Transocean Ltd. (NYSE:RIG) Cowen and Company 4th Annual Ultimate Energy Conference Call December 2, 2014 3:35 PM ET
Steven L. Newman - President and CEO
J.B. Lowe - Cowen and Company
Moving on, we are going to go with Transocean and with us today is Steven Newman, the President and CEO. Steven has been with Transocean since 1996 in a variety of roles, including from mid-2008 till late 2009 as Chief Operating Officer and President, and in March of 2010 he became the CEO and President. So with that, I'd like to turn it over to Steven and Transocean.
Steven L. Newman
Thanks, J.B. We appreciate the opportunity to be here today. I've been pleased with the quality of the meetings we've had over the course of the day. I'm still trying to decide whether it's genuine interest or morbid curiosity. And J.B. tells me I'm the last drilling contractor in the day, and so standing between you and the trip to the ice bar downstairs, is a bit of an uncomfortable position to find myself in, so I'll try and be crisp and focused with my comments.
Standard forward-looking disclaimer. Lawyers tell me there is at least a little bit I have to say about this page. Our business involves risks. Those risks I think are well detailed in our periodic filings with the Securities and Exchange Commission. Over the course of the comments today, I will make certain forward-looking statements that have to do with the outlook for our business, commodity prices, dayrates, financial results, things like that. Should the risks that we talk about in our periodic filings materialize, our actual results could be different than our expectation.
Hopefully you're well familiar with the Company, so I won't spend a lot of time in terms of the Company overview. I have spent a lot of time over the course of the meetings today talking about the market, so I'll give you a bit of a perspective on how we view the market today. But our objective as a management team is to position the Company to compete effectively regardless of what's going on in the broader market with respect to supply and demand and dayrates and utilization.
So what I really want to spend the majority of my time talking about today is the strategies and the initiatives that are underway at the Company to create value in terms of preserving and enhancing the Company's financial flexibility, continuing to invest for the long term and rewarding our shareholders. And I think it would be appropriate to close out today's comments with just a bit of an update on the Macondo litigation.
So just in terms of the Company, as I said at the outset, I hope you're well familiar with the story. The Company enjoys a premier position in Ultra-Deepwater. We've got a great position in the High-Spec and Midwater Floaters as well. Because of the Company's size and scale, we typically operate in most of the major markets around the world and we typically enjoy a position either at or near the top of the league table in those markets.
The Company has accumulated an unmatched list of industry firsts in our business. So we were the first to operate a rig outside the sight of land, we built the industry's first dynamically positioned rigs, we were the first to be able to drill year round north of the Arctic Circle with first to drill in excess of 10,000 feet, we brought dual activity to the industry. I'll show you at the end of today's presentation a few more of the firsts that we're working on now. But that history and that reputation for technological innovation and development creates really interesting reinvestment opportunity. So when our customers face the next challenge in their business, they are far more likely to bring Transocean in to help them address that and resolve that and continue to expand the boundaries for our business.
Talking about size, this just puts it in fairly vivid detail. We are the largest offshore drilling contractor. We've got a great position in Ultra-Deepwater. We also have a great pipeline of new rigs under construction today, seven Ultra-Deepwater Floaters and five Jackups. So we are continuing to position the Company as the leading operator of High-Spec Floaters and High-Spec Jackups.
Excellent backlog position, nearly $24 billion in contracted backlog. And when the industry enters into conditions like this, it is common for analysts and investors to ask us about the quality of that backlog and the ability of the Company to actually translate that backlog into income statement revenue. So I'll give you one statistic. At the height of the financial crisis in the latter part of 2008, the Company had $40 billion in contracted backlog and we lost 1% of that, $400 million, and it wasn't because customers walked away from the contracts or forced us into renegotiating those contracts, it was because the customers ceased to exist, they simply evaporated as a result of the financial condition.
Contract sanctity in our business has a long, long history, and so you should take a fair amount of comfort from that $24 billion in contracted backlog. As you would expect, the majority of that is associated with our Ultra-Deepwater fleet, tends to be longer-term contracts at higher dayrates. So, a nice picture of going on into the future, provides a little bit of foundation, a little bit of stability in what are some uncertain and potentially uncomfortable times.
The chart on the right hand side of the screen shows the diversification across the customer spectrum. So about a third, a third, a third between independents, IOCs and NOCs, and that's been relatively steady for the last few years. If you go back say 10 or 15 years, the size of the slice of the pie occupied by NOCs would have been much smaller back then, but the NOCs have become more and more active domestically in their home markets and they have expanded internationally as well.
