Transocean: Survivability Problems Are Piling Up (NYSE:RIG)


Image: Deepwater Invictus. Source: Vessel Finder

Investment Thesis

Transocean (NYSE: RIG) has been struggling for many years, and I have witnessed its slow financial deterioration on Seeking Alpha since February 2014.

Initially, I considered Transocean’s business model bulletproof on account of its massive backlog, which is still over $8 billion as we speak. Unfortunately, the whole building held one vulnerable support that would ultimately shake it down to the ground, and it is the debt load. It is what drove the majority of the offshore drillers that we know into their financial demise.

The backlog is probably why the company is still standing on its two feet while most of the offshore drillers that I have covered regularly have filed for bankruptcy or about to file a second one. From Diamond Offshore (OTCPK:DOFSQ), Valaris Plc (NYSE:VAL), Noble Corp. (NYSE:NE) to Seadrill (OTCQX:SDRLF), and many others, all of them were forced to file bankruptcy or just disappeared as Hercules Offshore moved to liquidate after a first unsuccessful bankruptcy.

The investment thesis is now clear. I do not consider Transocean as an investment and, thus, should be avoided. Meanwhile, for a specific group of traders, this struggling stock presents a nonnegligible opportunity as a trading vehicle that could reward those who can find the right timing.

Analysis: Two crucial financial elements that should be analyzed.

1 – Backlog Snapshot as of October 1, 2020

I suggest reading my preceding article about July 15, 2020 fleet status published on Seeking Alpha.

I have updated the backlog at the end of September. The company will publish the next fleet status around October 15, 2020. Of course, those numbers are not including the new contracts that have been awarded since July 15. However, looking at the market, I doubt that the company will provide a significant backlog addition this time. Furthermore, Transocean may indicate a few contract terminations or day rate renegotiations that will not surprise me.

The most recent average day rate was $307,800/d, and utilization improved from the same quarter a year ago. The third quarter may be the first quarter, with an average daily rate below $300K.

Day rates 2Q’19 3Q’19 4Q’19 1Q’20 2Q’20
Average daily rate $k/d 310.7 314.5 317.7 314.9 307.8
Average Utilization 56% 58% 61% 60% 66%

The total backlog is estimated at $8.3 billion as of September 30, 2020.

The backlog is not including the recent contract of the Deepwater Atlas for the Shenandoah project in the Gulf of Mexico with Beacon Offshore Energy for a backlog of $250 million.

The graph below shows the yearly distribution estimated by Fun trading. The $697 million estimated is about what is left for the last quarter of 2020.

Backlog Repartition per segment:

The graph below shows 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 Royal Dutch Shell contracts represent 53% of the total backlog of the company ($4.4 billion). The day rates in the contracts with Shell were reduced a couple of years ago, but the actual bearish oil market and Shell’s financial situation may require another cut soon.

Transocean is essentially an ultra-deepwater business, with over 73.2% 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 26.4% of the total backlog as of September 30, 2020.

2 – Debt Analysis as of September 26, 2020

1 – The debt

The debt load is the main issue here when it comes to the survival of the company. I do not think Transocean is immediately at risk of bankruptcy, but it cannot avoid it indefinitely. The stock price tumbled to $0.80 on Friday, which is a fresh record low. It is a clear warning that the company is treading water, and the situation could get worse fast.

RIG Transocean Ltd. daily Stock Chart

A quick review of the massive debt load and, more importantly, after assessing the dismal business environment created by the COVID-19 pandemic makes this drop quite obvious.

To add more anxieties, on September 16, 2020, analyst Charles Minervino a long time bull,

cut his rating to neutral, after being at positive since July 2018, while slashing his price target to $1.15 from $2.50.

He wrote in a note to his clients:

The offshore drilling industry is suffering from weak demand and substantial excess capacity, and while [Transocean] is among the better-positioned companies, it is not immune to the downturn,”

We know that the net debt (gross debt minus total cash) was $7.45 billion as of June 30, 2020, compared to $7.49 billion the same quarter a year ago, and the total cash is $1.51 billion.

2 – Recent development.

However, On September 9, 2020, Transocean managed to reduce its debt significantly.

