Transocean (NYSE:RIG), the world’s largest offshore drilling company, is poised for a relatively strong 2014 on growth in the deepwater drilling market, cost-cutting initiatives as well as easing corporate governance issues. Here is a quick look at what to expect from the company in 2014.
Growing Deepwater Market Will Benefit The Company
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Activity in the upstream space is largely driven by the outlook for oil and gas prices, which in turn influences oil companies’ capital expenditures. This year, Brent crude prices have largely been above $100 per barrel while natural gas prices have also been on the rise in most parts of the world. These higher prices have enabled oil and gas companies to undertake more expensive and risky plays such as deepwater exploration. The deepwater drilling market is currently one of the fastest growing segments in the oilfield services industry. According to consulting firm Wood Mackenzie, the number of deepwater exploration, appraisal, and development wells drilled each year is expected to increase from around 500 per year in 2012 to close to 1,250 per year by 2022. The outlook for deepwater spending looks promising as expenditures are expected to rise from around $43 billion in 2012 to close to $114 billion in 2022, translating to growth of close to 10% per year.  The higher drilling activity bodes well for demand for offshore rigs provided by drillers such as Transocean who have been focused on the higher-end of the offshore market.
Cost Cutting Plan Should Bolster Margins
Transocean has not been as profitable as some its peers such as Seadrill (NYSE:SDRL) due to higher operations and maintenance costs as well as a relatively older fleet. However, the company has been downsizing its shore-based support infrastructure following the sale of its jack-up rig fleet last year, and has also been streamlining and consolidating some business functions while eliminating some of its non-core operations. Transocean says that these initiatives should help raise operating income by around $800 million by the end of FY 2015. We believe that these improvements should help the company’s margins in 2014 as well.
Expect A Master Limited Partnership IPO
Transocean intends to spin off some of its assets into a master limited partnership in 2014, a move that the company says will complement its existing capital structure and provide some additional financial flexibility. The company is expected to conduct an IPO for the proposed entity next year. Many energy services companies are opting to move assets into MLP structures, since they do not need to pay income taxes at the corporate level and typically pay out a bulk of their cash flows to investors through distributions.  It is possible that the company could spin off assets such as its ultra-deepwater drillships which have long-term contracts and stable cash flows into this MLP structure.
Corporate Governance Issues Will Ease
Transocean recently mended fences with activist investor Carl Icahn, who had launched a proxy battle against the company earlier this year, by agreeing to raise the company’s dividend to around $3 per share for 2014-15 from a previous dividend of around $2.24 per share, and also agreeing to make some changes to the company’s board. Under the agreement, in return, Mr. Icahn has committed to restrict his future moves regarding Transocean  while supporting the company’s board in the next annual general meeting. These developments should clear some clouds that were hovering over Transocean’s corporate governance, and will allow management to focus on growing on the company’s core business.Notes: