Last week, leading offshore driller Transocean reported Q1/2020 results largely in line with expectations but on the conference call lowered its full-year contract drilling revenue outlook by 10% "due to contracts being deployed and contract adjustments recently negotiated with our customers" which is very much in line with general industry expectations stated by leading energy intelligence firm Rystad Energy last month.
Photo: 7th Generation Ultra-Deepwater Drillship "Deepwater Proteus" - Source: Company Website
Unlike industry peers, Transocean continues to benefit from a decent number of legacy, high-margin contracts. The cash flows derived from these contracts have helped the company serving its massive $9.25 billion debtload in recent quarters even after the ill-advised acquisition of competitor Ocean Rig in late 2018.
Particularly after the recent decision of competitor Diamond Offshore Drilling (OTCPK:DOFSQ) to restructure its debt obligations under bankruptcy protection and anticipated similar moves by peers Valaris (VAL), Noble Corporation (NE), Seadrill (SDRL) and Seadrill Partners (OTC:SDLPF) in the not-too-distant future, investors were eager to learn about Transocean's approach to deal with the renewed industry downturn. On the conference call, management was asked by an analyst about a potential threat from competitors emerging from bankruptcy with little or even no debt at all:
(...) So Jeremy, it appears that a number of your competitors could be heading for Chapter 11 protection in the not too distant future. It sounds very clear to me based on the commentary from the press release and on the conference call here that Transocean is on very strong footing from a financial standpoint.
Just kind of curious, you know in your mindset, when you think about the competitive landscape going forward and that some of your competitors are potentially going through a capital restructuring and coming out with let's say less encumbered balance sheets, do you think that that puts those companies on a better competitive footing or do you still feel very confident that from an operational and financial standpoint you guys will still lead the way through the next cycle?
Thanks Kurt. Good question and what I can tell you is we've already been through this. I mean, we've had multiple competitors that have already gone through restructuring. One of them we acquired in Ocean Rig, but in Pacific Seadrill, Vantage, all went through it and what we saw in that experience is that our customers clearly demonstrated a favoritism if you will, a preference for the more established drillers with the more solid balance sheet and our thought is that they recognize that those companies had the cash to invest in the training of the people and the proper maintenance of the assets and that they were a lower risk option than an otherwise risky venture.
And so what we saw during that first phase of restructuring a couple of years ago was that we won a disproportionate number of contracts, and so my expectation would be that as our competitors go through that restructuring phase, that once again our customers will look to the low risk option, which is Transocean, both from an operation standpoint, but also from a balance sheet standpoint and so my expectation would be that we would be able to grow market share at premium day rates during that period of time.
Now, once our competitors come out of restructuring and have the opportunity to demonstrate that they can still safely, reliably, efficiently operate, they will have a lower cost base, we recognize that. But I guess as they won’t come to restructuring without any debt and probably not a lot of cash and so they are going to need to as per day rate that help them generate enough cash to continue to invest in their business and service their maturity, which are likely to be pushed out, but they are still going to have them. And so we don't – we're not at this stage overly concerned about it, because what we've seen play out in the past didn't support that it gave any of those restructuring competitors a competitive advantages.
While I don't share CEO Jeremy Thigpen's expectations for competitors to emerge from restructuring with still meaningful debt and rather low cash balances, one thing appears certain, at least for now:
Transocean is not going to restructure its debt obligations under bankruptcy protection anytime soon as also evidenced by the company's decision to repurchase "approximately $76 million of near-dated debt in the open market during the quarter at a cost of $55 million" thus capturing an average discount of 27%.
In addition, CFO Mark Mey pointed to the company's debt also trading at "awfully low" levels and more or less openly hinted at further near-term debt buybacks:
(...) we've been opportunistic in the past, we’ve been aggressive in the past and you can expect us to look at this and take this opportunity this time (...)
