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Transocean (NYSE: RIG) continues to play a game of catch-up with the offshore rigs market. Every time the company makes a move to cut costs and preserve its financial position, producers continue to cut costs and lower the chances that Transocean will put an idle rig back to work.
This past quarter was much of the same. Earnings continued to decline, but Transocean kept its balance sheet in order to allow it to make its recent move to buy back the outstanding shares in Transocean Partners (NYSE: RIGP) and ride out this tough market. Let's take a look at the company's most recent results, why the company decided to buy out its partnership, and what investors should be watching for going forward.
By the numbers
Data source: Transocean earnings releases.
Transocean's earnings were a bit of a mixed bag, really. The company did see some expected declines in revenue and earnings, but its first-quarter results benefited somewhat from a gain related to an early termination fees on two rigs. With very little new work coming in the door, total fleet utilization was down to 47% compared to 75% this time last year.
At the same time, though, the company completed construction on two of its ultra-deepwater drillships --Deepwater ProteusandDeepwater Thalassa --and both started work under previously negotiated contracts. Transocean also reactivated one of its harsh-environment floater rigs and was able to lower its operating expenses from $665 million in the prior quarter to $500 million.
Transocean ended the quarter with $2.15 billion in cash on hand. The company did draw down its cash reserves in the quarter as it paid down $251 million in long-term debt. However, its current cash flow generation still exceeds its capital spending, so there's still some strength in the company's balance sheet as it works through this long slog of weak demand.
The second quarter was actually a pretty quiet one for Transocean from an operational standpoint. A couple of rigs came off contract, a few others picked up some short-term spot work, and its newly constructed rigs went into service. Financially, the company was able to lower its debt load by refinancing some of its debts and putting some of its cash to work.
The big news actually came just a few days ago, when the company announced it was buying back all outstanding shares in Transocean Partners. The deal will give 1.1427 shares of Transocean for every share of Transocean Partners, which, at the time of the announcement, was a 15% premium to market price.
The original intent of Transocean Partners was to be a vehicle that could help the company monetize its large newbuild program a little faster by dropping down partial ownership of newer rigs on long-term contracts to the partnership in exchange for cash. For this to work, though, it requires that the partnership have access to cheap capital through debt and share issuances. When Transocean planned the original spinoff of the partnership, it was projecting a distribution yield of 6.6% that it deemed a reasonable rate to raise capital. Now that share prices have dropped precipitously and its yield stands at 13.3%, it cannot raise capital effectively, making the whole purpose of having the partnership obsolete.
Rather than keeping this structure and allowing it to deteriorate even further, Transcoean will buy it back and realize the cost savings of common reporting as well as not shelling out cash to owners at the partnership level.
From the mouth of management
Transocean can't force producers to spend money on drilling, so the one thing it can do to control its destiny is keep its fleet under contract operating effectively and controlling costs on its inactive equipment. According to CEO Jeremy Thigpen, he likes what he sees on this front:
Revenue efficiency is a measure of how much the company's rigs under contract are actually working versus downtime -- the higher the percentage, the better.
What a Fool believes
Transcocean's fleet of rigs has changed drastically in the past two years. The company has scrapped 21 of its older rigs that were a drag on profitability, and it continues to cut costs by lowering its idle equipment expenses and bringing Transocean Partners back under the same umbrella. These moves are absolutely necessary to preserve any form of profitability over the next several quarters, because it doesn't look like the market for offshore rigs is going to improve any time soon.
For investors, it's encouraging to see management making the right moves, but it will likely take a long time before its stock actually realizes the benefits of these changes. While it may be worth keeping an eye on Transocean as a potential investment, there's certainly no rush to go and buy shares today.
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