[T]o exchange the existing notes set forth in the table below (collectively, the “Existing Notes”) for 11.50% Senior Guaranteed Notes due 2027 (the “New 2027 Senior Guaranteed Notes”) to be issued by Transocean Inc.

According to information […] $1,514,164,000 in aggregate principal amount of Existing Notes had been validly tendered […]

Based on the applicable total consideration and the amounts tendered as of the Expiration Time, approximately $688 million aggregate principal amount of New 2027 Senior Guaranteed Notes will be issued.

I have estimated the debt reduction at $826.2 million, decreasing the net debt to $6.62 billion now. Furthermore, Transocean will save approximately $34 million in interest annually, which is not negligible.

Note: On September 2, 2020, A notice of default has been issued to Transocean’s existing 2027 guaranteed notes. Even though Transocean has indicated it is meritless, we are still waiting for the court decision.

As a result of the interference caused by the filing of the TRO and Injunction and the delivery of the Notice, both of which Transocean believes are meritless, Transocean has elected to extend the Exchange Offers to provide Eligible Holders of Existing Notes the opportunity to continue to support Transocean and participate in the Exchange Offers.

Moody’s on September 10, 2020, said while rating the new notes:

Transocean’s Caa3 CFR reflects the company’s rising risk of default in light of its very high financial leverage, diminishing liquidity and Moody’s view on overall recovery on the company’s debt. The Caa3 CFR also considers the challenging offshore drilling fundamentals and limited prospects for the company to improve its cash flow generation and very weak credit metrics.

The rating outlook is negative, reflecting the continued oversupply of deepwater and ultra-deepwater rigs reducing the likelihood of sufficient dayrate improvement and increase in cash flow for Transocean.

3 – Concerns remain

One crucial concern is that Transocean shows a total of $2.788 billion in debt due in 2023 and 2024, which coincides with the renewal of the company’s undrawn $1.3 billion credit facility.

  • 0.50% Exchangeable Bonds due January 2023: $863
  • 5.375% Senior Secured Notes due May 2023: $503
  • 5.875% Senior Secured Notes due January 2024: $626
  • 7.75% Senior Secured Notes due October 2024: $390
  • 6.25% Senior Secured Notes due December 2024: $406

Source: 10-Q filing

4 – The deepwater Atlas and the Deepwater Titan

Adding more headaches, Transocean has two newbuild rigs, the Deepwater Atlas and the Deepwater Titan, to take care of in or before 2021.

The Deepwater Atlas on order from Sembcorp Marine’s subsidiary, Jurong Shipyard, has a contractual delivery date of September 27, 2020, but may be delayed. The rig has not secured a contract yet.

Transocean’s CEO, Jeremy Thigpen, said that the delivery date of the Deepwater Atlas might slip to the end of the year or into early 2021 due to shipyard challenges caused by the COVID-19 pandemic.

For the ones who are not familiar with building costs, I suggest reading this article.

Offshore drilling company Transocean expects its two ultra-deepwater drillships under construction in Singapore to cost it $2,25 billion in total, more than a double on the original order price.

Conclusion and Technical Analysis

The article above explains why offshore drilling is a lost cause, with oil prices struggling below $60 per barrel. It is a fundamental flaw in the Offshore drilling business model.

With low oil prices, operators have no incentive to invest a large amount of exploration CapEx, which will take over five years and perhaps ten years to generate the first dollar in cash flow.

Thus, daily rates have dropped to a level below the breakeven point due to lack of demand and increased competition caused by the number of rigs available.

Technical analysis for short-term trading

RIG formed a descending wedge pattern with support at about $90-$0.85 and resistance at $1.06-$1.10. The close on Friday may indicate a breakdown, but it is still not clear and needs confirmation.

However, assuming that an immediate restructuring does not threaten Transocean, I believe it is an excellent opportunity to buy and accumulate RIG at or below 0.80 with a wide-range sell target between $1.10-$1.60. This strategy is not without risks. Diamond Offshore surprised all of us recently when we all thought the company was potentially a survivor. I will probably take advantage of those low prices to trade short term RIG again.

Warning: Trade with caution only the money you can afford to lose.

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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 am trading short term RIG and find 0.80 or below attractive in this context.

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