On the left-hand side you see diversification across the asset classes, and I'll be perfectly frank with you, I wish we were a little bit more diversified. You can see, in excess of 90% of our revenues today come from our Floater fleet. I'd like to see a little bit more of revenue contribution from the Jackups. So you should see – expect us to continue to look for value creating opportunities to grow our presence and our competitive position in the jackup market.
As you look at the Company's committed fleet percentages going forward, about 60% of the Ultra-Deepwater fleet and about 80% of the Jackup fleet is committed for 2015, and that drops to about 40% for 2016, and further out you get the less committed we are. There's no question that this is a tough market right now but it should be no surprise to you that this is a cyclical industry, and so as bad as things might look today and as challenging as things might look for 2015, there will come a time when this industry turns and I think we will be extremely well-positioned to participate in that and benefit from that.
Few comments on the market. We have over the last several years been trying to position the Company as the leading operator of Ultra-Deepwater and High-Spec Jackups, and I think that is premised on at least in the Ultra-Deepwater space a recognition that that is where our customers are looking for significant accumulations and high return opportunity. So you see some statistics there for the last four years about the number of Ultra-Deepwater discoveries and the volumes discovered. We think that presents our customers with continuing excellent opportunities for high return, high reward investment, and our strategy is really to position ourselves to participate in that.
There is no dispute today that that Ultra-Deepwater market is oversupplied. The industry continues to take delivery of uncontracted newbuilds at the same time that our customers are holding back a little bit in terms of growth in demand, and so what you're seeing is a significant reduction in the amount of exploration spend, it's the easiest thing for our customers to suspend, but you also see programs being deferred and delayed. The farmout market is increasing. So our customers are in effect becoming drilling contractors themselves. And all of that is having an impact on dayrates. So dayrates for Ultra-Deepwater equipment are somewhere between $300,000 a day and $450,000 a day, depending on the specification of the asset and jurisdiction it's operating in and things like that.
Obviously when there is softness in the Ultra-Deepwater market, that tends to have a trickle-down effect on the Deepwater market and the Midwater market. So we're seeing that play out in terms of utilization in the Deepwater market. And while there are limited data points out there to go by, dayrates on conventional Deepwater equipment are somewhere between $250,000 and $300,000 a day.
In the U.K. and Norwegian sector of the North Sea, we think that's a relatively more protected market, notwithstanding some of the recent actions by Statoil, but the U.K. and the Norwegian sector tend to enjoy a little bit higher utilization, a little bit of a dayrate premium. So dayrates in that market are $280,000 to $340,000 a day, dayrates on Midwater equipment outside the North Sea around $200,000 a day.
High-Spec Jackups, we expect that business will come under increasing pressure as the industry continues to take delivery of uncontracted newbuilds out of the yards. There are some areas of that market that are holding up nicely. Dayrates in the U.K. sector are in the high 100s and dayrates outside the U.K. are in the mid-100.
That's about all I want to say with respect to the market. As I said at the outset, there is no question that the market conditions are challenging today, but our objective as a management team is to position the Company to compete effectively regardless of what happens with supply and demand and dayrates and utilization. And so our focus on creating value for our shareholders really revolves around financial flexibility, continuing investment and rewarding our shareholders. We think it's that combination of those three key elements of our capital strategy that creates value for our shareholders.
So think about financial flexibility, we think financial flexibility in a cyclical industry is a competitive advantage, and so we've taken actions over the last couple of years to continue to improve and enhance the Company's financial flexibility. That backlog of $24 billion provides a bit of stability, a bit of a foundation in what are some uncertain times.
We continue to focus on improving our cost structure and rationalizing our costs, and I think we've done a good job over the last year or 18 months in terms of improving our cost structure and mitigating to the extent we can the decline in dayrates by trying to protect and preserve our margin. We've implemented the MLP like vehicle, Transocean Partners. The reason we did that initially was to create another source of financing at an attractive cost of capital for the Corporation, and so we will continue to utilize Transocean Partners in that vein, in that manner.
We will continue to divest non-core assets. Over the last couple of years, the Company has sold about 64 drilling rigs and we've generated asset proceeds, asset divestiture proceeds in excess of $2 billion. I think we've done a great job repositioning the Company's Jackup fleet. We've got work to do on the Floater side, and so we will continue to look for opportunities to divest those non-core assets.
We're also continuing to focus on the strength and quality of our balance sheet and managing our credit metrics. Company's debt profile today is improving and we have followed through on our commitment with respect to managing that. And finally the investment grade credit rating. And it's not because we want to beat our chest and say, we are investment-grade credit quality, it's because investment grade credit rating provides access to capital at a reasonable cost, and in a cyclical industry I think that's important. So that's financial flexibility.
