Transocean Ltd. (NYSE:RIG)
UBS Oil and Gas Conference
May 21, 2013, 02:05 PM ET
Esa Ikäheimonen - EVP & CFO
Angie Sedita - UBS
Angie Sedita - UBS
Good afternoon. We are very pleased to have in our new spot lined up for the day Transocean; Esa Ikäheimonen, Executive Vice President and Chief Financial Officer of Transocean. He joined Transocean as CFO in November 2012. He has had a 22-year career in the energy sector. Before joining Transocean, he served as Senior Vice President and CFO of Seadrill from 2010 to 2012 and he has spent almost 20 years at Royal Dutch Shell in a number of senior financial positions.
Clearly, it is interesting time for Transocean as of late. The company certainly has had a lot on its plate with Macondo, Brazil, activist shareholders, raising the dividend and the start of a significant cost cutting program as well as the consideration of an MLP that further changes or positive changes are ahead for Transocean. So we are very pleased to have Esa her to give his views.
Thanks a lot and a very good afternoon to you all from my side as well. Thanks to UBS for having us here and particularly for being so flexible about our scheduling. We are forced to do some rescheduling as a result of some technical problems in Amsterdam with KLM, but it’s good to be here. My name indeed is Esa Ikäheimonen; I am CFO of Transocean since about three months ago, and has not been with the most boring six months in the history of the company as you probably know.
Before I get really started, I need to ask you to pay some attention to this disclaimer. I will make some statements that are forward-looking and they may include views on drilling industry, prospects for Transocean, expected revenues, CapEx, operating costs and results. All these statements as well as risks associated to them are comprehensively discussed in our most recent 10-K and other SEC filings; I suggest you pay some attention to those as well. Please be reminded that this is a risky business and actual results may materially differ from indications given during this presentation. With this I assume that you've been sufficiently warned and I will move forward.
In this presentation, I will give a generic overview on the company including its fleet, market position and some of the latest updates. I usually run out of my presentation time and we will see whether we've got any times for Qs&As, hopefully so at the end my presentation. And I will also cover our key strategies, most recent performance and our investment philosophy and finally I will give our perspective on the market developments before opening up for Qs&As.
Transocean is world’s largest offshore driller. It’s an industry-leader which is increasingly focused on high-spec, high capability assets. Our fleet is actively present in all markets and we benefit from excellent customer relationships with IOCs, NOCs and independents. And I will repeat this a few times, but this is a cyclical industry, therefore this diversity of assets, geographies and customers plays an important role in the success of our company. Transocean been leading the drilling industry from technology and innovation point of view and continues to invest in new technologies and new capabilities and I'll talk a little bit more about all of that during the remaining part of my presentation.
You will see fleet comparison here comparing ourselves with our key competitors. Overall, we’ve got the largest fleet in the industry. If I work from the bottoms up, our jackup business shrank considerably as a result of the recent divestment. It’s all pretty much high-spec now, so a much better platform for profitable growth going forward.
The next one up is the Midwater fleet. There are really only two large players in the industry in the attractive Midwater market that’s ourselves and Diamond. Our market share in that market is globally about 30%. And when we look at the Deepwater Floaters, we are the largest operator of high spec floaters in the world. The outlook for this asset class is particularly robust, so we believe this is the right portfolio focus for us going forward as well.
And on top, rigs in construction, and it is fair to say that Transocean somewhat missed the early part of the current newbuild cycle because of Macondo and other issues, but we still have got a very attractive new build program with eight rigs currently under construction and deliveries expected between 2014 and 2017 for all of those rigs.
Some more comments on our fleet, and when you look at this slide, you can actually see that our portfolio currently has got reasonable exposure to the strong market conditions going forward. We have got five Ultra-Deepwater units available later this year and including several rigs that we are currently in advance negotiations for with our clients. During Q1, we entered into eight new Ultra-Deepwater contracts including the Deepwater Asgard which is one of our newbuild rigs; expected to commence operations in Indonesia during quarter one next year.
We added four new contracts for our Midwater fleet in Q1 and particularly the UK North Sea part of the Midwater market is extremely attractive at this moment in time, some level of softening has taken place in Midwater market particularly as a result of developments in Brazil; I will revert to those as well later in my presentation.
