I have covered Transocean (NYSE: RIG) previously, so investors should view this as an update to my earlier articles on the company.
Last week, leading offshore driller Transocean reported fourth quarter results largely in line with expectations despite experiencing some unplanned downtime for the drillship Deepwater Pontus after the rig lost a blowout preventer (“BOP”) in the Gulf of Mexico.
Earlier this month, the company released a new fleet status report which showed some decent dayrate improvement for short-term work in the Gulf of Mexico but the ongoing absence of long-term contract awards resulted in a $ 600 million sequential backlog decline to just under $ 6.5 billion.
For the quarter, the company recorded Adjusted EBITDA of $ 250 million while cash flow from operations reached $ 185 million.
Liquidity continues to be strong with almost $ 1 billion in unrestricted cash at year-end and $ 1.3 billion still available under the company’s undrawn revolving credit facility.
Unfortunately, Transocean is projecting a whopping $ 1.3 billion in capital expenditures in 2022 with the vast majority of this amount related to the anticipated delivery of the 8th generation ultra-deepwater drillships Deepwater Atlas and Deepwater Titan later this year.
In addition, the company is facing an aggregate of $ 524 million in scheduled debt maturities and principal installments this year.
Even worse, Transocean will have to make up for an almost $ 230 million cash flow hit this year after the drillships Deepwater Conqueror and Deepwater Skyros finished their ultra-high margin legacy contracts last quarter.
Particularly the decision to extend the Deepwater Skyros contract with TotalEnergies by one year at a painfully low dayrate of $ 195,000 hurts but this determination was made in 2020 at a time when the sky appeared to be falling for the offshore drilling industry.
Undoubtedly, management has a lot to accomplish over the next couple of quarters to avoid a liquidity crunch and position the debt-laden company for the future.
First and foremost, Transocean’s $ 1.3 billion senior secured credit facility is currently scheduled to mature in June 2023. The company will either have to extend the facility or find other ways to enhance liquidity.
With activity in a number of regions picking up and the Gulf of Mexico already showing some real dayrate progression, Transocean now has a decent chance to secure an extension later this year or in early 2023 but banks will likely require some clarity on the fate of the so-called “CAT-D” rigs:
The “CAT-D” rigs Transocean Equinox, Transocean Endurance, Transocean Encourage and Transocean Enabler are scheduled to roll off their respective contracts with Equinor (EQNR) between Q4 / 2022 and Q1 / 2024.
These semi-subs have been purpose-built to the specifications of Equinor and accounted for 30% of the company’s revenues and an even higher percentage of Adjusted EBITDA last year.
While Equinor holds priced options for all rigs, the company is unlikely to exercise them in the current environment as dayrates offshore Norway have not really moved in recent quarters and exercise prices are well above current market levels.
On the flip side, activity in Norway is widely expected to pick up next year as generous tax incentives have spurred the sanctioning of additional projects.
At this point, I would expect Equinor to extend two rigs at market rates later this year and decide upon the remaining rigs at some time next year. At an assumed dayrate of $ 350,000, the company would face a rather manageable $ 50 million cash flow hit next year.
Failure to extend the rigs in a timely manner and at sufficient terms would be a disaster as banks might very well decline a credit facility extension in this case.
Transocean will also have to deal with almost $ 1.7 billion in aggregate debt maturities and principal installments in 2023 and 2024.
Last year, the company secured an aggregate $ 460 million in shipyard financing for the Deepwater Atlas and Deepwater Titan. In addition, Transocean expects to raise approximately $ 350 million in secured debt against the Deepwater Titan‘s long-term contract with Chevron (CVX).
In a move to bolster liquidity and strengthen the balance sheet, Transocean entered into a $ 400 million equity distribution agreement with Jefferies LLC last year. So far, the company has sold 36.1 million shares into the open market for net proceeds of $ 158 million.
But even when including the $ 1.3 billion credit facility, the above-discussed $ 350 million in new secured debt and $ 275 million in restricted cash, Transocean projects liquidity of just $ 1.4 to $ 1.6 billion as of June 23, 2023 which represents the credit facility’s maturity date.
In a recent presentation, the company made the case for its business supporting approximately $ 4 to $ 4.5 million in long-term debt going forward as compared to net debt of almost $ 5.8 billion as of December 31st.
Transocean requires an operating fleet of between 25 and 30 rigs working at average dayrates of $ 300,000 to $ 275,000 to generate sufficient free cash flow to reduce debt.
Thanks to a decent number of legacy high-margin contracts with Shell PLC (SHEL) and Equinor, Transocean’s average dayrate calculated to $ 365,600 last year but utilization of the company’s fleet was just 53.4% due to a large number of rigs being cold-stacked or temporarily sitting idle.
Particularly the former Ocean Rig drillships “Ocean Rig Apollo“,” Ocean Rig Mylos “,”Ocean Rig Athena“and”Ocean Rig Olympia“have been stacked for more than five years already which makes a reactivation appear increasingly difficult both from a technical and financial perspective. Quite frankly, I would not be surprised to see each of these rigs requiring an investment well north of $ 100 million to get back into service.
On the conference call, management stated its expectation to reactivate some of its cold-stacked rigs soon which is in stark contrast to competitors Noble Corporation (NE) and Valaris (VAL).
While Valaris is currently in the process of reactivating a number of floaters after securing long-term contracts last year, the company has no plans for un-stacking additional rigs at this time.
Noble Corporation does not even bid its cold-stacked drillships due to an alleged lack of long-term contract opportunities at sufficient rates.
On the flip side, leading provider of offshore drilling equipment NOV Inc. recently pointed to “reactivation discussions on more than a dozen stacked floating rigs“.
Given these conflicting statements, investors will be eager to learn more about Transocean’s reactivation plans. But even in case the company manages to secure long-term work for some of its cold-stacked rigs, reactivation will require massive upfront capex thus putting further pressure on liquidity.
With the first major market finally showing some decent improvement, I remain positive on the offshore drilling industry but as customers’ capex budgets remain tight, further recovery is likely to be gradual.
While Transocean’s large fleet of cold-stacked floaters provides plenty of optionality in a tightening market, I continue to prefer restructured players with clean balance sheets and decent liquidity like Noble Corporation or Valaris at this point in the cycle.
But should things in the floater markets really start to take off and Transocean manages to get a handle on its debt and liquidity issues, the company’s shares should start to outperform less-leveraged peers by a wide margin.
With the rising tide likely to lift all rigs, speculative investors should consider an investment in Transocean.