Indeed, with some of the company's longer-dated bonds now trading below 25% of face value and even the November 2020 notes currently changing hands in the low 70% range, there appears to plenty of opportunity for Transocean to capture much more meaningful discounts than realized in Q1:
For now, the company has put its focus on near-term maturities which obviously carry the lowest discount but taking them out now apparently lessens the amount of debt to be repaid at 100% in the short- to medium-term.
Even after recording $160 million in negative free cash flow, $55 million in debt repurchases and the redemption of the company's 9% 2023 notes in Q1, Transocean still has $1.5 billion in unrestricted cash on the balance sheet as well as an undrawn $1.3 billion revolving credit facility.
That said, the company is facing approximately $1.2 billion in debt repayments until the end of 2021 as well as almost $1.4 billion for the upcoming delivery of two newbuild drillships, the Deepwater Atlas and the Deepwater Titan.
While Deepwater Titan has been awarded a multi-year contract with Chevron for development of the Anchor prospect in the Gulf of Mexico expected to commence in Q4/2021, Transocean still needs to secure a similar contract for the Deepwater Atlas which remains scheduled for delivery in Q4 of this year:
We are also determining how best to manage the anticipated delivery of the Deepwater Atlas later this year.
Despite the dislocation between oil supply and demand, and the unprecedented decline in oil prices, there remained significant customer interests regarding Atlas and her potential to become the industry's second 20,000 psi ultra-deepwater drillship. That said we will continue to work closely with our customers and the shipyard, which is currently challenged to meet its year-end delivery schedule due to disruptions created by COVID-19, as we move close to delivering the state of the art asset to the industry.
In the question-and-answer session of the call, management provided additional color:
As I mentioned in my prepared comments, it's quite honestly been a bit surprising and pleasantly surprising to me to see that our customers who were previously interested in securing the Atlas and then upgrading her to a second 20K rig are still very much interested.
I would say, one of the customers is looking at potentially delaying the start of their program by a few months, but haven't changed their result in terms of moving forward and our other customer wants to move forward at the pace originally – that they originally expressed before we were all hit with this pandemic. And so work we're working both sides of it right now Ian. My guess is that the delivery of the Atlas does slip a little bit, whether that's later this year or early next to be determined, but we're just working right now as best we can with customers, the shipyards and the OEMs to work on the timing of that.
At least for now, Transocean is apparently looking to take delivery of the Deepwater Atlas despite the likely delay which could provide a potentially valid cause to terminate the newbuild contract.
Liquidity at the end of FY2021 was projected at $1.2 billion to $1.4 billion which includes the assumed issuance of $400 million of secured debt against the Deepwater Titan contract. Effectively, Transocean would be down to its credit facility at that time.
That said, the company could still try to delay (or perhaps even terminate) the delivery of the Deepwater Atlas in case no sufficient contract materializes and potentially use the previously earmarked funds for additional debt repurchases as Transocean still faces a $1.5 billion debt wall in 2023 as well as the requirement to extend its $1.3 billion revolving credit facility at that time.
Expect Transocean to hold its course and not follow peers into bankruptcy anytime soon. Instead, the company will likely focus on repurchasing meaningful amounts of distressed debt in the open market to better deal with short- and medium-term maturities.
Under this scenario, the company's 6.5% November 2020 unsecured notes would be a very interesting speculation with an annualized yield of above 80% at current prices.
Personally, I don't see Transocean avoiding a comprehensive debt restructuring as industry conditions are likely to remain weak for years to come with virtually no new work awarded on a net basis for the next couple of quarters and competitors likely having emerged from bankruptcy with considerably lower cost structures after that time.
But admittedly, Transocean still has some levers to pull like further delaying (or perhaps even eliminating) newbuild capex or potentially conducting a large distressed debt exchange.
Absent of individual news, expect trading in the company's shares to remain highly correlated with oil prices for the foreseeable future.
Speculative investors willing to take a bet on Transocean honoring its debt obligations for another couple of quarters should consider taking a position in the company's 6.5% November 2020 unsecured notes.