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By Erik Kobayashi-Solomon | 03-16-2012 10:00 AM

Prospects Looking Bright for Transocean

Morningstar's Stephen Ellis says the driller is getting a better handle on its operations, with new contracts, the recertification of current rigs, and a favorable Macondo settlement.

Erik Kobayashi-Solomon: Hi. I'm Erik Kobayashi-Solomon, co-editor of Morningstar's OptionInvestor newsletter. Today, it's my great pleasure to welcome Stephen Ellis, who is a senior analyst in charge of oil-services firms here at Morningstar. He is also co-editor of our sister publication called Opportunistic Investor.

Stephen, thanks for coming in.

Stephen Ellis: No problem. Thank you for having me.

Kobayashi-Solomon: So, in the OptionInvestor newsletter, we've taken a look at Transocean, a company that you cover, and I've recommended a couple of different investments in Transocean. These investments, frankly, weren't looking so good even two months ago, but things have really turned around now. I know there have been a lot of things going on, such as a dividend cut, a CFO change, a BP court ruling, and so on. What do you think are the most important things to know about Transocean right now?

Ellis: I think they are the things you mentioned, such as the BP court ruling. Transocean has indicated that it is taking a $1 billion charge for the Macondo oil rig settlement, which I think is really one of the more important things. From day one, we've been really of the position that the Macondo settlement going to be in an acceptable range, such as $1 billion potentially or maybe less.

Kobayashi-Solomon: But the market has been really worried about that, right? It's been a huge overhang for this stock.

Ellis: Yes. The fact that now we have an actual number can sort of put to rest some of those more crazy numbers out there of $3 billion, $5 billion, or $10 billion that could potentially bankrupt the company. I think that's a big issue of relief.

Kobayashi-Solomon: So, as long as that's off the table, now the stock can start trading more so based on fundamentals.

Ellis: Exactly.

Kobayashi-Solomon: Let's talk a little bit about your valuation. Your fair value estimate for the stock is $67 a share. Is that right?

Ellis: Yes.

Kobayashi-Solomon: The firm has had some recent good news with new contracts. But Transocean's stock is still trading a bit under that. What do you think it will take for the market to finally realize the fair value that you have on the stock?

Ellis: The good news today that you mentioned, I think, was actually kind of interesting. In January, Transocean indicated that it lost a contract for one of their rigs: Deepwater Expedition.

Kobayashi-Solomon: This is a huge deal, right? This is more than $0.5 million a day with the rig fees that the firm wouldn't be getting if it lost this contract.

Ellis: Exactly. The rig pretty much continued its downtime, and the customers said, "This is unacceptable; we can cut the contract." What happened is that in the recent Fleet Status Report, Transocean announced a two-year contract for that same rig at $650,000 a day, with the same day rate. So the firm got all its money back for a rig that you would have thought would have gotten a much lower day rate.

Kobayashi-Solomon: So this is really consistent with what your thesis has been all along that Transocean is taking some time to work through, let's say, upkeep problems with its rigs but it's going to work out.

Ellis: Yes. The firm has also been disclosing that maybe about half of its floating rigs have been recertified, and taken to the shipyards to have their blowout preventer (BOP) pressure-control equipment examined. Transocean is going to do that with maybe about another seven or eight rigs, this year. So, it seems like the firm is getting a better handle on things, on the downtime issues.

Kobayashi-Solomon: Transocean is starting to see the light at the end of the tunnel then.

Ellis: Right.

Kobayashi-Solomon: Well, that's great news and very interesting. Thanks for coming in and talking to me today.

Ellis: No problem. Thank you for having me.

Kobayashi-Solomon: Thank you for joining us. Please stop by the Morningstar OptionInvestor website where you'll find many more option ideas based on Morningstar's fundamental research.


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