Banking on the crude rally, if there is one industry that is ready for more consolidations, it is the offshore drilling space. In this regard, the offshore drilling giant Transocean Limited RIG recently inked a deal to acquire smaller rival Ocean Rig UDW, Inc. in a $2.7-billion deal.
Shares of Ocean Rig rallied 12% post the announcement of the deal. Ocean Rig's joining hands with one of the largest offshore drillers and receiving a premium of more than 19% on its stock holdings boosted investors' confidence in the stock. On the other hand, shares of Transocean declined around 6.7%, reflecting shareholders' apprehension as the deal is likely to hurt the near-term liquidity of the company.
With Transocean obligated to pay $12.75 a share to Ocean Rig's shareholders in cash, it will shell out a total of more than $1.1 billion, which will put pressure on its balance sheet. While Transocean seems to be betting on the recovering offshore space, investors do not seem quite convinced.
Per the deal, Transocean will exchange 1.6128 shares of its common stock along with $12.75 in cash for each share of Ocean Rig. Transocean's bid represents around 19.2% premium to Ocean Rig's closing share price of $27.08 on Aug 31, thus valuing the latter at $32.28 a share. Notably, the cash-stock transaction is valued at around $2.9 billion. However, the negative net debt of Ocean Rig brings down its total value to $2.7 billion.
The deal has been unanimously approved by the board of directors of both the companies. Subject to satisfactory closing conditions, along with its shareholders' consent and other regulatory approvals, the deal is set for closure by the first quarter of 2019.
Post the culmination of the deal, Transocean will own 79% stake in the combined entity and Ocean Rig will hold the remaining 21%.
Deal in Sync With Transocean's Strategy
The deal falls exactly in line with Transocean's strategy. The Zacks Rank #3 (Hold) company has been streamlining its portfolio by exclusively focusing on deep-water floaters and tapping into lucrative growth opportunities. You can see the complete list of today's Zacks #1 Rank (Strong Buy) stocks here.
In sync with this objective, it sold 15 jack-up drilling rigs to the Norwegian offshore drilling contractor Borr Drilling last year. It also acquired Songa Offshore, which boosted its backlog, portfolio and long-term opportunities in Norwegian markets.
The latest acquisition announcement is yet another strategic move by Transocean. Ocean Rig's complementary assets and strong fleet quality will strengthen Transocean's portfolio. Specifically, the deal will add nine ultra-deepwater rigs, two harsh environment submersibles along with two additional ships under construction to Transocean's portfolio.
Notably, Ocean Rig emerged out of Chapter 11 last October, wiping out $3.7 billion of debt. Currently, the company is financially stable, comprising more cash than debt obligations. Given Ocean Rig's impressive portfolio and decent financials, it seems quite a prudent move for Transocean to acquire the former.
Ocean Rig Acquisition Creates an Offshore Behemoth
The deal is likely to further cement Transocean's position in the offshore drilling industry, with the addition of 13 drillships to the company's fleet, bringing the total to 57. It will enhance the already robust backlog of Transocean by $743 million, resulting in a total of $12.5 billion.
The strategic acquisition is expected to lead to significant commercial, financial and operational synergies, owing to the integration of asset, systems and staff. The transaction aims to reduce costs through economies of scale and the company is likely to gain annual cost savings of $70 million. The deal will expand Transocean's presence in Brazil, Norway and West Africa, placing it much ahead of its competitors in terms of number of deep-water rigs.
While the deal may adversely affect the near-term financials of Transocean, we believe that it is expected to boost its long-term opportunities and help the combined entity to penetrate the deep-and harsh-water markets more effectively.
The unapparelled fleet of the combined entity will become well positioned to capitalize on the expected market recovery, which is expected to give a new lease of life to deepwater drilling very soon.
Consolidation Picks Pace: Offshore Industry on Recovery Mode?
Being one of the worst sufferers from the crude slump, the offshore industry has been struggling since the past four years. Various major operators including SeaDrill Limited SDRL and Ocean Rig, among others, filed for bankruptcy protection last year. Low utilization rates, weak financials and stiff competition had hit the industry hard. With old contracts rolling off, the companies either had to get the rigs stacked or bear high reactivation costs and accept much-reduced dayrates. As a result, overall revenues of the company were impacted.
Amid the grim backdrop, Ensco plc's ESV buyout of Atwood Oceanics in the first half of 2017 was viewed as one of the biggest game changers for the oversupplied energy drilling industry. Transocean's buyout of Songa Offshore and Borr Drilling's acquisition of Paragon Offshore also raised optimism within the sector. Consolidations would likely lead to a less-fragmented sector offering synergy and scale benefits.
Moreover, with crude prices picking momentum of late, things have started looking up for the deepwater industry, which has long lagged behind the shale fields. In fact, offshore drilling, which was once expensive, has evolved over time and has become more economical than operating wells in the shale play.
While one does not expect the sunny days of the offshore industry to return immediately, signs of recovery can definitely be seen.
Very recently, Royal Dutch Shell plc RDS.A told Financial Times that the breakeven oil price for deepwater drilling has dramatically decreased to $30 a barrel. Also, according to Ensco, breakeven oil prices for several offshore projects are clearly less than $40 per barrel, which is significantly below the latest Brent crude price of $77.61 a barrel. Transocean expects the day rates for deepwater drilling to double by 2020.
The industry is likely to gain further momentum in the coming years on the back of rising crude strength. Sector consolidation, adoption of superior technologies, new operational systems optimization of the fleet by strategic sell-offs and acquisition, seeking profitable collaborations, among other strategic strides, will certainly boost the future prospects of the offshore drilling companies.
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Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report Royal Dutch Shell PLC (RDS.A): Free Stock Analysis Report Ensco plc (ESV): Free Stock Analysis Report Transocean Ltd. (RIG): Free Stock Analysis Report To read this article on Zacks.com click here. Zacks Investment Research