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Transocean Passes Debt Market Acid Test With Flying Colors, Discloses New Contract Awards

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About: Transocean Ltd. (RIG), Includes: BORR, DO, NE, PACD, SDLPF, SDRL, VAL
by: Henrik Alex
Henrik Alex
Momentum, event-driven, short-term horizon, tech
Summary

Discussing recent recovery rally in offshore drilling stocks and related debt securities.

Transocean successfully places $750 million in new 2027 8% senior unsecured notes. Expect majority of proceeds to be used for further redemptions of the company's 2023 9% senior unsecured notes.

Company provides update on new contract awards, secured approximately $353 million in backlog over the past three months.

Overall dayrate picture continues to improve with no sub-$200,000 dayrate contracts signed outside of option exercises anymore.

General picture hasn't really changed. The industry desperately needs a return of real pricing power to proactively deal with outsized debt maturities kicking in around 2022/2023.

Note:

I have covered Transocean (NYSE:RIG) previously, so investors should view this as an update to my earlier articles on the company.

A little over two months ago, I considered leading offshore drilling services provider Transocean's shares "an interesting trading opportunity" after management not only reiterated its usual upbeat industry view on the company's Q3/2019 conference call but actually offered some encouraging data points to underscore its assessment.

In addition, I expected investors to become somewhat more constructive on the offshore drilling industry going into 2020 given increased customer demand and anticipated higher utilization levels which should bode well for further dayrate increases.

Bildergebnis für deepwater inspiration"Photo: 6th Generation Ultra-Deepwater Drillship "Discoverer Inspiration" - Source: Company Website

Since then, the stock has increased by almost 50% at the peak of the recent recovery rally which was fueled not only by the anticipated shift in investor sentiment but also by rising oil prices amidst increased geopolitical tensions. Even after this week's major setback, the shares are still up by more than 70% from recent 52-week-lows.

That said, many of the company's peers have done even better in recent weeks with some of the most distressed players taking the lead:

Sources: Bloomberg, Yahoo Finance, Author's own work

At least equally important, bond prices have also recovered across the board. For example, fellow contributor Left Brain Investment Research highlighted Transocean's 2027 7.45% senior unsecured notes as a potential bargain in an article just seven weeks ago. Since then, the bonds have recovered by almost 20%, quite a movement for a fixed-interest security within just a couple of weeks. And while some of the company's longer-dated bonds are still trading at somewhat distressed levels, they have rallied even stronger from recent lows.

Apparently, the recent, material improvements in the debt markets did not go unnoticed by Transocean's management as the company decided to test the unsecured debt markets for the first time in over a year:

Transocean Ltd. announced today that Transocean Inc., its wholly-owned subsidiary (collectively with Transocean Ltd., “Transocean”), has commenced an offering of U.S. $750 million aggregate principal amount of senior unsecured notes due 2027 (the “Notes”) to eligible purchasers pursuant to Rule 144A/Regulation S. The Notes will be fully and unconditionally guaranteed by Transocean Ltd. and certain of Transocean Inc.’s subsidiaries.

Transocean intends to use the net proceeds from this offering to refinance, repurchase and/or redeem certain of its existing indebtedness in one or more transactions, and/or for general corporate purposes.

Remember, the company botched a similar, but considerable larger notes offering in mid-2016 as the deal ended up being downsized and priced at an industry-high interest rate of 9.00% at that time.

But this time, the transaction went smoothly, with pricing announced just hours after commencement. Granted, the 8.00% coupon isn't exactly something to write home about but could still contribute to lower the company's interest obligations somewhat if proceeds will be directed towards further reducing outstanding amounts under the unfortunate 9.00% notes discussed above.

Over the past couple of quarters, Transocean has been already focused on reducing the outstanding amount ($753 million as of September 30, 2019) under these particular bonds due in July 2023 in order to avoid a covenant-related early expiration of the company's $1.3 billion secured credit facility in April 2023.

With the debt markets apparently open again, I would expect peer Valaris (VAL) to follow suit with a previously contemplated secured debt offering in the not too distant future.

As usual, timing will be of the essence as oil price spikes caused by geopolitical events usually reverse within rather short notice.

To support the offering, Transocean also provided an update on recent contract awards:

Transocean Ltd. announced today that as the offshore drilling market continues to improve, the company is observing an increase in contract opportunities for its ultra-deepwater and harsh environment drilling services.

“Customer demand for the highest specification ultra-deepwater floaters now equals or exceeds the number of marketable rigs currently available in many areas,” said Transocean President and Chief Executive Officer Jeremy Thigpen. “As a result, new contracts more consistently reflect materially increased dayrates, which will generate significantly improved cash flow.”

(...)

In total, approximately $353 million in contract awards have been secured since the company released its most recent fleet status report on October 17, 2019:

Source: Transocean Press Release

Investors should note that the contracts for the "Leiv Eiriksson" and "Development Driller III" have been disclosed previously while the "Deepwater Inspiration" will soon roll off an ultra-high margin legacy contract with Chevron (CVX). Under the new dayrate of $210,000, Transocean will suffer a $30+ million quarterly cash flow hit. That said, even at the new dayrate, the rig will still generate positive cash flows from operations which is obviously much better than sitting idle.

In addition, the exercise of some inexpensive options by operators of the "Deepwater Invictus" and "Deepwater Nautilus" doesn't exactly look great from a dayrate perspective but should not come as a major surprise either.

Also keep in mind that the company has a $800+ million quarterly revenue run rate. While contract activity has picked up substantially from the painfully weak October 2019 fleet status report, the calculated book-to-bill ratio of 0.44 will actually result in a further reduction to overall backlog.

Moreover, Transocean did not manage to put idle rigs back to work like, for example, the "Deepwater Orion" (former "Ocean Rig Poseidon").

In sum, the new awards appear insufficient to make up for the cash flow impact from the upcoming expiration of the high-margin "Deepwater Inspiration" contract.

That said, the overall dayrate picture continues to improve with no sub-$200,000 contracts signed outside of customer option exercises anymore.

Bottom Line:

Transocean just passed the debt markets acid test with flying colors, successfully placing $750 million in 2027 8.00% senior unsecured notes after a recent rally in oil prices caused investor sentiment to improve further.

I would expect net proceeds to be used for redemption of the company's 2023 9.00% senior unsecured notes thus further improving its debt maturity profile.

That said, the general picture hasn't really changed. The industry urgently needs a return of real pricing power to proactively deal with outsized debt maturities kicking in around 2022/2023.

Wednesday's successful debt offering marks an initial step towards this all-important goal for Transocean with peer Valaris likely to follow suit.

As usual, movement in industry stocks will remain highly correlated with oil prices but investors should abstain from chasing the shares on geopolitical events as these rallies tend to be rather short-lived.

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.