In terms of capital investment, I think the only way a drilling contractor can drive long-term shareholder returns is by continuing to invest in our fleet. So over the last four, five years, we've taken delivery of 18 new rigs, 14 Floaters and four Jackups, and the Company has 12 rigs under construction today, five Floaters that are backed by very attractive contracts, two Floaters to be built on spec and five high-quality Jackups.
And then the third element of that capital strategy is the return of capital to our shareholders. The $3 dividend in today's environment with what's happened with the equity price over the last couple of days, that $3 dividend provides a very attractive and competitive yield.
So in terms of managing our financial flexibility, the Company will continue to manage financial exposure. You've seen us make significant progress in terms of resolving some of the Transocean-unique uncertainty that's out there in terms of the Frade incident in Brazil and the Norwegian tax disputes and the Macondo litigation, managing that financial exposure by reducing the uncertainty and taking a portfolio approach to managing the fleet.
At the time we did four Shell newbuilds a couple of years ago, there was a lot of question marks about why we would take 10 year contracts at those dayrates. I don't hear a lot of pushback on that today because that provides stability and flexibility and helps us continue to manage the overall profile and portfolio.
It is important to us to continue to maintain our investment-grade credit rating while we continue to invest in our fleet. So at the time of the 2013 dividend decision, we made a commitment to the rating agencies that we would retire $1 billion in excess of the stated maturity, and we followed through on that commitment and the last tranche of that $1 billion was retired in November.
And alongside that we've launched the MLP like vehicle, Transocean Partners. The initial IPO provided the Corporation with proceeds of a little bit over $400 million, and again that provides another opportunity for the Corporation to access capital at an attractive cost of capital.
I talked about the success and progress the Company has achieved in terms of divesting non-core assets. I think we've done a great job on the Jackup side, we've got work to do on the Floater side, but that continued focus on divesting non-core assets should continue to generate some amount of asset divestiture proceeds for the Corporation.
And then finally, simply focusing on and improving the underlying operating metrics. At the end of the day, we're a drilling contractor and our customers hire us to drill wells efficiently and safely and managing our cost structure in the context of doing that should improve our financial results, all things being equal, going forward. So I think we've done a good job in terms of increasing our revenue efficiency and reducing the cost and the out-of-service time associated with major maintenance and overhaul and shipyard projects.
Left-hand side you see the revenue efficiency. We came off a bit of a low point in the first quarter of 2013 associated with some vendor quality issues on our subsea equipment, and at the beginning of 2014 we guided towards a revenue efficiency number for 2014 of 94%. Given our performance in 2013, I think there was rightly a little bit of skepticism with respect to our ability to achieve that. We are delivering results in excess of that guidance year-to-date 2014 when you consider our third quarter results.
Utilization, the graph on the right-hand side, obviously reflects the softening impact of the market condition. We made a commitment that we would improve our margins by $800 million versus our 2012 base, and I think we have demonstrated our ability to – we said we would do that by the end of 2015 – because of the conscious focus on that and the diligent action against those various initiatives, we've been able to accelerate a lot of the 2015 opportunities into 2014. So we are well ahead of schedule in terms of delivering on that commitment.
I've spoken a couple of times about Transocean Partners and I'll take you back again to what I said about the original genesis of the idea. It was all about creating for the Corporation another way to access capital at an attractive cost of capital. So when we went on the road and launched the product, it was extremely well received in the marketplace. It's a great structure. The rigs that we have put into that are obviously some of the best in the Transocean fleet. Extremely well received, very pleased with the IPO, and we will continue to leverage that vehicle, continue to make use of that vehicle because it does exactly what we wanted it to do, it provides the Corporation with access to capital at a reasonable cost of capital. And as we draw on proceeds from drops into Transocean Partners, we'll continue to employ the same balanced approach to allocating that capital that we have been applying, financial flexibility, continued investment and rewarding our shareholders.
In terms of the newbuild program, which this approach to continuing investment in our fleet is the second component of that capital strategy, over the last few years Company has taken delivery of 18 new rigs and those rigs are performing extremely well, customers are very happy. I think we have developed with our customers and with the industry a reputation for our ability to deliver rigs relatively on time, relatively on budget with relatively trouble-free startup. So that timeline of deliveries across the bottom of that screen takes some comfort in our ability to deliver those rigs on time, on budget with trouble-free startup.
And you should remember that of the seven Floaters the Company has under construction, the first five are backed by very attractive contracts. So we don't face any speculative exposure to the Floater market until the second quarter of 2017, and I think that positions us extremely well to take delivery of those rigs, get them out on contract and on payroll and earning cash.
