Transocean - The Deepwater Asgard. Year Built: 2014 - Source: MarineTraffic
Investment Thesis
One unique characteristic of Transocean (NYSE:RIG) is that it is the only offshore driller that shows an impressive long-term backlog of about $9.6 billion as of April 2020. It is not a complete shield against the risk of bankruptcy that has spread like bushfire recently, but it is still a reassuring value that cannot be dismissed. The question is to know if it is enough? 
However, after this, Black Swan Event shocked the world and particularly the oil industry, with a plummeting demand pushing oil prices to a fresh multi-year low. It is time to question how Transocean will be able to repay over $9 billion in debt? Free cash flow is now a loss with a record loss of $155 million this quarter alone, and the outlook is negative.
While it is likely that the company will outlive the next couple of quarters and perhaps in 2020, I am not optimistic about the longer-term prospect, and I believe a restructuring of the debt under chapter 11 is unavoidable. The question is not if, but when?
The issue in this situation is not really if Transocean will survive these terrible times. It will, and restructuring the debt will be quite positive for the company even now. No, the issue is the common shareholders that will be wiped out and get to own only a fraction of the new company - generally, about 1% or 2% of the shares outstanding of the new Co.
Thus, be very careful here and trade while you can to reduce your exposure and limit your loss while the company stays as it is. The investment thesis is now to avoid Transocean and the entire offshore drilling industry and perhaps use the next few quarters to reduce your exposure significantly and limit your loss by trading short term.
Jeremy Thigpen, the CEO, said in the conference call:
we do not have any rigs that are currently in a force majeure status as a result of COVID-19. As a reminder, the strength of our backlog enabled us to bolster our liquidity over the past few years by securitizing the two largest parts of our backlog, the combined eight contracts with Shell and Equinor.
[...] in response to this deep decrease we have seen in oil prices in the past three months, customer budgets have been significantly reduced. So while our backlog remains a source of strength, our near term outlook for new work and escalating day rates is obviously tempered.
Fleet Status for 1Q'20, and Backlog Snapshot
I suggest reading my preceding article about the April fleet status published on Seeking Alpha for more details if necessary.
The company's fleet status was released on April 16, 2020. Transocean indicated that it added $10 million in additional contract backlog. Also, the company retired a few old rigs.
Looking at our fleet, we've recently taken the action to responsibly recycle four older stacked assets, the Polar Pioneer and the Songa Dee from our harsh environment fleet and the 711 and 714 from our mid-water fleet. (Jeremy Thigpen - conference call)
Also, the company is looking at ways to delay the delivery of the deepwater Atlas.
In the event market weakness continues throughout the year, we will act decisively to ensure our fleet is either operational or stacked to protect our liquidity. We are also determining how best to manage the anticipated delivery of the Deepwater Atlas later this year.
One encouraging sign that makes me think we may have reached the bottom is that the average daily rate in the first quarter fell to $314,900/d from the year-ago level of $306,500/d. Furthermore, utilization is improving from the same quarter a year ago while down sequentially.
| Day rates | 4Q'18 | 3Q'19 | 4Q'19 | 1Q'20 |
| Average daily rate $k/d | 293.1 | 314.5 | 317.7 | 314.9 |
| Average Utilization | 62% | 58% | 61% | 60% |
The total backlog is estimated at $9.6 billion as of April 29, 2020. The graph below shows the yearly distribution.
Note: Those contracts are firm, and if terminated for convenience, Transocean will be compensated by an amount above 80% of the total backlog remaining, making them quite safe.
However, the company can also renegotiate down its "firm" contracts. There is uncertainty on how much of the actual amount is safe? It is especially true in the present situation.
The graph below is showing the yearly impact of Shell's (RDS.A) (RDS.B) backlog on the total RIG backlog. The five drillships involved were Poseidon, Deepwater Pontus, Deepwater Proteus, Deepwater Thalassa, and Deepwater Nautilus.
I have estimated that Shell activity represents 49% of the total backlog of the company ($4.7 billion). The contracts with Shell have been renegotiated down a couple of years ago.
Transocean is essentially an ultra-deepwater business, with over 71.7% of the total backlog attached to the Ultra-Deepwater portion. However, with the acquisition of Songa Offshore, the semisub segment Harsh-Environment (mainly in the North Sea) increased to 27.6% of the total backlog as of February 14, 2020.
