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Transocean Analysis
Prepared by: John R. Pangere
July 2010
Sources: Transocean Ltd. Company filings and presentations, ETrade, Personal Calculations
Transocean, Ltd. (NYSE: RIG)
Date of Report: 7/14/2010 Shares Outstanding (Millions): 320
Current Price: $52.36 Institutional Holdings: 70.5%
52-week range: $41.88-$94.88 Fiscal Year Ends: 31-Dec
Average Daily Volume: 16,658,000 FY 2009 Net Income (Millions): $3,159
FY 2009 EPS (Reported): $9.84 Book Value, as reported (Millions): $20,559
FY 2009 P/E: 5.32x Market Cap. (Millions): $16,670
Dividend Yield: 0% Price/Book Value: 0.79x
Index Membership: NYSE Industry: Oil Services
Business Description:
Transocean, together with its subsidiaries, is the largest provider of international offshorecontract drilling services for oil and gas wells. Their particular focus is on deepwater and harsh
environment drilling services. Most of the company’s revenue is derived from dayrate contract
drilling. In addition, the company provides oil and gas drilling management services, drilling
engineering and drilling project management services, and oil and gas exploration and
production activities. The company was founded in 1919 (then known as Danciger Oil and
Refining Company) and is headquartered in Zug, Switzerland.
Investment Thesis
With the recent decline of nearly 50% in market value over the last 52 weeks due to the Gulf
of Mexico oil spill, the company is selling at a compelling valuation. The Gulf of Mexico oil
spill, due to the explosion and sinking of the drillship Deepwater Horizon, has pushed shares of
the company to sell at a discount to its book value and a loss of nearly $15 billion in market cap.
Currently, the book value (as adjusted by my estimates) is approximately $58.50 per share,
$5.50 less per share than the stated book value of the company based on their FY2009 annual
report. The adjusted book value represents the reproduction cost of the assets if a competitor
were to enter into the offshore business and reproduce all the assets currently held by RIG.
Adjustments include the loss of the Deepwater Horizon and a reduction in assets by the total
amount of debt the company currently holds.
With the shares trading at $52 per share, the shares can be bought at a discount of
approximately 11% adjusted book value. Historically, the company trades at a premium tobook value of approximately 2.5x over the past 5 years, with a high of 5x and a low of 1x. The
current book valuation compares favorably with the Oil & Gas Drilling industry, which currently
sells at approximately 2.3x book value, with the average of the company’s 4 closest competitors
at 1.46x book value.
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Transocean Analysis
Prepared by: John R. Pangere
July 2010
Sources: Transocean Ltd. Company filings and presentations, ETrade, Personal Calculations
A return to historic book valuation would provide a 180% gain from current prices (best casescenario), while a return to the average of the company’s 4 closest competitors book value
multiples would provide a 65% return.
The company has proven to be very profitable. Over the last 5 years, the company has had an
average net margin of approximately 33% of sales. Again, the market is discounting the shares
of the company due to the uncertainty of the oil spill, but the company earned just over $3
billion in FY2009, or $9.84 per share from continuing operations. With the stock around $52
per share, this implies a price-to-earnings ratio of approximately 5.3x. On a trailing 12-month
basis, the company earned approximately $2.9 billion, implying a price-to-earnings ratio of 5.7x.
Historically, the company has a price-to-earnings ratio of 15x on average over the last 5 years.
The company has sold at a low price-to-earnings of 4.3x and a high of 38.5x over the past 5
years. The current industry price-to-earnings ratio is approximately 19x, with an average price-
to-earnings ratio of the company’s 4 closest competitors of 9x. The current price of the
company is favorable with the current price-to-earnings ratio near its 5-year low.
On a trailing-twelve-month basis, a return to the historic company average price-to-earnings
ratio would provide a return of nearly 160%, while a return to a modest 9x earnings would
provide a return of 56%.
The company has been able to pass on higher costs to its customers. The contract dayratesfor the company’s fleet has steadily increased over the past 3 years from approximately
$210,000 per day in 2007 to $271,000 per day in 2009, an increase of 28.5%. Even though
revenues have been steadily decreasing since FY2008, part of the decrease has been offset by
higher rates being charged to customers. With this kind of pricing power, the company should
be able to offset the majority of any declines in sales of future operations.
The company produces a large amount of free cash flow to use at its discretion. Over the last
3 years since the merger with GlobalSantaFe, the company has averaged approximately $2.5
billion in free cash flow (defined as the cash provided by operations, plus depreciation and
amortization, less capital expenditures, taxes and interest). In FY2009, the company collected$2 billion in free cash flow. Cash flow for FY2010 is expected to increase, despite an expected
fall in revenues, due mainly to reduced capital expenditures (as seen below from the
comparison of Q1 2010 and Q1 2009).
