Transocean/GlobalSantaFe Deal Leaves Investors Speechless

How hungry are investors for profits? Monday's merger between Transocean Inc. (RIG) and GlobalSantaFe Corp. (GSF), two offshore oil and gas drilling companies, shows that investors are ravenous.

The deal does not give shareholders on either side a premium for their shares. Instead, it monetizes part of the two companies' back orders of drilling contracts to 2015 -- worth a combined US$33-billion--and has handed both shareholder groups nearly half of that value in the form of a special dividend. That's right: Shareholders are getting a total of US$15-billion of the merged company's future cash flow for the next eight years, the money coming from a bridge loan from Goldman Sachs Group Inc. and Lehman Brothers Inc.

Talk about a no-lose deal. If oil and gas prices plummet, and drilling activity dries up, investors will already have been compensated with the cash that would have been earned if the drilling activity had remained active. In an environment where mergers and acquisitions are booming, this one stands apart for its ability to leave investors speechless. In fact, judging from the trading activity following the announcement of the deal, investors are ecstatic about the terms. Transocean, GlobalSantaFe and a number of other offshore drilling stocks hit record highs Monday.

"In our opinion, investors have been clamoring for this type of transaction, and will enthusiastically applaud the deal," said Mark Urness, an analyst at Calyon Securities, in a note to clients. "We expect other offshore drilling companies with large contract backlogs to contemplate similar transactions," he said, pointing to Diamond Offshore Drilling Inc. (DO), ENSCO International Inc. (ESV) and Noble Corp. (NE).

Monday's deal also puts strategic buyers back in the M&A fray, after being essentially sidelined recently by private-equity firms looking to take firms private and spin them off at a profit somewhere down the road. Strategic buyers are looking for things like corporate heft and the ability to reduce costs through better efficiencies.

"We've always had strategic mergers, but in the past couple of years strategic buyers have been unable or unwilling to pay the prices that private-equity players have been paying," said Brian Pukier, a partner at Stikeman Elliott. "But that's partly because private-equity players have had an abundance of relatively cheap capital with which to make acquisitions."

That is changing. Borrowing costs are up -- and a number of recent private-equity deals, involving the sale of billions of dollars of high-yield debt, have seen their debt offerings rejected by investors. This has made these takeovers more difficult to finance and makes future deals trickier to arrange.

Even though the deal between Transocean and GlobalSantaFe directs a huge chunk of its future cash flow to investors, it does not use new debt to finance the special dividends.

Robert Lehodey, a partner at Osler, Hoskin & Harcourt, said the strategy of selling mergers by distributing cash to shareholders appeals to a wider spectrum of investors in part because cash is easy to understand and value. Another reason? In today's M&A frenzy, which has driven up stock prices to record levels, a less-than-spectacular takeover offer is likely to be met by indifference from investors. They are hungry, and they are being fed.