Investors Should Follow Carl Icahn's Lead On Transocean

| About: Transocean Ltd. (RIG)

Transocean Ltd. (NYSE:RIG) provides offshore contract drilling services for oil and gas companies throughout the world. The company is based in Vernier, Switzerland, and it has a market cap of $19.9 billion with a stock price of around $55.

November 11th was a big day for Transocean. The embattled deep-sea drilling contractor finally cut a deal with activist investor Carl Icahn. Mr. Icahn is the outspoken hedge fund manager that currently controls 6% of the company's shares.

Earlier this year when Mr. Icahn got involved with Transocean, he made it clear that he wanted changes. First he wanted to increase shareholder value by increasing the dividend from $2.24 per share to $4.00 per share. In the November 11th agreement, Transocean's board of directors gave in to Mr. Icahn's pressure and agreed to raise the proposed dividend to $3 a share to be paid in 2014-15.

The second change that Mr. Icahn was looking for was a change in the company's business plan. He wanted to improve the company's margins by increasing cost cuts by the end of 2015 to $800 million from a previously announced $300 million. Again the board gave in and agreed to the $800 million in cuts.

The third change that Mr. Icahn was shooting for was for Transocean to spin off some of its assets into a master limited partnership. Transocean's board of directors again gave in and agreed to launch an initial public offering for an MLP by the summer of 2014. Transocean had considered the possibility of a spinoff since 2012, after their closest competitor Seadrill Limited (NYSE:SDRL) floated a partnership in 2012 which raised around $176 million.

After the November 11th agreement, Mr. Icahn said "I am especially happy about the commitment to pursue an MLP, raise the dividend and increase margins by $800m through cost cutting and increased efficiency. I believe that Transocean is now on the road to realise its great potential."

Transocean's Turnaround

Transocean, whose earnings floundered during the last two years, has now turned things around. After losing $5.76 billion in 2011 and $219 million in 2012, the company has finally moved back into the black. The company has been profitable in each of the first three quarters of 2013 during which it reported net income of $1.17 billion. The company had been struggling due to over-aged rigs, a decrease in day rates for their drilling rigs, and the consequences of its involvement with BP plc (NYSE:BP) in the 2010 Horizon oil field disaster.

Improving Earnings

When the company reported third quarter earnings on November 7th, the numbers were encouraging. Revenues came in at $2.56 billion up from $2.43 billion in the third quarter of 2012. Net income was $546 million up from $-381 million in the same quarter of 2012. The company's day rates also increased from $376,200 per day to $392,400 per day. The primary reason for the improvements was because the company was able to charge higher day rates from all classes of its rigs.

While Transocean's earnings have improved, so have those of other competitors in the industry. Noble Corporation (NYSE:NE) grew third quarter revenues by 22% and net income by 43% on a year-over-year basis, Ensco plc (NYSE:ESV) grew its third quarter revenues by 13% and its net income by 10%, and Tesco Corporation (NASDAQ:TESO) grew its third quarter from the third quarter revenues by 5% and its net income by 30% during the third quarter of 2012.

Stock Financial Analysis

During 2013, Carl Icahn accrued about a $1.15 billion ownership stake in Transocean. Presumably because he liked the company's improving financial situation which over the first nine months of 2013 included a year-over-year revenue increase of $1.4 billion and a year-over-year net income increase of $1.649 billion. During the same period, the company decreased its debt by $2.92 billion and saw its free cash flow increase by $237 million.

Conclusion

Transocean's stock performance has been mediocre, over the last year the stock price has increased by 23%. However, since the third quarter earnings announcement on November 7th and the announced agreement with the Carl Icahn group on November 11th, the stock price is up 14%. It is obvious that investors liked the company's earnings and the changes that Mr. Icahn negotiated for.

While Transocean's stock price is currently near its 52-week high, I think that it still has room for growth for two reasons:

  1. During the third quarter, the company increased the efficiency of several of its key revenue drivers. Its overall revenue efficiency increased to 94% and its specialty Ultra-deepwater rigs had an efficiency rating of 92.5%. Also its fleet utilization increased to 83% up from 80% in the prior quarter. In addition, the $800 million reduction in cost will increase margins and drive up profits. Looking to the future, the company will not lack for business as it has $29.8 billion in backlog orders. With its increasing efficiencies and backlog of orders, Transocean's earnings will continue to increase.
  2. As a result of the concessions that Carl Icahn secured, Transocean's stock has become more investor friendly. In six months, Transocean's dividend will increase by nearly 34% which means that at the stock's current price the yield would be about 5.5%. Also the proceeds from the mid 2014 spin off of the master limited partnership will be substantial and will allow Transocean to pay off debt and pay dividends.

With the prospects for higher earnings, along with the increase in the dividend, it is reasonable to believe that Transocean's stock price will reach $75 within the next 12 months.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.