Fleet Analysis Snapshot
Rig fleet per category (minus recently scrapped rigs or held for sale) - No Jackups:
| Total | UDW | Deepwater Semi-subs | HE Deepwater Semi-subs | Midwaters | |
| Number of Rig operating | 30 | 18 | 0 | 11 | 1 |
| Cold-stacked/idle | 11 | 6 | 0 | 3 | 2 |
| New build rigs - no contract | 1 | 1 | 0 | 0 | 0 |
| New build rigs with a firm contract | 1 | 1 | 0 | 0 | 0 |
| Total | 43 | 28 | 2 | 14 | 3 |
Transocean - 1Q'20 and Selected Financials History - The Raw Numbers
| Transocean | 3Q'18 | 4Q'18 | 1Q'19 | 2Q'19 | 3Q'19 | 4Q'19 | 1Q'20 |
| Total Revenues in $ Billion | 0.816 | 0.748 | 0.754 | 0.758 | 0.784 | 0.792 | 0.759 |
| Net Income in $ Million | -409 | -242 | -171 | -208 | -825 | -51 | -392 |
| EBITDA $ Million | -49 | 270 | 249 | 265 | -356 | 335 | 19 |
| EPS diluted in $/share | -0.88 | -0.41 | -0.28 | -0.34 | -1.35 | -0.08 | -0.64 |
| Cash from operating activities in $ Million | 214 | 238 | -51 | 153 | 91 | 147 | -48 |
| Capital Expenditure in $ Million | 48 | 44 | 52 | 86 | 121 | 128 | 107 |
| Free Cash Flow in $ Million | 166 | 194 | -103 | 67 | -30 | 19 | -155 |
| Cash and short-term investments $ Billion | 2.307 | 2.160 | 1.886 | 2.243 | 1.906 | 1.790 | 1.483 |
| Long-term Debt in $ Billion | 9.33 | 9.98 | 9.41 | 9.73 | 9.39 | 9.261 | 9.157 |
| Shares outstanding (diluted) in Million | 463 | 510 | 611 | 612 | 613 | 612 | 614 |
| Backlog | 3Q'18 | 4Q'18 | 1Q'19 | 2Q'19 | 3Q'19 | 4Q'19 | 1Q'20 |
| RIG Backlog in $ billion | 11.5 | 12.2 | 12.1 | 11.4 | 10.8 | 10.2 | 9.6 |
Source: Most of the data indicated above come from Morningstar, company press release, and Fun Trading for the last quarter.
Trends and Charts: Revenues, Earnings Details, Free Cash Flow, and Net Debt
1 - The company posted quarterly revenues of $759 million in 1Q'20
Transocean's total revenues in 1Q 2020 increased to $759 million from $754 million in the same period of 2019. The first-quarter 2019 adjusted net loss was $187 million or $0.30 per diluted share (excluding $205 million of net unfavorable items).
Shares outstanding on a diluted basis are now 614 million in the first quarter.
Cash and short-term investments were $1.483 billion at the end of the quarter, with total liquidity at $2.85 billion - including the company's $1.37 billion revolving credit facility. Cash flows from operating activities were a loss of $48 million.
2 - Free cash flow
Note: The Generic free cash flow is the cash from operating activities minus CapEx.
RIG had a free cash flow loss of $155 million in Q1 2020. The yearly FCF ("ttm") is a loss of $99 million. The company is not doing well in this segment, and the situation will continue to degrade. Lack of free cash flow means more debt, and Transocean has a considerable debt load or over $9 billion already, as we can see below.
3 - Net debt (gross debt minus total cash) is now $7.68 billion.
Net debt is about $7.68 billion as of March 31, 2020, which is a 3.5% increase from $7.52 billion the same quarter a year ago.
In this present condition, the debt is too high, and while it is not a present danger, the company will have to restructure its debt load down the road. The recent move from Diamond Offshore (DO) has been a wake-up call for the entire industry.
Conclusion and Technical Analysis
Transocean released its first-quarter 2020 results, and the initial reaction was a sigh of relief from shareholders because the company was smart enough to avoid some alarming comments related to the present situation. Jeremy Thigpen said in the conference call:
we've been encouraged to see that our customers are not canceling projects that were likely to proceed earlier in the year, but rather looking to defer and postpone their sanctioning generally by nine to 12 months.
However, we cannot remain optimistic in this environment, and we must conclude that Transocean will not be able to survive as it is and will have to restructure the debt to respond to the "new normal." We are entering a world where demand is falling fast, and production must be curtailed significantly. The offshore drilling sector is the first one to get affected by it, and the entire industry will have to go through a painful restructuring to adapt.
It is essential to know that this slowdown slop can't be stopped, and for the remaining long-term investors, you should use your trading to reduce or even exit your position with the minimum of damage. You still have little time to exit the sector without too much damage to your finance. However, the outcome can't be avoided.
Technical analysis for short-term trading
RIG is forming a descending wedge pattern with line resistance at around $1.30 and line support around $0.75. The stock will likely yo-yoing between the two lines for a while. It is crucial to accumulate at about $0.75 and sell at resistance between $1.25 and $1.30. Unless something new happens, that pushes the stock to cross the resistance or the support.
The only risk is on the downside right now. If oil prices continue to weaken, Transocean may experience contract terminations or renegotiation, and the contracting outlook may turn dismal. It could push many investors to bail out and force the company to start restructuring earlier while it has some leverage. I see a potential of $0.35 in this case and an opportunity for some suitable short-term trading.
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