Transocean have added a lot of backlog during 2010 including the four Shell newbuilds as well as Deepwater Invictus all on very long contracts; the four Shell rigs actually on 10-year contracts adding about $8 billion to our backlog. This backlog provides a lot of visibility even in the context of uncertainties relating to the market and the cyclical nature of it. A very important point here is that all of our newbuilds are actually on contracts, so we do have any rigs currently under construction that wouldn't have a contract and that obviously adds the level of robustness to our newbuild program. Our backlog is clearly biased towards Ultra-Deepwater; some 70% of the backlog revenue is tied to Ultra-Deepwater fleet. We believe this is the right bias recognizing the underlying fundamentals supporting the Ultra-Deepwater segment.
The backlog provides visibility and what I would call cycle resistance; the diversity of customer and asset portfolio provides further protection going forward. And it is expected that the importance of the NOCs, the national oil companies and the independent oil and gas operators will grow going forward and so that's the revenue related to those clients. The shot on the right hand side shows a nice balance and diverse customer base. We are also geographically well balanced with a leading presence in all key oil and gas regions.
On the left our revenue is clearly ultra deepwater biased, but it still provides a reasonable balance through strong revenue from the other asset classes including the conventional deepwater as well as the midwater asset class, as a result of recent divestments the importance of the jackup asset class has reduced considerably.
Resolving our contingencies has been a major focus area for Transocean particularly as a result of the Macondo incident in 2010. We have made significant progress in resolving our key liabilities and removing the overhang associated to them.
This slide here includes the three key areas that we've been focusing on and clearly the Macondo issue is the major one. Just to update you briefly on the developments regarding the Macondo incident and associated liabilities, already during 2011 and 2012 we received several positive rulings regarding our liability under the existing legislation that's primarily the Oil Pollution Act and the Clean Water Act OPA and CWA and on our contractual indemnity with BP.
In January this year, we reached a major milestone through a settlement with the DoJ on civil and criminal liabilities. The remaining liabilities are on trial as we speak, the first phase of the trial concluded some five weeks ago. The major focus of the Phase 1 was to determine the events and the responsibilities leading to the blowout and the emphasis was on should I say actions and inactions by relevant parties including Transocean to determine the responsibilities for the blowout. Phase 2 is scheduled to start in September and this part of the trial will focus on the quantification of damages and the allocation between parties. For the remaining liabilities that are not covered by the DoJ settlement. We remain open to reasonable settlement but in absence of a reasonable settlement, we will continue to litigate with competence in our case.
The other case here that is listed on this slide has to do with the Frade incident in Brazil. We are making progress and this one is moving forward as well. The criminal case was dismissed. So there is no criminal case against any Transocean entity or any employees of Transocean any longer, but the company remains a defendant in the civil case. This incident has had no impact on our operations any longer. And finally, the Norway case is really all about reviewing the tax planning undertaken by the company, some 10 to 12 years ago and we are making good progress there and continue to believe that our tax filings were materially correct and the interpretation of the law and taken by the company at that point in time was robust and was in line with acceptable practices as well as the legislation at that point in time.
Few things about our recent focus and objectives; for the last 18 months or so, the company has been really focused on a handful of key objectives. One of them very clearly and very importantly has to do with improving our operational performance. Second one has to do with executing our asset strategy. We have also been further developing and updating our financial strategy and capital allocation philosophy; obviously very heavily debated as part of the situation that led to our AGM last Friday. And finally as I said earlier, we have been focusing on resolving our key uncertainties such as Macondo. As I already covered Macondo, Frade and the Norway Tax case, I will focus on the first three of these strategic objectives during the next few slides.
Company has continued very systematically to improve its revenue efficiency to reach and sustain a level of 95%. During the second half of last year, Transocean almost reached the level which obviously was very encouraging and demonstrated that the efforts taken and the improvements put in place were starting to deliver. Company has been saying continuously that it's not a linear process. And we saw that during the first quarter of this year when we achieved only a disappointing 88% efficiency. This was partially impacted by events out with Transocean’s control such as the downtime related to the defective boats. But it still remains to be a volatile development and clearly the need for further improvements and further stability was outlined by the performance in first quarter this year.
We are also continuously improving our out of service time. We have clearly put the basics in place already and now it’s the time to shorten the period it takes to execute our out of service time. This is a key component of our margin improvement program going forward and I will mention a few things about that. We have also stepped up our efforts to cut our operating costs. The first step is to reduce our shore based expenses by approximately $300 million by 2015, and as you might have seen from our recent disclosures and might have heard during the first quarter call we anticipate that about $200 million of those savings will already materialize during next year and then from 2015 onwards we will have matured our cost saving program and therefore you should expect to see at least $300 million on an annual basis reduction on our shore based costs in comparison with 2012. That is a considerable reduction. It is a very challenging target, but we are very committed to deliver that and actually very convinced that we will be able to do that.