We do have an objective to continue to high-grade our fleet. We think there are opportunities on both the Jackup side and the Floater side. We view the Floater market as a long-term growth market. Notwithstanding the fact that there are lower-end Floaters that are at risk of either being bifurcated into a lower dayrate environment or completely displaced out of the market, we view the Floater market as a long-term growth market. So we want to make sure we're a participant in that long-term growth market.
By contrast, we view the Jackup market as a replacement market. So we want to be a participant in that but only to the extent that we participate in delivering High-Spec Jackups and displacing somebody else's low-spec equipment, and that was really one of the drivers behind repositioning the Company as an operator of only High-Spec Jackup equipment.
And our focus is on positioning the Company as the leading operator of High-Spec Floaters and High-Spec Jackups, and as the starting point I'm kind of indifferent about whether that continued investment takes the form of building our own or buying somebody else's that are under construction or buying somebody else's that are out in the marketplace, as long as the assets meet our asset strategy and the economics make compelling sense. So we will continue to be very disciplined in how we think about investment. The threshold we set for any investment decision is a return that exceeds our cost of capital.
We showed this chart for the first time about a year ago, and this just lays out where we are today in terms of our fleet and where we want to be five years from now. We have, specifically on the right-hand side, been very conscious about not listing absolute numbers of rigs and more just an allocation of the fleet, but that 50% focus on Ultra-Deepwater, 10% focus on Harsh Environment and 40% focus on High-Spec Jackups, I think will give us the right level of diversification. I showed you that chart earlier that indicated that over 90% of our revenues today come from our Floater fleet. This would give us a more balanced source of – or a more balanced approach to diversifying revenue across the asset classes.
And if you think about what that might look in terms of our annual commitments, if we continue to renew the fleet at the pace I think we need to and some of that will take the form of newbuild capital, I think that represents somewhere between $1.5 billion and $2 billion a year on average in newbuild capital. As I said, we'll be disciplined about it, we'll be opportunistic about it, and because it's an average you should expect that some years will be more and some years would be less.
And in terms of thinking about how to fund that newbuild capital and those growth opportunities, operating cash flow is the best source but Transocean Partners is an attractive source of capital for us and an attractive cost of capital, and then the continued divestment of non-core assets. When we presented that now and future fleet chart last year, we gave ourselves a five-year timeframe within which to do that, and that's not an attempt to set an artificial deadline, it's just an attempt to convey that we want to be diligent and urgent about this without destroying value or entering into any sort of firesale exercise.
So if you think about financial flexibility and continued investment in our fleet, the third component of our value creation strategy is the returns for our shareholders, long-term returns through equity price appreciation, prompt returns through the dividend that we're paying today, and this chart was obviously put together before the recent decline in the Company's stock price but the $3 dividend on the basis of today's stock price provides a very, very competitive yield.
Couple of comments about Macondo. We were pleased with the ruling that came out on September 4. It had three key components for us. Because we were not found grossly negligent, that eliminated the Company's exposure to punitive damages. The judge ruled that because we were not grossly negligent, the indemnity that exists between BP and Transocean as part of that contract is enforceable, which means BP has got to indemnify us for the compensatory damages. And the third key component of that ruling was the judge found that the release that BP granted to Transocean as part of the drilling contract is enforceable. So all of the direct damage claims that BP had assigned to the PSC as part of BP-PSC settlement, the PSC is barred from pursuing those claims. So three key elements to that ruling that we think effectively eliminates the financial exposure associated with the below-surface discharge of oil in the Macondo accident.
We entered into an agreement with the U.S. Department of Justice in January of last year that addressed the federal government's civil and potential criminal claims against the Company. So we've got some remaining progress payments associated with that $1.4 billion settlement. If you think about the court ruling and the settlement with the U.S. Government, I think we've done an excellent job in continuing to manage down the uncertainty associated with the Macondo accident.
There are some lingering and outstanding issues. The BP's claim as an additional insured on our excess liability policy is still subject to ongoing litigation and debate. We don't expect any answer out of the Texas Supreme Court until the middle of next year on that particular issue.
If you think about what the Company has done over the last couple of years in terms of being very transparent about the objectives we're undertaking and then following through on those objectives, I talked about the importance of improving the underlying operating results of what is at the end of the day an operating company, I think we made great progress in improving our revenue efficiency and we're actually beating our 2014 guidance in that regard. We've done a great job of managing down the Company's cost structure and we will continue to look for opportunities to do that.
We have eliminated exposure to the low-spec Jackup asset class, which in an environment like today that is the most volatile and vulnerable segment of the asset class, we are only an operator of premium Jackup equipment today and we've built a very attractive pipeline of newbuilds to continue to enhance our position.