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Transocean Analysis
Prepared by: John R. Pangere
July 2010
Sources: Transocean Ltd. Company filings and presentations, ETrade, Personal Calculations
2009 2008 2007 2006 Q1 2010 Q1 2009
Operating Cash Flow $4,974 $5,769 $3,059 $1,637 $1,066 $1,287Capital Expenditures $3,052 $2,208 $1,380 $876 $379 $708
Free Cash Flow $1,922 $3,561 $1,679 $761 $687 $579*Numbers in millions
This free cash flow can be used in several ways, such as to increase the cash position of the
balance sheet or to repay debt. In addition, the company has authorized a share repurchase
program of up to $3.2 billion worth of shares (approved in 2009 and of which it has purchased
$200 million worth of shares at an average price of $81.63 per share), and a cash dividend,
approved by shareholders, of $3.11 per share beginning in July of 2010. The cash dividend will
currently provide shareholders a yield of 6%. The average yield of the industry is 2.5%.
Simply put, Transocean uses approximately half of its operating cash flow (on average, $4.6billion over the last three years) and reinvests it back into the business. The rest it uses to
reduce debt and add more cash to the balance sheet (thereby, strengthening its financial
position), buy-back shares, and beginning in July, issue a dividend to shareholders. The
dividend will cost approximately $1 billion to implement, which the company has proven it has
the capacity to generate.
The company has a strong balance sheet. Since the merger with GlobalSantaFe, Transocean
has been strengthening their balance sheet. After initially taking on more debt to merge with
GlobalSantaFe (as many other companies that acquire their competitors do), they have been
steadily reducing the debt on their balance sheet (numbers in millions, except
Debt/Debt+Equity ratio):
2007 2008 2009
Cash 1,241 963 1,130
Debt 17,257 13,557 11,717
Net Debt 16,016 12,594 10,587
Equity 12,571 17,167 20,559
Debt/Debt+Equity 0.56 0.42 0.34
A stronger balance sheet allows the company more financial flexibility in order to weather a
downturn in offshore oil production.
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Transocean Analysis
Prepared by: John R. Pangere
July 2010
Sources: Transocean Ltd. Company filings and presentations, ETrade, Personal Calculations
Investment Risks
Uncertainty regarding the outcome of potential litigation and costs associated with theDeepwater Horizon accident. Transocean has been named in a number of lawsuits stemming
from the oil spill and the outcome and costs associated with those lawsuits could take a
number of years (the Exxon Valdez spill took 19 years to be decided in court). There were 11
deaths, 9 of whom were company employees, when the Deepwater Horizon exploded. The
company maintains insurance coverage of up to $10 million per occurrence and $50 million in
aggregate for crew personal injury liability and $950 million liability coverage exclusive of the
personal injury deductibles. The company is at risk for any claims over $950 million.
Uncertainty regarding potential future off-shore drilling regulations in the US. While off-
shore drilling is already heavily regulated in the US, the oil spill may push lawmakers to increasethe already stringent regulations causing a substantial increase in operating costs in US waters.
In FY2009, the company generated 19.3% of revenues from operations in the US ($2,239
billion). Increased costs and/or any stoppage of drilling in the US could impact revenues
causing the stock to decline further. For instance, if operations were to cease in the US (worst-
case scenario), assuming revenue and costs of goods sold declined proportionally with all other
costs remaining the same (see table below), a 20% loss of revenues from the prior year, all else
being equal, would indicate the following (numbers are in millions excepts per share amount):
Sales (net) 9,245
Cost of Goods Sold 4,112
Selling, General &Administrative 209
Depreciation 1,464
Total Operating Expenses 5,785
EBIT 3,460
Interest expense (479)
Other Income (expense) (net) (351)
Pretax Income 2,630
Income Taxes - total 526
Net Income (loss) 2,104
Shares fully diluted 321
EPS per fully diluted share 6.55
At an earnings per share of $6.55, a meager price-to-earnings ratio of 9x would value the shares
at $58.95 per share, and a return to the historic ratio values the shares at $98 per share.