Currently looking at ways to accelerate the savings already, so it’s going very well and there's more to follow when it comes to our cost cutting program. This is only the beginning, this shore based cost reduction. We've got another $5 billion to address as part of our offshore cost, the real rig related expenses. So there's a lot more opportunity for optimization and improvement of our cost performance as well as the margins and eventually the bottom lines of Transocean.
I already mentioned a significant performance improvement from 2011 to 2012. This slide provides some further details as to how significant that improvement was. It was very considerable and obviously added a lot to our earnings in 2012. Company is clearly on the right path and will continue with urgency. We are not satisfied yet but the direction is right and I have to repeat what I said earlier, the development particularly when it comes to revenue efficiency will not be linear going forward but as I said we are moving to the right direction.
I will move on to our capital allocation philosophy. As I said earlier that was heavily debated as part of the proxy challenge and I would like to just repeat the key elements of that philosophy. Firstly this is cyclical and capital intensive business. As such it requires a strong flexible balance sheet that is not only a luxury, but it’s also a competitive advantage. And it’s also a necessity for a company such as Transocean still facing considerable uncertainties such as Macondo. The other element of our capital allocation strategy or philosophy is the continuous high grading of the fleet through reinvestment that really is an absolute must for an offshore driller. Divestments or selling down non-core or lower spec assets is clearly a part of this high grading. I would revert to that in a moment in a little bit more detail.
And finally, returning capital to shareholders is something Transocean has always done. There is no intention to spoke that. Question recently has been about the timing and the right level to start at. All this and the $2.24 per share dividend received an overwhelming support from our shareholders at the AGM on Friday.
I mentioned the strong balance sheet, investment grade rating obviously provide us with ongoing access to credit as and when it may be needed. We have successfully increased our financial flexibility on future options through building our new rigs on contract, essentially customer providing financing or at least underwriting it. We've also continued to divest lower spec commodity assets, not only for the cash flow but also for the structural improvements it brings along in order for us to improve our profitability going forward and we have as I said also significantly de-risk Macondo through the settlement reached in January this year.
I also mentioned the necessity to continuously reinvest in new capacity. This is really the only way to ensure longer-term competitiveness for anyone in this industry and I emphasize longer-term competitiveness over a shorter period of time, reinvestments may not be necessary but with the longer-term perspective, it's very difficult to argue against a well thought through reinvestment program.
We have been successful in doing this without adding speculative capacity to the market and we continue to prefer customers underwriting our investments rather than ordering a new capacity on a speculative basis.
In this industry acquisitions remain opportunistic. Best way to prepare for this is really to ensure sufficient financial flexibility and ability to take advantage of opportunities that (inaudible) will present themselves. That is clearly a part of our investment strategy and part of our fleet high grading approach going forward, but only as and when acquisitions do make sense from portfolio high grading perspective as well as from valuation perspective and only as and when they provide economics that are comparable or better than the newbuild opportunities.
Transocean’s asset strategy is fairly simple. Its asset strategy drives our investment. This drives our newbuild and this drives any potential acquisition that we might consider. The strategy in all simplicity is actually to high grade the portfolio and to focus on modern high spec rigs.
That includes growing our leadership position in ultra-deepwater and harsh environment. It also includes growth in high spec jackups. As I said earlier, the size of our check-up business currently is not where it should be and therefore part of our asset strategy is to look for ways to strengthen that position.
At the same time we are continuously looking for opportunities to reduce our exposure to low-spec commodity assets and that has led and will lead in the future to divestments and selling down of non-core assets that we don't see belonging to our longer-term portfolio.
Regarding the asset strategy, as I mentioned Transocean has been and is still reluctant to add speculative capacity to the industry, an example of an opportunity to grow without relying on speculative market conditions is the four rig package agreed late last year with Shell. These rigs under construction currently are the latest news in ultra-deepwater capability. They add almost $8 billion to our backlog and a 10-year contract with Shell provides some 1.5 times simple payback on the investment. And these all with no need to speculate how market rates fluctuate and where in the cycle we will be in three or five or 10 years’ time.
Although Transocean somewhat missed the start of the current newbuild cycle as I said earlier particularly as a result of the Macondo uncertainty, it still has six ships and two jackups under construction and that newbuild program is one of the largest newbuild programs in the industry as we speak, but as I've said earlier we look continuously for ways to increase that part of our portfolio in line with our asset strategy but only as and when our economic criteria are met.
