Shiv Kapoor

Thoughts on Baker Hughes' BJ Services Acquisition

BHI has in my view done just fine on customer satisfaction considering the rapid rate of growth. I also believe that the BJS acquisition is an excellent one because looking into the outyears, companies without the ability to deliver IPM will go nowhere.

IPM is revolutionary in that it makes available expertise for a fee. In the past NOC's partnered with big oil for expertise and to share risk. Several NOC's are increasingly carrying higher risk and buying in expertise from OFS companies. I expect this trend to continue and strengthen. For major oil, expansion through risk sharing and execution is a considerable strength so they will continue to have a role to play; but even here outsourcing expertise to highly skilled external experts makes good sense.
I think WFT might have been a better fit and would see a future combine between BHI+BJS & WFT as making sense.

Is It Safe?

Yank - I do not see oil falling below $50 on a worst case scenario for the next several years. What I do see is global rig utilization dropping to 85%-90% levels once new rigs start becoming available (roughly 2012).

When the utilization hits these levels, day rates are hit very hard (a 50% drop in average day rates from peak to trough is common place). At this point in time, cost management is important, a lot of it happens automatically as variable pay elements come down drastically. Because Transocean is an exceptionally well managed company, you can look for long term margins to be preserved at 15%-20%. But on a lower revenue base this hits EPS hard. Day rates tend to stop falling once some rigs are removed from the fleet through cold stacking. Transocean has strong backlog which will cover it through 2011, even 2012; its after that I am concerned about. Analysts closely monitor utilization, new builds and day rates and the minute you see clouds on a falling backlog build you will see an exodus from RIG (clouds gather on distant horizons once the rate of backlog growth starts slowing - that has started and should start escalating pretty soon). The Jeffries Report is an excellent source of information for an industry review but it is expensive. Have a look at the prior price history of drillers during the 98 time period it went from $60 to $20 over 10 months; during 2000 it went from $65 to bottom at $18. Now I am not suggesting the same will re-occur; it is a different time, energy has just started a huge secular up-move, but a panic bottom of $40-$50 can happen before it moves up again. I do not expect this to happen because I think the backlog will carry Transocean through this downcycle; but it would not surprise me if it did happen - simply because it has been the nature of the industry. I have absolutely no doubt that Transocean will trade at $160 again. But I do believe there will be better price points to enter. I do see value now and it is certainly worth a nibble, but not yet time to bet the bank in my view. RIG has had a relatively long timewise correction since it peaked in Oct 07; it should complete its unwind pretty soon now - for me its a buy at $75, a strong buy at $65 and a bet the bank at $50. I would be much happier if they kept the tentative special dividend as I feel they are somewhat over-leveraged (though the backlog should cover debt nicely).

FYI - my past experience is with oilfield services (SLB) & drillers (RIG); both are top in their respective fields, both class employers, both with top notch management.

Is It Safe?

I agree with energy and oilfield services and drillers have sound long term fundamentals. But we are nowhere near the point at which an investment makes sense. There is huge demand for drilling rigs capable of deep and ultra deepwater work. The supply of such vessels was just not there and so several 3rd, 4th and 5th gen rigs have enjoyed super normal day rates. During the past cycle, there have been large investments in building of jack-ups, semi-submersibles and drill ships. Several of these are spec builds, while many are built with underlying contracts. I have no doubt that the fantastic backlogs will pay for these assets and leave behind a high quality fleet largely paid for with modest debt remaining on the books. But all of this is priced. What is not priced is a return to long term margins once day rates fall because utilization will fall with the coming of a huge fleet onto the markets. While healthy demand is a given, fleet supply will be in place to match demand. During y/e 12/31/04 net profit as a % of revenue was under 1%. By end 2007 it has risen to 51%. The long term profitability of the sector once fleet supply and demand are in balance is roughly 15%; add to that significant moderation in day rates - rates will fall very significantly once supply and demand are in balance. Expectations of long term growth need to come down to earth. Transocean is an absolutely brilliant company; top management, top engineering talent, top asset quality; the company has every reason to be proud. It is a good buy once the valuations make sense. Just now we are nowhere near that point; I would not be surprised to see a 50% cut from where we are today on bearish extremes.