Investors Should Expect This From Transocean

| About: Transocean Ltd. (RIG)


After having been slammed as oil prices fell and after seeing contract cancellations, Transocean has a dangerous quarterly release coming up that could harm it or help it immeasurably.

In this release, there are two things that I think the company should address (and has a decent chance doing so).

One of these relates to continued moves by management to reduce the company's cost structure.

The other is a plan that could help to reduce leverage by buying back debt on the cheap, something the company is in a position to do right now.

After the market closes on February 24th, the management team at Transocean (NYSE:RIG) is due to report revenue and earnings for the company's fourth fiscal quarter for 2015. Heading into this uncertain time, shares of the business have dipped meaningfully lower, driven by a combination of contract cancellations and the fear that low oil prices may worsen the business's financial standing in the long run. In a previous piece, I highlighted how the company's strong liquidity position leaves investors with attractive prospects to consider, but no amount of liquidity in such a poor environment can solve the company's problems if management does not how results that will improve the business's chances of success down the road. In what follows, I will dig into what analysts expect for this quarter and highlight, more importantly, what I think investors should hope for moving forward.

Analysts have low expectations

For the quarter, analysts don't expect much from Transocean. For the company's fourth quarter, they anticipate that revenue for the offshore driller will come in at $1.43 billion. Although this is a nice chunk of change for people like you and I, it represents a significant departure from the $2.24 billion the company reported for the fourth quarter of its 2014 fiscal year. To put this in perspective, this drop would represent a decline of 36.2% year-over-year and would come as more and more rigs are stacked or idled thanks to the non-renewal of contracts, combined with outright cancellations. Seeing as how the company delivers fleet status reports that show things on a rig-by-rig basis, I'd say analysts will probably be right or very close to it for the quarter.

On the bottom line, the picture is likely to be bad as well. For the quarter, analysts expect Transocean to report earnings per share of $0.71 on a non-GAAP basis. This compares poorly to the $0.95 in earnings reported just a year earlier but this, too, is non-GAAP. Actual earnings per share in the fourth quarter of 2014 came out to a loss of $2.04 because of a large non-cash impairment charge and I would imagine that some sort of impairment charge will take place this time around as well. On a non-GAAP basis, however, I wouldn't be surprised if Transocean beats expectations because of the company's history of strong cost controls.

Investors should expect costs to fall moving forward

One thing that I believe investors should expect, not only for the company's fourth quarter but also for 2016, is for Transocean to continue to see a decline in its cost structure moving forward. In the table below, you can see what has happened between 2011 and 2014, as well as what has taken place during the first three quarters of the company's 2015 fiscal year thus far. The results have been quite impressive no matter how you stack it.

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Based on the data provided, Transocean has cut down costs immensely. Most of these early reductions can be attributed to the company's cost-cutting initiatives while the more recent declines are driven by the fact that, as rigs become stacked or idled, the costs of maintaining them drop significantly on a per-rig basis. Unfortunately, the company's cost structure did manage to tick up during the third quarter of last year, but I suspect that the general trend should be for this number to decline, especially when it comes to operating and maintenance expenses.

Debt buybacks make sense

Right now, the amount of liquidity Transocean has on hand is significant, with cash and cash equivalents of $2.23 billion and an untapped credit facility totaling $3 billion. However, the company also has a great deal of debt ($8.75 billion) as of the time of this writing. In the image below, you can see the overall debt schedule of the company. Fortunately, a great deal of these amounts are due over a long period of time, but the business does have some debt amounts due in the near-term ($995 million alone in 2016).

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What is interesting, however, is the perception by Mr. Market relating to Transocean's debt. The general assumption is that, as time goes on (and the market believes the oil downturn persists), the probability of the company surviving drops dramatically. In the table below, you can see the cheapest debt (at current market prices) from Transocean that is available as of the time of this writing through 2020. In general, the market seems to indicate that the survival prospects of the company this year and next year are pretty good but that starts to trail off in 2018. By 2020 (there is no public debt for 2019) that falls significantly, with debt going for just $0.56 on the dollar.

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This, in my mind, presents the company with some attractive opportunities moving forward. Although some longer-term debt is trading at cheaper levels than those looked at above, the company's prospects for the next few years are likely positive (absent a material amount of contract cancellations). Because of this, the business will have to buy back debt (assuming it can't refinance, which is not likely in this environment) anyways so now may be a great time to consider jumping into this strategy. The 2020 debt with a 6.50% interest rate shown above, for instance, can be repurchased (if current rates hold, which is not likely) for $512.4 million today, representing a discount of $402.6 million a few years from now. Interest saved from this approach would total $59.48 million per year moving forward. Of course, I would not expect such a large buyback but I do suspect that some debt buybacks are likely to take place at some point.


Right now, Mr. Market doesn't seem to like Transocean but the business doesn't appear to be at any material risk of bankruptcy for at least the next two to three years. However, in the near-term, I believe there's a good chance that management will further reduce the probability of a permanent loss of capital by reducing its cost structure further and by engaging in some form of debt repurchases.

Disclosure: I am/we are long RIG.

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.

Additional disclosure: My firm's long position in the company is in the form of call options dated January of 2017, not shares