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Transocean Analysis
Prepared by: John R. Pangere
July 2010
Sources: Transocean Ltd. Company filings and presentations, ETrade, Personal Calculations
Any loss from the company’s largest customer, BP, could result in depressed revenues. BP
accounted for 12% of company revenues in FY2009. Any loss of business from BP couldmaterially impact the company’s profitability. The loss of the Deepwater Horizon will reduce
2010 revenues by approximately $126 million. While $126 million is a very small percentage of
total revenues, a total loss of revenues stemming from BP (another worst-case scenario)
amounts to $1.4 billion per year. Assuming this decline (as above) would indicate the following
(numbers are in millions, except per share amounts):
Sales (net) 10,781
Cost of Goods Sold 4,626
Selling, General & Administrative 209
Depreciation 1,464
Total Operating Expenses 6,299
EBIT 4,482
Interest expense (479)
Other Income (expense) (net) (351)
Pretax Income 3,652
Income Taxes - total 730
Net Income (loss) 2,922
Shares fully diluted 321
Earnings per fully diluted share 9.10
As above, a return to a modest 9x earnings would indicate a value of $81.90 per share, and a
return to the historic price-to-earnings ratio would indicate a value of $137 per share.
In addition, the following chart represents the drillships currently under contract with BP:
Rig Location
ContractStartDate
Expiration Date
CurrentDayrate
EstimatedOut ofServiceDays Notes
DiscovererLuanda Angola
FY2010Q3
FY2017Q3 $430,000
*UnderConstruction
DeepwaterHorizon USGOM
Sept.2007
Sept.2013 $497,000
*Lost inaccident
GSFDevelopmentDriller II USGOM
Nov.2008
Nov.2013 $580,000 10
DevelopmentDriller III USGOM
Nov.2009
Nov.2016 $403,000
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Transocean Analysis
Prepared by: John R. Pangere
July 2010
Sources: Transocean Ltd. Company filings and presentations, ETrade, Personal Calculations
Sedco Express Angola June.2005 June.2010 $188,000
*Contracted to
Noble EnergySept. 2010Paul B. Loyd,Jr. UKNS
Apr.2009
Mar.2012 $485,000
GSFConstellation Trinidad
Aug.2009
Aug.2010 $110,000
*Contracted toTotal Sept.2010
*USGOM is the US Gulf of Mexico
A breakdown of the expected revenues from BP for FY2010, adjusted for the loss of the
Deepwater Horizon, are as follows:
2010 Revenue from BP (Estimated)Discoverer Luanda $ 58,050,000
Deepwater Horizon $126,735,000
GSF Development Driller II $205,900,000
Development Driller III $147,095,000
Sedco Express $ 33,840,000
Paul B. Louyd, Jr. $177,025,000
GSF Constellation $ 26,400,000
Total $775,045,000Adjusted for loss of DeepwaterHorizon $693,040,000
Even with the loss of the Deepwater Horizon, the impact on revenues is limited. BP still has
several ships under contract for various periods of time in locations worldwide. If Transocean
were to lose BP as a customer, it would not happen until the length of the contracts on all ships
contracted to BP run their course. Note: There was a loss of revenue due to the recent
moratorium on offshore drilling in the US. The moratorium was found to be unlawful, but the
amount of revenue generated from the USGOM is still uncertain.
The price of oil can materially affect the number of drillships utilized in any given year. The
oil services business is highly cyclical, and any fall in the price of oil may cause fewer contracts
for drilling operations due to less profitability for the company’s customers. In the past year, as
the price of oil has declined from its high of near $150 per barrel, the utilization rate of thecompany’s rigs has also declined.
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Transocean Analysis
Prepared by: John R. Pangere
July 2010
Sources: Transocean Ltd. Company filings and presentations, ETrade, Personal Calculations
Potential Catalysts:
1. Any claims against the company involving the Gulf of Mexico oil spill are dismissed :While it is highly unlikely the company will not incur any costs associated with the oil
spill, the possibility exists that they will be cleared of being totally at fault. Transocean is
mainly an oil and gas drilling company, not an exploration company such as ExxonMobil
or BP.
According to Transocean’s latest SEC filings, the company’s contracts are written in such
a way as to hold them harmless in the event of a blowout of the well and any
environmental damage associated with such a disaster. In the case of the Deepwater
Horizon accident, BP, the customer in this case, has agreed that they will indemnify
Transocean from the costs associated with the accident, except for lost revenue to thecompany. According to Transocean’s latest quarterly report for the first quarter of
FY2010:
“Under our drilling contract for Deepwater Horizon, the operator has agreed, among other
things, to assume full responsibility for and defend, release and indemnify us from any loss,
expense, claim, fine, penalty or liability for pollution or contamination, including control and
removal thereof, arising out of or connected with operations under the contract (other than for
pollution or contamination originating on or above the surface of the water from fuels,
lubricants, motor oils and other substances, as to which we similarly agreed to assume
responsibility and protect, release, and indemnify the operator). The operator has also agreed,
among other things, (1) to defend, release and indemnify us against loss or damage to the
reservoir, and loss of property rights to oil, gas and minerals below the surface of the earth and
(2) to defend, release and indemnify us and bear the cost of bringing the well under control in
the event of a blowout or other loss of control.”
