Shares of Transocean (NYSE:RIG) fell after management reported on August 1st that the firm would be buying up the rest of Transocean Partners (NYSE:RIGP) that it doesn't already own in an all-stock deal valuing Transocean's unowned stake in the latter at around $247 million, but rose during the rest of the week through August 5th due in part to strong earnings but also due, I believe, to a better understanding of its deal. In what follows, I decided to dig into the transaction and discuss exactly why I believe this is a good deal for Transocean and what it likely means for investors moving forward.
A look at the deal
According to Transocean's press release on the matter, the firm will be issuing shares in order to exchange those for 19.7 million shares of Transocean Partners. This will mean that the company is buying up the 51% of the interests in three vessels, the Discoverer Inspiration, the Discoverer Clear Leader and the Development Driller III, that it does not already own. Instead of a share-for-share exchange, however, Transocean will be giving owners of Transocean Partners 1.1427 shares for each share of Transocean.
Using July 29th's closing price, this implies a value per share for Transocean Partners of $12.56 apiece, representing a gain on the company's share price that day of 15%. In the grand scheme of things, this is a fairly small premium, but given the tough energy environment that all players in this space are facing, it's something that owners in Transocean Partners probably can't complain a great deal about.
But does the deal make sense?
In my own view, the transaction makes a good deal of sense for Transocean at the moment. According to management, the firm will recognize instant cost savings of $10 million per year due to synergies between the parties. On top of this, Transocean will be able to retain around $29 million each year that Transocean Partners has been paying out to its noncontrolling owners (its shareholders). All-in-all, that represents cash flow to the company (after factoring in taxes of 20% (which I've used in prior financial forecasts for the firm)) of $37 million per year, implying a multiple of 6.7 times.
The best part of it is that the cash costs to shareholders of Transocean will be nothing since the deal is all-stock in nature. As opposed to dealing with additional debt and/or cash outlays by Transocean, they will need to contend with a diluted stake in the combined business instead. However, with Transocean having 365.39 million shares outstanding as of the time of this writing, total dilution should be about 5.8%.
Interestingly, there are other benefits to Transocean acquiring Transocean Partners in this manner. At this moment, the latter has cash and cash equivalents totaling $171 million. By all rights, Transocean already owns a good deal of this, but by acquiring the rest of the company that it does not already own, the remaining cash on hand, combined with the cash that will eventually come from the $108 million associated with Transocean Partners' accounts receivable, will also find its way into Transocean's bank account. It should be noted that these data points have, historically, been consolidated into Transocean's books, but the benefit will be that management will have greater flexibility regarding the cash now.
Besides these factors, one other thought comes to mind regarding the transaction. As of the time of this writing, Transocean Partners has no debt to its name. While Transocean does, this should, in theory at least, give Transocean additional collateral that it can utilize for the purpose of either issuing more debt or protecting its still-untapped $3 billion credit facility should lenders get scared about the business's chances of survival down the road. Add to this the fact that Transocean is receiving backlog worth $1.45 billion (though by the end of the fourth quarter, the very quarter in which this transaction should be completed, this will drop to $1.08 billion), and I don't see any issues associated with the deal. Again, it should be mentioned that the results of the backlog would eventually be consolidated into Transocean's financials anyways, but the value is the portion of it that it receives that it otherwise wouldn't.
Based on the data I have regarding this transaction, I cannot say that I dislike what Transocean is trying to accomplish. By merging back into a single entity, the company is increasing cash flow to itself, which will help it cope with declining sales, increasing its assets on hand, and maybe making it possible to issue more debt using those assets as collateral down the road. Yes, investors in Transocean are hit by some dilution but, in all honesty, I don't see this being an issue at this moment.
Disclosure: I am/we are long RIG.
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 own 2017 calls, not shares, in RIG.