Size Alone Won't Be Enough for Transocean

Transocean (RIG) announced normalized 4th quarter 2007 earnings of $862 million on revenues of $2.1 billion (see conference call transcript). These are eye-popping figures from what is, after last year’s mega-merger between Transocean and GlobalSantaFe, now the largest offshore drilling contractor in the world.

Of course, when it comes to determining what the future holds for this ocean-dwelling behemoth, most observers will likely focus on the long-term demand that exists for technically capable offshore drillers possessing high-spec deepwater rigs. And with leading-edge dayrates for these opportunities in some instances approaching $600,000 per day, one would have to be remarkably indifferent to not be at least partly intrigued by the company’s prospects.

Unfortunately, lost in the discussions and analysis of the company’s combined fleet, prospects for new builds, plans for asset sales, and impacts of financial leverage will be the merger’s impact on customers, some of whom we understand were less-than-enthused to hear of the combination when it was first announced. Not only do mergers concentrate market power in the hands of fewer suppliers –- inevitably causing some providers to feel less beholden to their clients -- they can also be highly disruptive to the operations of the combining companies. As a result, customers can understandably lose confidence in contractors that are more focused on making mergers work than on meeting clients’ needs.

Yet, having independently gathered customer satisfaction data on both Transocean and GlobalSantaFe since 2004, we suspect customers might find this particular merger –- at least from a cultural and operational standpoint –- to have a little better chance of enjoying smoother sailing. This is not to say there aren’t apparent differences in the two companies' performance and culture. The old Transocean has clearly rated higher than GlobalSantaFe in terms of total satisfaction by respondents in EnergyPoint’s past surveys, driven in part by stronger marks for its equipment and technology. Transocean also rated better in deepwater and other more technically demanding applications. However, respondents saw less in the way of differences between the two in areas such as pricing and HSE.

As we see it, the real risk in this case is that the people, practices and culture that caused customers to contract with Transocean or GlobalSantaFe prior to the merger will be replaced with the kind of mediocrity and lack of focus that so often accompany these kinds of category-killer mergers. The reality is companies that acquire the size and scope of today’s Transocean need to pay close attention to the level of service, professionalism, flexibility and responsiveness they offer since most customers still prefer to work with contractors that excel in these oft-overlooked areas -- regardless of a supplier’s global prowess. One thing is for certain: if the new Transocean is to truly succeed it will need to offer customers something more than simply the opportunity to work with the world’s largest offshore driller.

Disclosure: none

Comments

[Miker1:]

I think "ocean-dwelling leviathan" would be a better fit than "ocean-dwelling behemoth", but I'm nitpicking on that one, I do appreciate the article.

As for the stock, the fact that Boone Pickens recently decided to unload RIG says it all for me, I wouldn't try to out-think that gentleman.

2008 Feb 24 10:16 PM

[long_on_oil:]

This article would apply to any company. Customer satisfaction drives successful companies.

2008 Feb 25 09:47 AM

[Yael Pipano:]

Definitely, that's why Charles Schwab is still around - CUSTOMER SATISFACTION, you can't argue with that one. And yes, Pickens knows his stuff..

2008 Feb 25 06:06 PM

[thinking ahead:]

Your focus is right and wrong at the same time. You are right about people being the most important determinant of RIG's future success. But the customer service aspect in your survey is not important. Maybe at Penny's, but not it this business. What is important is having a stranglehold on the talent needed to run these amazing platforms. That is why they bought GSF - not for the hardware (though that is very scarce too). Any customer service friction is and will be handled by contract adjustments - just like always. RIG is going to be making a lot of money for a very long time.

2008 Feb 26 11:29 AM

[Doug Sheridan:]

In response to "Thinking ahead's" comment that "the customer service aspect in your survey is not important", I respectfully disagree. First of all, you confuse customer SATISFACTION in the oilfield (e.g., is the company and its employees good at their jobs, is the company's equipment well maintained, are their operations safe, etc.) with the kind of customer SERVICE you look for at J.C. Penny (e.g.. was the chashier friendly, did they help me find what I want, etc.).

I can promise you that parties paying $500,000 per day for services and equipment very much consider the extent to which they and their companies are satisfied with the vendor they use!! Furthermore, poorly performing oilfield vendors in terms of customer satisfaction unquestionably suffer the consequences via negative word of mouth, lower levels of repeat customers, time and resources dealing with customer complaints, etc. Alternatively, vendors that satisfy customers enjoy positive word of mouth, increased customer loyalty, and more focused operations. It's very fundamental stuff that studies have confirmed over and over again.

