VTDRF - Transocean: Registration Statement For Largest Shareholder No Reason To Worry - Buy

2023-09-07 13:28:40 ET

Summary

• Last week's registration statement has caused some flurry among investors with Transocean Ltd.'s largest shareholder, Frederik Mohn seemingly looking to dispose of some or even all its holdings in the company.
• With Mr. Mohn's overall return on his investment in Transocean still negative and considering ongoing, strong industry conditions, I would be very surprised to see him selling shares anytime soon.
• Assuming full conversion of the company's remaining exchangeable notes, Transocean would be required to issue 143.2 million new shares.
• While the company has the option to settle the remaining exchangeable notes partially or even entirely in cash, the stock's stellar performance has resulted in required cash outlays becoming prohibitive.
• With oil prices at their highest levels year-to-date and ongoing, strong demand for offshore drilling services, I would advise investors to look through the noise resulting from last week's shelf registration statement and potential, additional exchangeable notes conversions in the near future and use any major weakness to initiate or add to existing positions.

Note:

I have covered Transocean Ltd. ( RIG ) previously, so investors should view this as an update to my earlier articles on the company.

With oil prices at 10-month highs and ongoing, strong demand for offshore drilling and related support services, one would assume all stocks in my offshore oil and gas coverage universe trading at or near 52-week highs.

While this holds true for leading offshore drillers Noble Corp. ( NE ) and Seadrill ( SDRL ) as well as support and specialty services providers Tidewater ( TDW ), SEACOR Marine Holdings ( SMHI ) and Helix Energy Solutions ( HLX ), other stocks have been struggling to reach new highs.

Particularly shares of jack-up pure play Borr Drilling ( BORR ) have experienced meaningful selling pressure following a surprise outlook revision last month.

But even shares of market leader Transocean have retreated somewhat from recent highs, but this doesn't change the fact that the stock's 12-month and year-to-date performance has been absolutely stellar and second only to offshore support services provider Tidewater.

However, last week's registration statement on form S-3 has caused some flurry among investors, with the company's largest shareholder Perestroika (Cyprus) Ltd. or "Perestroika" seemingly looking to dispose of some or even all its holdings in the company:

To provide some background:

Perestroika is owned by Frederik W. Mohn, a member of the Board of Directors and former controlling shareholder of Songa Offshore SE ("Songa"), a Norway-based offshore driller which was acquired by Transocean in 2018.

Perestroika AS, Songa Offshore's largest shareholders, will through the Offer become Transocean's largest shareholder, with a holding of shares and rights to shares equal to approximately 12% of the combined entity on a fully diluted basis. Perestroika has accepted a 12-month lock-up on the Consideration Shares to be received by it. As part of the Combination, it has been agreed that the Transocean Board will nominate Mr. Frederik W. Mohn, chairman of Songa Offshore, to serve as director on the Transocean Board.

Please note that Mr. Mohn's position in Transocean has been underwater basically right out of the gate, but after adding to his holdings at lower prices through open market purchases and the recent conversion of exchangeable notes, he has moved somewhat closer to break-even.

Remember also that last week's S-3 filing simply replaced the previous registration statement, which was about to expire after three years, with the only difference that Perestroika A/S recently exercised conversion rights for approximately $213 million in exchangeable notes (emphasis added by author):

On August 14, 2020, Transocean Inc. issued $237,933,000 aggregate principal amount of 2.5% Senior Guaranteed Exchangeable Bonds due 2027 (the "New Exchangeable Bonds") in exchange for $396,556,000 aggregate principal amount Transocean Inc.'s existing 0.5% Exchangeable Senior Bonds due 2023 (...).

In April 2023, Perestroika (Cyprus) Ltd. exchanged approximately $213 million aggregate principal amount of the New Exchangeable Bonds under the terms of the indenture governing such bonds at the applicable exchange rate. As part of the transaction governing the exchange, we delivered approximately 34.6 million Transocean Ltd. shares and additional immaterial cash consideration to Perestroika (Cyprus) Ltd.

The Registration Rights Agreement provides that we will file a registration statement registering the resale of all of the registrable securities. This registration statement is being filed to satisfy this requirement under the Registration Rights Agreement.

With Mr. Mohn's overall return on his investment in Transocean still negative, and considering ongoing, strong industry conditions, I would be very surprised to see Perestroika selling shares anytime soon.

In a recent presentation , the company also disclosed the conversion of the remaining $24.6 million aggregate principal amount of the 2.5% Senior Guaranteed Exchangeable Bonds into approximately 4 million common shares.

Considering the fact that both the company's 4.00% Senior Guaranteed Exchangeable Bonds due December 2025 and 4.625% Senior Guaranteed Exchangeable Bonds due September 2029 are even deeper into the money, I would expect additional conversions in the near future with up to 143.2 million new shares potentially being issued.

Assuming full conversion, Transocean's debt would be reduced by close to $600 million.

While the company has the option to settle the remaining exchangeable notes partially or even entirely in cash, the stock's stellar performance has resulted in required cash outlays becoming prohibitive.

At prevailing share prices, Transocean would have to pay close to $1.2 billion to settle approximately $600 million in outstanding exchangeable notes.

With liquidity still tight, I do not expect management to even consider using valuable cash for partial settlement of additional exchangeable note conversion notices:

On a different note, market participants might have been disappointed about the recent contract announcement for the 6th generation drillship Dhirubhai Deepwater KG1:

Transocean Ltd. (...) today announced that Oil and Natural Gas Corporation Ltd awarded the Dhirubhai Deepwater KG1 a binding Notification of Award for work offshore India. The 21-month program is expected to commence in the first quarter of 2024 and will contribute an estimated $222 million in backlog, excluding a mobilization fee of $5 million.

While the calculated day rate of below $350,000 indeed lags well behind recent contract fixtures, investors should note that the contract does not require costly services like managed pressure drilling ("MPD") and operating expenses offshore India being among the lowest in the world.

Consequently, I do not expect the contract's margin profile to deviate substantially from recently announced awards in other regions of the world.

Investors might also been waiting for a formal contract announcement for the newbuild 7th generation drillship Deepwater Aquila which has reportedly been awarded long-term work by Petrobras ( PBR ) offshore Brazil.

Please keep in mind that Transocean only holds a 20% stake in rig-owning entity Liquila Ventures but maintains the exclusive right to market and manage operations of the drillship.

Lastly, market participants are still looking for Transocean to secure near-term contract awards for its cold-stacked fleet of 6th and particularly 7th-generation drillships.

Bottom Line

With oil prices at their highest levels year-to-date and ongoing, strong demand for offshore drilling services, I would advise investors to look through the noise resulting from last week's shelf registration statement and potential, additional exchangeable notes conversions in the near future.

Considering management's less-than-stellar Q3 projections and recent overall stock market volatility, shares have actually held up pretty well.

Please note that Citigroup analyst Nikhil Gupta expects Transocean to generate almost $2 billion in free cash flow until the end of 2025, which in combination with exchangeable note conversions would result in net debt decreasing to well below $4 billion over the next 30 months.

Consequently, investors should continue using any major weakness in Transocean Ltd. shares to initiate or add to existing positions.

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