aim for. The Mond Nickel contract is the chance for Northern to establish themselves in long-term specialized work and become a premium drilling company. One of the biggest competitors in the area Boart is struggling. It is a great opportunity to build a good relationship with Mond Nickel for potential follow up contracts, for what Bremner is known for. The improved infrastructure with experienced employees and new machinery would put Northern into a good position to pursue other complex jobs in the future. The Mond project is also a perfect opportunity to train new inexperienced drillers for those future jobs. Finally, it is a perfect opportunity to get a higher market share in the Canadian market. At the moment they are only at 4% (Exhibit 18). With the Mond Nickel contract their market share would increase and Northern will be even more likely to be considered in future RFPs of different companies.
Why buy new drills?
Although the contract with Noranda Nickel is up for renewal at the end of the year, it is very likely that Noranda Nickel will need exploration drilling in the immediate future. It is a company that is operating in an industry where the average output price has gone up by more than 300% (Exhibit 1 Original Case). Moreover, they are in a capital-intensive industry with high fixed costs and it is very unlikely that Noranda will not want to change something about their current excess infrastructure. Bremner should further explore the good relationship with Noranda and be able with his team, which by now is trusted and liked by Noranda, to accommodate Noranda’s future exploration efforts immediately when needed. Finally, if they will not do it, they will be in the same position every time a RFP opportunity comes along. They have to commit to their growth strategy and with Boart struggling, now is the time.
Financially and operationally feasible?
One important factor is, if awarded Northern needs to fulfill the contract on time. If you have a closer look at Exhibit 17, which calculates the number of days Northern has in excess to complete the contractual meters, Northern has a comfortable error buffer to complete the required meters per year for the Mond Contract. Moreover, the Net Profit in each of the options (Exhibits 7-13) leaves a margin of error if the employees make a mistake and the drilling will take more shifts/days than theoretically calculated. Therefore it is highly probable that no matter what job or jobs Northern wins they have a sufficient cushion to manage a delay in drilling both financially and operationally, while still fulfilling the contracts requirements.
As previously mentioned, Northern is a financially sound company. A benchmark or information about the competitors financials is not given, however, it can be concluded that in such a capital intensive industry, Northern has a very low level of debt and would not be harmed if it took on more debt to finance the Mond investments. In fact, as can be seen in Exhibit 20, its debt ratio in the case of fully financing 4 newly bought drills would be at 18%, even lower compared to Dec10A. In case of financing 8 newly bought drills (Exhibit 19) the ratio will raise to 33%, which considering the capital-intensive industry is still quite low. However, Northern can use their high amount of current assets to pay for the investment and still have a comfortable current ratio not putting in danger Northern’s ability to cover their current obligations by its current assets (Exhibit 21-22). Thus, bidding for both projects and buying 8 new drills is also supported by the sound balance sheet.
Operational Challenges
Operationally there are two major challenges Northern has to deal with. In order to fulfill both jobs, Bremner needs to hire 24 new qualified workers that are experienced in drilling as deep as the Mond Nickel contract requires. Peter Bremner is an excellent manager. Within just five years he managed to get the company where it is today. And even within the difficult climate the industry is in at the moment, he managed to increase its revenues by 25%, which might have also entailed hiring new drillers, while other major companies are struggling. This makes me believe that while it is very ambitious, Peter Bremner with his contacts, with his expertise and corporate culture he established at Northern, would manage to get 24 additional experienced hires, especially considering the long-term contract of Mond Nickel on the horizon. Bremner could for example try to poach some experienced drillers from the struggling Boart company. Even though it is a risk to hire the employees before he is awarded the job, he has to take it in order to have a very competitive proposal for Mond and lessen the fact that this job entails drilling deeper than Northern is used to. Considering their strong financial state and growth strategy it is a risk worth taking. Moreover, the procurement of the new drills will be a challenge. Those drills are quite complex and therefore the corresponding delivery time should be taken in to account. But considering the time buffer (Exhibit 17) of 189 days in the first year, it is not a serious problem so that Bremner can wait to start buying them until they are awarded the contract.