On the divestment side, the company has sold a total of 57 non-core rigs in the last two years, very significantly that includes the 38 rigs sold to Shelf Drilling. There were all standard jackups. I'm hesitant to say lower spec jackups, but the package of older assets that we didn't see fitting into our longer-term asset portfolio at all and therefore it was a divestment that was fairly easy to justify.
All this has significantly shifted the fleet towards the goal of high grading the fleet and only operates high-spec non-commodity assets going forward and it has clearly reduced the exposure to commodity class assets. It has reduced our exposure to bifurcation, particularly in the jackup industry as well as outright displacement of rigs that are no longer favored by our clients.
No doubt the remaining fleet is much more competitive than what was the case a couple of years earlier, it’s much more [mixable] longer time and provide a much stronger platform for profitability improvement going forward. We are structurally in a lot better place than we were a couple of years ago and that is a very important development that has taken place recently.
Our asset strategy is also aligned with our capital allocation philosophy as I tried to mention earlier and we remain on course and will continue to execute the asset strategy without any major changes to it. We think this is the right strategy for Transocean and we are committed to continue with it.
Finally, some more thoughts about the markets, I start with the ultra-deepwater market because clearly we've got quite a strong bias towards that marketplace given our emphasis on operating and owning ultra-deepwater rigs. Ultra-deepwater continues to look strong. Recent exploration successes are very encouraging with high volume discoveries in different parts of the world.
Demand in the near-term is clearly driven by Gulf of Mexico, West of Africa and East Africa activity but also several other emerging markets provide further stimulus to ultra-deepwater.
We believe that the current strong demand and also anticipated strong demand growth in the ultra-deepwater will be able to absorb the additional newbuild capacity currently under construction. It's a very significant additional capacity being buildup as we speak, but at the same time the fundamentals of the ultra-deepwater demand are very strong as well.
Some of the lower-spec ultra-deepwater units will have to compete down and earn a lower day rate than $550,000 to $600,000 day rate level that we see continuing this market. A couple of our recent fixtures show the rate level. For instance, the Deepwater Millennium had $605,000 a day. Our most recent fixture as well as Cajun Express had $600,000 a day, very strong fixtures with attractive day rates and very attractive contracts for Transocean.
If we look at the other markets, the conventional deepwater market, the midwater market and the jackup market, the conventional deepwater rates recently have been around $450,000 to $500,000 a day, with West Africa and Australia the key markets for Transocean. Midwater market is very tight particularly in the UK side of the North Sea and the day rates have reached historic high level in the UK sector. Our recent fixtures include Sedco 714, the Artic, the Prospect and John Shaw all in excess of $400,000 a day, which is a level pretty much at an all time high level for midwater rigs. Jackup market looks very attractive as well very high utilization and positive prospects going forward. That has led us to conclude that there is a strategic drive for Transocean to further improve its position in the high spec jackup market.
I get back to a summary that I pretty much started with; Transocean continues to lead the industry. It is the largest player in the offshore drilling space. We believe we have got the right strategies when it comes to improving our operational performance. We believe our capital allocation philosophy has been tested as part of the proxy challenge and confirmed correct by our shareholders, and we firmly believe in our asset strategy that will deliver results going forward. The market is strong; there is no reason to be too negative about the market irrespective to the fact that a large additional capacity is going to enter it. And we’ve got a very strong backlog of contracts that provide visibility going forward.
With that I open up for Qs & As that’s assuming that we have got some time left free.
Angie Sedita - UBS
I can start it off, you mentioned assets and upgrading, continuing to upgrade the fleet. Would Transocean as a whole look for one-off acquisition and assets or could you consider a larger company to company merger.
Yeah, we don't have a particular preference; our preference is simply driven by our asset strategy. So we look for the right fit, so we look for the right asset, that's the most important part. The second most important part is the valuation. So obviously whatever we acquire will actually have to meet the test and provide acceptable returns. Thereafter we are open to acquiring single assets, we are open to build new build assets and we are open to buy larger packages. Typically the problem with larger packages and corporate acquisition is that you get what you get, so you get the good stuff and you get the not so good stuff and that's why the bias is more towards kind of bolt-on acquisitions and we've been very selective in terms of what assets you want to add to your portfolio. The last thing you want to do is buy a couple of attractive assets and a whole bunch of not so attractive assets which will basically increase the challenge that you've got in pruning our existing portfolio.
Angie Sedita - UBS
And then given new Chairman of the Board changes within the Board, do you think that and obviously your history at Seadrill that the Board and management will revisit building rigs on spec and you were talking about high spec jackups being an interesting markets to continue to expand. But do you think that's more seriously they could reconsider that decision that they have made that's been unique in this industry today.