This bodes well for Transocean since the estimated cleanup costs of the spill are in the
multi-billions. While there will be other costs the company will incur due to the
accident (mainly litigation), the company should benefit from not having to provide
substantial amounts of money for the cleanup associated with the accident.
2. A rise in the price of oil : Oil is essential for economies worldwide to operate without
interruption. Until there is a better, cheaper alternative, oil will be produced andconsumed by the world. According to the US Energy Information Administration, the
world as a whole consumes 84 million barrels of oil per day, an increase of nearly 10
million barrels per day from just ten years ago. In addition, with developing nations
such as China and India requiring more and more oil to continue their development,
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Transocean Analysis
Prepared by: John R. Pangere
July 2010
Sources: Transocean Ltd. Company filings and presentations, ETrade, Personal Calculations
consumption of oil may increase even more substantially over the next ten years than it
did the previous ten years.
3. Reduction/sale of unused and/or less profitable fleet. The company generates the bulk
of its revenues from its fleet of high-spec and mid-water floaters. The following table
represents the utilization of ships by type of drillship:
Utilization Q1 2010Avg. DailyRevenue
High Spec Floaters
Ultra-deepwater Floaters 88% $486,000
Deepwater Floaters 71% $383,800
Harsh Environment 98% $400,100Midwater Floaters 67% $331,600
High-Spec Jackups 63% $166,000
Standard Jackups 53% $133,100
Other Rigs 50% $72,700
Total Fleet 66% $295,700
Taken together with the utilization rates of their less profitable drillships, the company
may be able to unlock larger margins and reduced expenses with a disposition of the
less utilized and less profitable fleet while concentrating solely in deep water, harsh
environment and mid-water areas.
Recommendation:
Upon my review of Transocean’s company filings and taking into account the Deepwater
Horizon accident, I believe the recent selloff in the company’s stock is overdone. It is true that
there is uncertainty regarding future offshore drilling operations in the US, but given that the
majority of the company’s revenues come from outside of the US and the fact that oil is
essential for the world economy to continue production, the problems the company currently
face will be compensated for through their continued and future offshore operations.
Based off of my calculations and assumptions, I believe that Transocean is worth, at the very
least, $81 per share, more than 50% above the closing price as of Wednesday, July 14, 2010.
The company is still selling at a discount to its book value, but I suspect that that will not be for
very much longer. I feel that the stock is safe to buy up to my calculation of adjusted book
value of $58 per share. In addition, while the upcoming dividend may be attractive to those
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Transocean Analysis
Prepared by: John R. Pangere
July 2010
Sources: Transocean Ltd. Company filings and presentations, ETrade, Personal Calculations
seeking dividend income from their investments, my opinion is that those funds set aside for a
dividend payment are better used to buy back shares at the current price.
I will continue to monitor Transocean as an investment until I believe my thesis no longer holds
true. The 2nd
quarter of 2010 earnings are due out shortly, so a clearer picture of the impact
from the Deepwater Horizon incident may emerge at that time.
Appendix:
Comparison of Transocean and 4 largest competitors:
Company Current Price P/E Price-to-Book
Transocean 52.36 5.32 0.82
Noble 31.87 5.10 1.23
Diamond Offshore 65.91 6.95 2.52
Ensco 41.61 8.27 1.07
Pride 24.68 16.03 1.01
Average of 4 competitors 9.09 1.46
Comparison of Transocean and 4 largest competitors pre-accident:
Company Price P/E Price-to-Book
Transocean 88.77 9.02 1.39
Noble 42.42 6.79 1.64
Diamond Offshore 91.01 9.60 3.48
Ensco 46.91 9.33 1.21
Pride 31.01 20.14 1.27
Average of 4 competitors 11.46 1.90
Oil Consumption/Production Comparison:
Consumption 2009 Production 2009 Consumption 1999 Production 1999
US 18686 9000 19519 8993
China 8200 3991 4363 3317
India 2980 879 2031 765
World 83737 84000 75758 74849Obtained from US Energy Information Administration website: www.eia.doe.gov