2008 Feb 26 01:05 PM

[David Fessler:]

When the CEO says he can't see an end to the demand for deep water drilling contracts, and when 6 of the 8 new ships are already leased out for 2 years, hence., I think you are nitpicking. Doug Sheridan has hit the nail on the head: anyone spending this kind of money KNOWS who they are working with. This company will surprise to the upside for years to come.

2008 Feb 26 07:51 PM

[Mmarrkk:]

Doug: I think I'll have to disagree with you on this one and agree with "Thinking" and Favido. If I am not satisfied with RIG's performance, I don't really have any options. There are no surplus drill ships available and very few talented people to run them. So if I don't like what RIG is delivering, I can fire them but I don't have a drill ship/rig to replace them so I don't get my well drilled. The rigs are on multi year contracts so waiting for another one will take time and I can't just throw money at them because they are under contract. And all during this time, the lease I have from the government has a time clock ticking away. You have only a few years to drill the exploration wells and then appraise the discovery and come up with a development plan. If you postpone getting the drilling done because you're upset with RIG, you may find that you run the risk of losing your multi-million dollar lease.

When supply is short, you don't have the option of being happy. Sometimes you have to suck it up and pay $10 for that bottle of water because there is no fresh water available!!

2008 Feb 27 09:34 AM

[Doug Sheridan:]

MMarkkk, thanks for your post. While offshore contractors do currently enjoy leverage with their customers as you describe, those that do not meet the expectations of customers (for whatever reasons) do not simply receive free passes in the market place because times are tight. The customers that employ these rigs are experts at making sure they have the options they need to execute their programs in the longer term. Should any vendor or class of vendors perform poorly or attempt to unduly take advantage of tight markets, customers eventually figure out how to entice capable new entrants into the market (via long term commitments, etc.) such that the supply and demand picture becomes more balanced. Furthermore, any vendor that does not perform for its customers will find that new competitors will be disproportionately attracted to its markets in an effort to capture its disgruntled customers and unenthused prospects. It's a cycle that has played itself out time and time again in this and other industries, and one that absolutely should be a consideration of thoughtful observers.

2008 Feb 27 11:44 AM

[Camden:]

Doug,

Given the nature of the business, the expertise, and money required, it would take SEVERAL YEARS for "customers [to] figure out how to entice capable new entrants into the market (via long term commitments, etc.) such that the supply and demand picture becomes more balanced". I can assure you THAT is a consideration of thoughtful investors – and that is one small reason why Transocean will continue to make huge profits for years to come.

2008 Feb 28 01:08 AM

[Doug Sheridan:]

Gschwinn, thanks for your comment. I agree that the ability of customers to entice new entrants into the market place does not happen overnight. However, the majority of value in a company lies in what it can do beyond the next few of years. For example, if a company's net cash flow is projected to grow 10% annually for 20 years, 85% of the PV of the resulting stream of cash flows is generated AFTER the third year. My point (and the point of the original article) was that merging companies can experience problems at the customer level that can at times cause customer satisfaction levels to fall, and thus potentially impact cash flows well into the future. I focus on customer satisfaction in my analyses because it is an oft-overlooked factor that can cause companies to underperform or overperform compared to market expectations (in this case, your and others' expectations for "huge profits").

2008 Feb 28 10:19 AM

[Camden:]

Doug,
There have been quite a few mergers in the oil services sector over the past 20 years. Can you document a case in the sector where a lack of customer satisfaction (due to merger or not) has been considered the culprit for a shortfall in meeting market expectations?

2008 Feb 28 10:52 AM

[Doug Sheridan:]

GSchwinn, go to energypointresearch.co.... On the "Surveys" page, click on the "Oilfield Notes" button at the bottom. Then click on the "May 2007" under Monthly Notes. This report provides an analysis of the relationship between customer satisfaction and stock price performance in the oilfield product and services sector going back to 2004 (when EnergyPoint first started conducting its surveys). Included in the analysis are companies that are the result of past mergers and or high levels of M&A activity (i.e., Patterson-UTI, Weatherford, National Oilwell Varco, etc.). And remember, the point of the original article was not that the merger between Transocean and GlobalSantaFe was automatically going to result in lower customer satisfaction; only that there exists an increased risk that customer satisfaction will suffer as a result of the distractions and possible overconfidence that can accompany mergers.

2008 Feb 28 03:02 PM