Yeah, as far as I know and I'm quite new to Transocean I'm not sure whether there's a formal decision on this one, there's just a strong preference which I think is quite understandable. This is a supply and demand industry and adding capacity is always a bad thing in theory at least; of course you have to replace the fleet and you have to provide clients what they want, but in principal adding capacity is not necessarily beneficial to the supplier. So there's a strong justification for that bias. There's no formal decision just the preference. New Board is very alike the old Board. There are two new members and there's one member that has left. I don't expect that to have a wholesale change to the way we look at this world and the way we think about adding supply to the industry, but this is a topic for an ongoing discussion as part of our ongoing development of the asset strategy and we will discuss our investment plans almost every single time we meet with the Board and the discussion continues. But currently the preference is unchanged and of course the new Board is very new Board, so it was just basically elected on Friday. Time will tell whether there are some new ideas and new preferences, but that's currently what we believe is the right one for Transocean.
Angie Sedita - UBS
I'll ask another on the MLP. Obviously Seadrill considered an MLP, (inaudible) what's your feeling so far on the Board interest on considering an MLP, just still just casually looking at it or do you think the interest is more sincere and where do you think you are in the stages of deciding whether it's the right opportunity for Transocean?
Yeah, the Transocean Board is a very serious board. So they don’t just casually look at things. When we look at some thing like an MLP, we look at it seriously and that’s what we also said, I think two and half months ago and we reported our Q4 results. And I pretty much repeated the same as we reported Q1. We have spent a considerable amount of time in evaluating the MLP, the do-ability of the MLP, the way would fit in to our capital structure going forward and we see lot of good things and we see a lot of not so good things. If I focus a little bit on not so good things, it's going to be very complicated. Seadrill MLP is complicated, Transocean MLP would be complicated. Anybody in the drilling industry doing an MLP would find it extremely complicated and also a little bit exposed to potential changes in tax treaties. Now I don’t want to go in to the details, but all I want to say, it's complicated, not straight-forward.
The future of an MLP in a drilling type industry which is cyclical by nature is very uncertain. So it's very difficult to anticipate as to how the drilling MLP would fare through the cycles let alone the fact if the cycles are compounded with a significant change in the interest rate environment. So the longer-term viability of an MLP for a drilling industry is obviously something that we are still looking in to and trying to make sure that we understand it fully and we understand the potential consequences.
So what I am saying is that MLP is still work-in-progress for us. We’ve got an ongoing engagement with the Board and that was the old Board and that the same continues with the new Board. And when we are ready to conclude, we will conclude and communicate accordingly.
Angie Sedita - UBS
I will ask one more and then I will put it over. On the midwater you touched on the Petrobras change in demand to some degree, do you think that existing rigs could risk some in the industry not I am sorry Transocean, but in the industry could risk being restack or some rig pressure given the change demand out of Petrobras for midwater?
Yeah. I think short term it’s obviously not a positive development. Midwater is a bit of a mixed bag, the North Sea midwater market is extremely tight. Unfortunately, the international midwater rigs are not fit for purpose for the North Sea conditions and therefore you can't simply just take a rig out of Brazil as and when Petrobras releases it and take it to the UK sector. So it doesn’t happen, you have to reinvest quite significantly and upgrade rigs for that purpose.
Luckily Arctic I which is one of our midwater rigs released out of Brazil is actually capable of operating in the UK and we are currently negotiating a potential contract for that rig to get back, but short-term implications potentially a little bit of downtime in between contracts, medium-term we believe we will be able to get those rigs back into work with very minimal downside. As a matter of fact actually getting a midwater rig from Brazil to the North Sea is not necessarily a negative thing because the North Sea day rates are very attractive.
You’re talking about your presentation saying that drilling is cyclical and you kind of like the diversification geographically and (inaudible) different of rigs, but what are your thoughts on contracting a business model where you kind of have more focused entities with harsh environment rig, ultra-deepwater rig, jackups and separate entities versus let me say this entity where you have diversification, how would you think along those lines?
No, it’s a very good question actually and I don't think there's only one model that works, so it can be very harsh environment biased and succeed really well. I think given where we start from which is that we've got a global footprint, we've got global operations, we've got global capabilities and global organization. This diversification of geographies, clients and asset classes work very well for us. A part of that by the way is that we are a leading operator in the harsh environment area so you get a little bit of both quite honestly in this framework, but it’s not my intention to say that the pure-play model wouldn't work for somebody else.
Angie Sedita - UBS
Any other questions? All right, we want to thank Transocean and Esa Ikäheimonen for being here this morning/afternoon. Thank you again.
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