Can Transocean Survive The Ongoing Commodity Slump?

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Despite the unabated softness in the offshore drilling markets, Transocean ( RIG ) has managed to remain in the black through the last two years. The world's largest offshore service provider posted positive results even in the last quarter , exceeding the market expectations by a large margin. Yet, the company's stock has crashed to almost half since the beginning of this year, and is currently trading at around $8 per share. This is largely because the recent descent in commodity prices has weakened the prospects of an anticipated recovery in the offshore markets by 2018.

Given the gloomy outlook of the commodity markets, Transocean is taking measures to weather the ongoing downturn. Recently, the Switzerland-based company sold its high-specification jackup fleet to Borr Drilling, and turned into a completely floater-based company. While this move has increased its liquidity, it is likely to restrict the company from winning any new contracts in the short term, thereby impairing its revenues in the coming quarters. That said, the company is working towards reducing its long term obligations to enhance its capital structure. We believe that this strategy, if executed efficiently, could help the company improve its shareholders' return and its overall value. Further, being the leader in the offshore drilling markets, Transocean is well positioned to benefit from the recovery in these markets, whenever it happens.

See Our Complete Analysis For Transocean Here

Source : Google Finance; US Energy Information Administration ( EIA )

Industry Leading Position To Boost Chances Of Recovery

Due to the prolonged weakness in commodity prices, Transocean's contract backlog has declined sharply over the last two years due to the sluggish drilling demand and pricing pressure in the industry. The oilfield contractor's backlog has dropped from $23.5 billion in the third quarter of 2014 to roughly $10.8 billion in the latest quarter of 2017, representing a fall of more than 54% in the last eleven quarters. While this is a significantly low rate compared to what the company was attracting before the slump, the company continues to hold the largest contract backlog in the industry.

In addition, Transocean holds about 41 rigs in its current fleet, of which 17 rigs have been added since 2008. This implies that the company not only has the largest, but also the youngest fleet in the industry. To top this, the offshore contractor has more than 60% of its fleet (current and future) already contracted, as opposed to its competitor, Seadrill Ltd. ( SDRL ), which holds only 45% of contracted fleet. Thus, we figure that although the offshore markets continue to remain tenacious, Transocean has held on to its industry leading position due to its expertise in this space, and is likely to leverage it to win new contracts.

Source: UBS Global Oil & Gas Conference, 23rd May 2017

Sale of Jackups Could Hamper Top Line

Since the onset of the commodity downturn in mid-2014, Transocean has been forced to either sell or stack a number of its rigs in order to conserve its costs. Due to its dwindling liquidity and inability to attract new contracts, the offshore driller has recently divested all its high-specification jack-ups to Borr Drilling for a sum of $1.35 billion((Transocean Sells Jackup Fleet To Borr Drilling, 31st May 2017, This includes 10 of its existing high-specification jackups and five of its jackups that are currently under construction. The company has received cash of roughly $320 million from the deal, and will continue to operate and record the revenue from three of its jackups working in Thailand until the current drilling contracts expire. However, it has transferred the remaining financial obligations related to the five jackups under construction to Borr Drilling.

With the completion of this deal, Transocean has become a pure-play floater company, and will continue to hold its leading position in the ultra-deepwater and harsh environment markets. Additionally, the transaction has enhanced the company's liquidity position in the short term due to the upfront cash received as part of the deal. However, the decision to venture out of the jackup markets in entirety could be detrimental for the company's top line in the near term. This is because in a trade-off of these two, jackups are preferred in a low price environment since they enable E&P companies to optimize production from their existing wells and save their costs. Floaters, on the other hand, require large upfront investment for installation, and hence are unable to attract new contracts in sluggish markets. This implies that while Transocean's floaters might attract higher dayrates compared to its jack-ups when the commodity markets recover in the long term, the company will have to forego potential contracts in the short term, which could hamper its already declining contract backlogs, and revenues.

Lowering Debt Could Improve Margins & Returns

Despite being profitable for most part of the commodity slowdown, Transocean's balance sheet has remained highly levered over the years. Thus, the company has been relentlessly working towards repaying and/or refinancing its long term obligations to reduce the leverage from its books. Earlier this month, the offshore contractor announced its plans to purchase its long term debt of up to $1.5 billion, due in 2017, 2018, 2020, and 2021((Transocean Announces Cash Tender Offers, 13th June 2017)). To complete this tender offer, the company aims to utilize the proceeds from the Borr Drilling deal ($320 million) and its cash balance of $3.1 billion (at the end of March quarter).

The move appears to be a sensible one, as paring down the company's debt is the most judicious use of its excess cash. Although the company is likely to pay a premium to redeem its debt, lower long term obligations will yield interest cost savings for the company, which will boost its margins in the coming quarters. Further, even after the completion of the tender offer, Transocean will have around $1.9 billion of cash (excluding restricted cash), and a credit facility of $3 billion (unused) on its books, providing it enough flexibility to survive the prolonged downturn.

Transocean's Projected Liquidity by 2018

Thus, in the light of the above discussion, we believe that due to its expertise in the offshore drilling markets, Transocean continues to hold a lion's share of contracts in this segment, and is likely to bounce back with the revival of these markets. Further, the company is optimizing its capital structure to sustain its margins and enhance shareholder value. However, the pace of recovery of commodity prices will make or break the company's efforts to weather the downturn.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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