Financial Engineering At Transocean

| About: Transocean Ltd. (RIG)

Summary

In this piece I decided to look at not only recent balance sheet maneuvering performed by Transocean's management team but also at its just-announced debt deal.

In essence, the management team at the firm is using its contracted ships as collateral for debt and the interest rate on that debt keeps falling with each issuance.

What management plans to do with this debt is something we need to wait and see but it's clear that its large cash position is a positive.

I continue to like what I see with RIG and believe that this will likely bode well for the business in the long run.

On November 29th, news broke that Transocean (NYSE:RIG), a large and world-class rig operator, priced another set of notes that it intends to use toward its capital expenditures. This follows a trend being developed wherein management has been playing with the company's books in order to improve its financial condition during this tough energy environment. In what follows, I will dig into these improvements and give my thoughts on what it means for the business and its investors moving forward.

A history of financial engineering

Over the past few months, the management team at Transocean has been working on refinancing certain debt and fighting to delay large cash payments in order to save itself during this energy downturn. In addition to negotiating with the shipyards it has working on its newbuilds to have some of its projects delayed, the company, in July of this year, decided to tender up to $1 billion worth of its Senior Notes.

As part of the transaction, the firm ended up redeeming $942.93 million worth of Senior Notes in exchange for $845.25 million of cash. This saved principal of $97.68 million compared to if the firm had waited and paid off the notes as they came due. Of these notes, $343.96 million was expected to come due in 2020, $464.20 million should have come due in 2021, and the remaining $134.76 million should have come due in 2022.

However, as opposed to using some of its more than $2.53 billion in cash on its balance sheet to make this transaction possible, management instead offered up a new term loan of $1.25 billion (they received $1.21 billion net of costs and discounts associated with its issuance). While this extended the debt out to 2023 for the amount of notes redeemed, it did come at a high interest rate of 9% per year, increasing total interest expense by $55.43 million each year (nearly double the prior debts' expense).

While this deal may have been controversial, management has continued to play with its books. Earlier this year the company decided to issue another $600 million ($584 million net of costs and discounts) in secured notes, using its Deepwater Thalassa vessel as collateral, with an interest rate of 7.75%. This is a little better but still somewhat high. According to the firm, the issuance is for the purpose of paying, in part at least, for its construction of the Thalassa but with just $17 million owed this quarter and none due after that, it's essentially a reimbursement of cash they paid out for the vessel. What they will do with that cash has not been revealed but hopefully we see it used for other capital expenditures and/or see it used to reduce other debt.

For those interested, another venture embarked upon by management is its acquisition of Transocean Partners (NYSE:RIGP). For the sake of brevity, I will refer you to my prior article here about this transaction, where I talk about it and what it means for the firm but the basics is that it will generate additional cash flow for Transocean, add cash to its balance sheet, and increase its backlog. Due to a failure to make the deal go through earlier this year, the company's board of directors recently approved an upsized offer for the firm, granting shareholders 1.20 shares of Transocean for every shares of Transocean Partners. Given Transocean's share price of $11.02 as of the time of this writing, the deal is worth (for the shares the company doesn't already own) $262.28 million but is being done without any cash.

Management's at it again

In addition to all of these developments Transocean has gotten itself into over the past few months, the firm announced on November 29th that it is issuing an extra $625 million in secured notes. Like in the case of the Thalassa mentioned above, the transaction will use one of the firm's vessels, the Deepwater Proteus, as collateral. Also, like the Thalassa, which has backlog (if you start in January of 2017) of $1.61 billion extending through part of 2026, the vessel has backlog to support it, an amount equaling $1.63 billion (using the same method as the Thalassa).

Also like in the case of the Thalassa, the debt associated with the Proteus is essentially being used to reimburse the company for capital expenditures associated with it. With net cash coming in of $609 million (this is after costs and discounts) and with an interest rate of only 6.25%, there's a lot the company can do to maximize their options. In addition to using it for M&A activity if they see fit, they can hold onto it for tough times, allocate it toward debt reduction (I like this if they can't find attractive acquisitions), or use it to cover future capital expenditures due under its other vessels.

What's more is that they have a while before the debt is due. Management does not need to pay the debt off until 2024, giving them around 8 years before maturity. Of course, if it makes sense, they have the right to call that debt on December 1st, of 2020. This could make for a wise decision down the road if the market has recovered by then, at which time they could either use their credit facility to pay down the debt, take on lower-interest debt, or take on debt on similar terms but preferably debt that is not callable (callable rate debt tends to bear higher rates than debt that isn't callable).

Takeaway

Based on the data provided, it's clear that the management team at Transocean is very active and that's a good thing. While some of their moves may be questionable (such as their high-rate loan for $1.25 billion), many of their moves, especially lately, have been clearly positive for the company. Add to this the possibility that the market should recover over the next few years and Transocean may be positioning itself nicely for the long haul.

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: I own RIG call options that expire in January of 2017, not shares of the business