Transocean: Long-Term Contract Commitments Are Back (NYSE:RIG)

Note:

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

After Monday’s market close, leading offshore driller Transocean released Q2 results largely in line with expectations.

Much more important, the company managed to extend its revolving credit facility by two years to June 2025 albeit at tough terms and vastly reduced capacity:

(…)(i) extend the maturity date to June 22, 2025 from June 22, 2023 with respect to the 2025 Extended Commitments (as hereinafter defined), subject to (a) permitted extensions thereof in accordance with the terms of the Revolving Credit Facility and (b) certain early maturity triggers, including if on any date the aggregate amount of scheduled principal repayments of indebtedness (excluding certain specified indebtedness) due within 91 days thereof is equal to or in excess of $200 million and available cash (pro forma for the repayment of such debt) is less than $250 million,(ii) reduce the borrowing capacity from $1.33 billion to $773.5 million until June 22, 2023, and thereafter reduce the borrowing capacity to $600 million until June 22, 2025 (the “2025 Extended Commitments”), including a reduction in the sublimit for the issuance of letters of credit from $500 million to $350 million,(iii) replace the Company’s ability to borrow under the Revolving Credit Facility at the reserve adjusted London Interbank Offered Rate plus a margin (the “Revolving Credit Facility Margin”) with the ability to borrow under the Revolving Credit Facility at a forward looking term rate based on the secured overnight financing rate (“Term SOFR”) plus the Revolving Credit Facility Margin and a Term SOFR spread adjustment of 0.10%,(iv) decrease the required available cash needed as a condition to borrowing from $500 million to $325 million,(v) require the Company to prepay outstanding borrowings under the Revolving Credit Facility if its available cash exceeds $325 million and(vi) permit the refinancing of certain indebtedness, subject to certain conditions, including limitations relating to liens, guarantees and maturity of any such refinanced indebtedness.

During the quarter, the company also bolstered liquidity by issuing almost 24.7 million shares under its existing $400 million at-the-market offering program (“ATM”) for net proceeds of $103 million. At the end of Q2, the company had utilized the ATM by more than 90%.

That said, Transocean had saved the best for last as subsequent to the earnings report, the company disclosed long-term contracts at new recovery-high dayrates for the ultra-deepwater drillships “Petrobras 10000” and “Deepwater Conqueror” with an aggregate backlog addition of $1.24 billion:

1. Drillship Petrobras 10000 received a 5.8-year contract for work offshore in Brazil. The contract will keep the rig busy until the end of the decade while adding an estimated $915 million in backlog excluding income associated with the customer’s anticipated use of the company’s patented dual-activity technology. The dayrate calculates to $432,000.
2. Drillship “Deepwater Conqueror” has been awarded a two-year contract in the U.S. Gulf of Mexico at $440,000 per day with up to an incremental $39,000 per day for additional products and services. The firm backlog portion calculates to $321 million. The contract is expected to commence in December in direct continuation of the rig’s current contract.

Particularly the Petrobras 10000 award is an important achievement as Transocean might be able to raise up to an estimated $450 million in secured debt against the contract.

With customers apparently willing to commit to privately-negotiated long-term contracts at highly attractive terms again, the already decent industry outlook has improved even further as also stated by CEO Jeremy Thigpen in the press release:

While the past eight years have been extremely challenging for the entire industry, it is clear that the recovery in offshore drilling is underway, as contracting activity, utilization rates for high-specification ultra-deepwater and harsh-environment assets, and dayrates all continue to rise. And, with a backdrop of hydrocarbon supply challenges, we are increasingly encouraged that this momentum could continue for the foreseeable future.

Bottom Line:

With the long-standing credit facility overhang now being addressed and the likely ability to raise a material amount of secured debt against the new Petrobras 10000 contract, Transocean’s liquidity should remain sufficient despite currently elevated capex requirements for the company’s newbuild drillships Deepwater Atlas and Deepwater Titan.

Thanks to the new long-term contracts, I would estimate reported backlog to increase to at least $6.8 billion in the company’s next fleet status report in October, up from $6.2 billion in July.

As customers have started committing to long-term contracts at industry-leading rates again, the already decent outlook for offshore drillers has improved even further.

Notwithstanding structural disadvantages induced by the company’s massive debt load, Transocean has demonstrated its ability to secure long-term contracts with leading operators at highly attractive rates.

Investors should consider getting or increasing exposure to the offshore drilling industry as the ongoing recovery shifts into high gear.

Given the positive developments discussed above, I am upgrading Transocean’s shares from “buy” to “strong buy” despite its premium valuation relative to restructured competitors Valaris (VAL), Noble Corporation (NE) and Diamond Offshore Drilling (DO).