We implemented Transocean Partners which provides the Corporation with attractive source of capital at an attractive cost of capital. We followed through on our commitments to retire an incremental $1 billion above and beyond the stated maturities of our debt. We beat analyst expectations for six quarters in a row.
And I mentioned at the outset, the Company's accumulated list of firsts. We are the first drilling contractor that will deliver rigs capable of carrying a 20,000 psi BOP. We are the first drilling contractor to deliver rigs with a hybrid power plant. You think about our customer's cost structure, they pay for the diesel fuel. So if we can provide a drilling rig that burns less diesel fuel and accomplishes the same objective, that's a benefit, a clear, clear benefit to our customers.
We're partnering with one of our key customers to develop a next-generation BOP control system, which I think will redefine BOP control system reliability, and we continue to position ourselves to participate in the Arctic drilling when that takes place.
And then you think about some of the uncertainty that's been unique to Transocean, the Frade incident in Brazil, the Norwegian tax disputes and the Macondo litigation, I think we've done a great job in reducing that uncertainty.
So in conclusion, I think we're delivering on our commitments to create value. Not much I can do about supply-demand and commodity prices, there's a lot we can do about financial flexibility and continuing investment in our fleet and rewarding our shareholders, and you're seeing us take the actions to do that. We are focusing on the things we can control, and I think we are well-positioned to participate when the industry turns around, and we all know it will. Happy to take a few questions.
Q - J.B. Lowe
Yes, we would open it up for questions. Anyone have any questions for Steven?
Thanks, J.B. So you gave the dayrates across some of the various asset classes. How far as a percentage decline do they have to go before you're at cash breakeven?
Steven L. Newman
So let's talk about Ultra-Deepwater because that's kind of the starting point. Operating costs on an Ultra-Deepwater rig for us are about $180,000 a day give or take depending on the jurisdiction and that particular asset. So we're somewhere in the $300,000 to $450,000 range. We're still delivering a very healthy cash margin. You think about Midwater equipment in the North Sea, operating costs on that equipment are about $85,000 a day, so dayrate somewhere between $280,000 and $340,000. Again, still a very, very attractive cash margin.
About the full utilization.
Steven L. Newman
[Was there deductible] [ph], is that the full utilization?
Steven L. Newman
We are not at full utilization today.
Steven L. Newman
What calculus you want me to do?
Steven L. Newman
We do have a couple of idle Ultra-Deepwater rigs today. And so when you factor a couple of idle Ultra-Deepwater rigs across the Ultra-Deepwater fleet, I'm not sure the multiplier is 75. It's probably closer to 90 or 95. So I think we're still in an attractive position there. Obviously the lowest end of our Floater fleet would be Midwater rigs outside of North Sea. We have a number of rigs stacked. And so your calculus is probably more appropriate for that end of the asset class. We're probably on a consolidated basis when you do your math a little bit closer to cash breakeven today on that low-end asset.
One more question. With all these rigs coming to the Gulf or other places, do you expect the rig count because of falling prices to go up or to decline over the next year or two?
Steven L. Newman
The global rig count I think is at best for 2015 going to be flat. We expect 2015 to be every bit as tough if not more difficult than 2014. Now if you ask me on a basin by basin basis, it gets a little bit more difficult. So the rig count in the Gulf of Mexico is likely to go up, rig counts in some other areas of the world is going to have to go down to compensate for that.
In terms of asset divestitures, could you just give us a little update on Caledonia and where you see that playing out?
Steven L. Newman
So we were pretty transparent about what we were trying to do with Caledonia. We tested the private placement market. We talked over the last several months about the alternatives that are available to us in terms of an outright sale to a third-party, some sort of IPO or private placement type exercise in a spin to our shareholders.
So we tested the private placement market. We went into that exercise with a fairly clear idea of what Caledonia was worth to us. We were interested in selling up to 20% and we didn't get the valuation on that 20% that we anticipated. So rather than keeping four-fifths of it, we decided to keep five-fifths of it, which is at the end of the day not a bad outcome. Caledonia will deliver somewhere around $650 million in EBITDA next year.
We will continue to look at the various alternatives that are available to us. I think our spin type transaction is the least preferable to us because it doesn't generate proceeds for the Corporation, and part of our exercise in divesting assets is to raise proceeds so that we can continue to invest in the assets we want to operate long-term. But we will continue to look at alternatives, and in the meantime we are quite happy to take five-fifths of the cash flow and EBITDA that comes out of that. Okay?
Alright, good. Thank you very much.
Steven L. Newman
Thanks very much.
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