Transocean: Love Industry Consolidation

Sep. 05, 2018 1:53 PM ETTransocean Ltd. (RIG)DO, VAL, ORIG21 Comments

Summary

  • Transocean agrees to buy Ocean Rig for an equity value of about $3 billion.
  • The deal further consolidates the industry into a few strong players that typically sets up a rally.
  • The purchase as utilization rates turn higher provides exceptional timing.
  • Look for downside risk to $9 as an ultimate time to buy Transocean.

With Transocean (NYSE:RIG) ending the initial trading down nearly 7% following the agreement to purchase Ocean Rig (ORIG), the market clearly doesn't like the deal. Industry consolidation is great for the sector providing an opportunity on any significant dip in the stock. The chart suggests waiting for $9, if $11 doesn't hold.

Buying High-Quality Assets

The deepwater drilling sector is froth with risk as having high-quality assets aren't beneficial to shareholders without contracts. The purchase of Ocean Rig provides Transocean with high-quality assets, but at a risk due to a lack of contracts and the cash payment.

Transocean agreed to pay 1.6128 shares plus $12.75 in cash for each share of Ocean Rig. The market doesn't like that Transocean is adding roughly $990 million to net debt to obtain Ocean Rig in the form of using $240 million in cash on hand and taking on $750 million in additional financing.

No doubt, Transocean makes a great case for purchasing the 11-rig fleet of Ocean Rig. The deepwater driller has eight modern ultra-deepwater rigs that the company is acquiring at a value of $278 million each while new construction costs are up to $700 million per rig.

Source: Transocean/Ocean Rig merger presentation

The Ocean Rig rigs were generally built in the last seven years. The rigs are mostly stacked, causing the hiccup in the deal and the need for consolidation in the industry.

Airlines Example

Ultimately, one can't predict how the offshore drilling market goes in 2019, but the airline sector provides a prime example of the immediate benefits of major consolidation. At the end of 2013, US Airways and American Airlines merged into American Airlines Group (AAL). The move followed the bankruptcy of American Airlines and other industry consolidations leaving three to four major airlines. The stocks

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Stone Fox Capital Advisors, LLC is a registered investment advisor founded in 2010. Mark Holder graduated from the University of Tulsa with a double major in accounting & finance. Mark has his Series 65 and is also a CPA.


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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in RIG over 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: Also long ESV.

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