Transocean Buys Ocean Rig: I Don't Like The Deal

Sep. 04, 2018 6:38 PM ETOcean Rig UDW Inc. (ORIG), RIG114 Comments
Vladimir Zernov profile picture
Vladimir Zernov
16.14K Followers

Summary

  • Transocean announces a deal to buy Ocean Rig.
  • Ocean Rig shareholders are well compensated with Transocean shares and cash.
  • For Transocean, it looks like a rather risky and aggressive move, similar to the one made by Ensco.

As many of you have already heard, Transocean (NYSE:RIG) has just announced that it will buy fellow driller Ocean Rig (NASDAQ:ORIG). This is a major move from Transocean and it certainly deserves a closer look.

Here’s the deal. Ocean Rig will be valued at $32.28 per share. Holders of Ocean Rig stock will get 1.6128 newly issued shares of Transocean for each share of Ocean Rig that they hold plus $12.75 in cash per share. The first reaction of the market seems to be negative, as Transocean shares are down premarket on a day when oil shows significant strength.

So, what is Transocean buying? Ocean Rig has two harsh-environment semi-subs and nine drillships. Also, the company has two drillships under construction, Ocean Rig Santorini and Ocean Rig Crete. The delivery of Ocean Rig Santorini has been postponed until September 30, 2019, while the delivery of Ocean Rig Crete has been postponed until September 30, 2020. In the latest press release on the topic, Ocean Rig indicated that the remaining yard installments for Santorini were $372 million, significantly above current drillship values.

Out of two harsh-environment semis, one is on contract (Leiv Eiriksson) and one is cold stacked (Eirik Raude). Ocean Rig has previously indicated its desire to put Eirik Raude back to market due to ongoing strength of the harsh-environment segment.

The situation is less rosy with drillships. Only one drillship, Ocean Rig Skyros, is on long-term contract. Another, Ocean Rig Poseidon, recently scored a number of jobs which will keep the rig busy into the beginning of 2019. Drillships Ocean Rig Corcovado and Ocean Rig Mykonos are warm stacked. The remainder of the fleet – Ocean Rig Apollo, Ocean Rig Athena, Ocean Rig Mylos, Ocean Rig Olympia and Ocean Rig Paros are cold stacked. As I discussed in my recent article on Ocean Rig titled “Is Ocean Rig Undervalued?” much value is assigned to these cold stacked rigs as per Bassoe Offshore valuations, but their real value might be considerably lower if they are not reactivated in time.

With Ocean Rig fleet valued at about ~$2 billion, net cash position of $370 million and a mostly high-margin backlog of $743 million, the valuation of the deal does not appear outrageous. However, the deal significantly increases Transocean’s risk profile. The first obvious impact on the balance sheet is the obligation to pay $12.75 per share to Ocean Rig shareholders, calculating to about $1.1 billion. The next thing not to be forgotten is Ocean Rig’s deal with the company of its former CEO, George Economou, called TMS Offshore. The deal was a $150 million management contract which now has to be ended and, I suppose, George Economou will be compensated for this.

Also, the deal comes with “implied obligations.” To prevent half of the fleet from degradation into a zero value, Transocean will have to reactivate them in time. From what I heard, the number for reactivation of a modern drillship after several years of stacking may reach $100 million. There are five such drillships, so it’s a potential $500 million investment. Also, Transocean almost will surely invest in reactivation of the cold stacked harsh-environment semi-sub Eirik Raude. Besides this, the company will now have to find contracts for Corcovado and Mykonos, as well as follow-up jobs for Poseidon.

I’d like to highlight that Transocean already has a number of potentially competitive, cold stacked drillships – Deepwater Champion, Discoverer Luanda, Discoverer Americas, Discoverer Clear Leader. So, Ocean Rig’s cold stacked drillships go on top of this small stacked fleet.

My first opinion is that I don’t like this deal. The purchase of Ocean Rig is completely different from the previous purchase of Songa, where Transocean de-facto bought Songa’s backlog and relationships with then-Statoil (now Equinor (EQNR)). To me, the deal is very similar to Ensco’s (ESV) purchase of Atwood Oceanics – the purchaser is piling additional workless rigs on top of existing ones. The Ensco deal put considerable pressure on Ensco’s capitalization after the deal was executed, and I expect that some pressure will be put on Transocean shares as well.

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This article was written by

Vladimir Zernov profile picture
16.14K Followers
I'm a trader who trades both short-term and long-term. I started my career as a day-trader for a trading firm, but then turned to longer time frames and went on my own to manage my portfolio. I use technical analysis as well as fundamental analysis in my research.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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 may trade any of the above-mentioned stocks.

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