How Will General Electric's Deal With Diamond Offshore Benefit Shareholders?

By Markets Fool.com

Image source: Diamond Offshore.

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"New" and "unique" aren't words you often apply to 60-plus-year-old companies. ButGeneral Electric(NYSE: GE), founded in 1878, andDiamond Offshore(NYSE: DO), which traces its roots back to 1953, have just teamed up on something new and unique in the oil drilling business.

No, it's not a new extraction method or piece of technological equipment: It's a new business model.A brand new business model that observers are saying represents a "material change" for the industry. Well, that's all right, but will it hold those same implications for shareholders?

Safety first
General Electric has been in the blowout preventer business since 1948.BOPs are high-pressure safety valves designed to close off a well hole to prevent the escape of the underground fluids and prevent a blowout from occurring.They became a household term when their failure aboard the Deepwater Horizon drilling rig caused the infamous BP oil spill in the Gulf of Mexico in 2010.

The BP oil spill demonstrated how BOPs are a critical safety component of a drilling rig, both onshore and offshore. So critical, in fact, that they are tested frequently. If any problems or issues are discovered, the entire rig needs to be shut down until they are repaired. This is, of course, an expensive proposition. According to Diamond Offshore CEO Mark Edwards, it costs the company (and its customers) half a million dollars for each day of rig "downtime."

That cost was considered a routine cost of business for the industry. Edwards referenced it as an "Achilles' heel," since even a small glitch could put a rig out of commission for days as the BOPs were serviced and tested. [http://www.reuters.com/article/us-diamond-offshore-ge-idUSKCN0VH1WM]That is, until now.

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Lease is the new buy
As part of the deal, GE bought back the BOPs aboard Diamond Offshore's four drilling ships in the Gulf of Mexico for a cost of $210 million. Now the company will lease those same BOPs to Diamond Offshore for an hourly rate (the program is officially called, "Pressure Control by the Hour").What makes the arrangement unique is that GE will not get paid when the rigs are offline. This passes some of the cost of an offline rig on to GE and encourages it to have "skin in the game" and to get the BOPs back online quickly.

That's good for Diamond Offshore, since it should help to reduce the rigs' downtime and also mitigate some of the costs of an idle rig -- although the exact daily pay rate hasn't been disclosed. Even better, Diamond Offshore's rigs will probably become more desirable to clients, who are affected just as much by offline rigs. The move is also expected to boost liquidity and reduce costs, benefiting Diamond Offshore's bottom line.

One potential drawback is that the desirability of Diamond Offshore's rigs may be short-lived. Industry analysts expect that there will be a lot of interest in this new model, which may result in similar deals among GE's and Diamond Offshore's competitors, such as Noble Corpand National Oilwell Varco. But for now, Diamond Offshore is likely to reap the rewards of being first.

A steady stream
GE will also benefit from this new arrangement. Sales of rig equipment tend to be lumpy, characterized by a big purchase and then a long wait. With this arrangement, GE is ensuring itself a more reliable income stream for a longer time horizon. The deal with Diamond Offshore is set to last for 10 years.

The equipment lease, though, is only one part of the story. Under the agreement, GE will also provide what it calls "engageDrilling Services"to Diamond Offshore. GE Oil & Gas personnel will be present on all rigs managing equipment monitoring, overhaul, repair, and certification, as well as software and data analytics.

This is part of a larger push by GE to become a "digital industrial company," offering customers not just equipment, but also software platforms, controls, analytics, and support. It also has the handy side effects of establishing long-term relationships between GE and its clients and improving its industry know-how and technology. GE's ability to develop and successfully execute these kinds of long-term partnerships will be critical for the company moving forward, as it completes the divestiture of its financial businesses.

The Foolish bottom lineThere's not much good news coming out of the oil and gas industry these days. So it's nice to see two important players in this space coming up with novel solutions that are mutually beneficial. According to Diamond Offshore's Edwards, "Subsea equipment repair and maintenance is the single largest cause of nonproductive time across our industry," so the advantages of this deal are clear and should result in improved operational outcomes for the company moving forward.

For GE, which is continuing to invest in its oil and gas unit despite recent industry turmoil, it's imperative to improve customer relationships and revenue streams, and this deal seems to do just that. It also aligns well with the moves that CEO Jeff Immelt is taking to reinvent the company.

That said, however, these are still trying times for the oil and gas industry and the companies providing services to that industry. While current investors of GE and Diamond Offshore should cheer this news, it's not quite strong enough to warrant buying into either company right now.

The article How Will General Electric's Deal With Diamond Offshore Benefit Shareholders? originally appeared on Fool.com.

John Bromels owns shares of National Oilwell Varco. The Motley Fool owns shares of and recommends National Oilwell Varco. The Motley Fool owns shares of General Electric Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.