How The MLP Spin Off Helps Transocean

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Transocean Partners, a master limited partnership (MLP) created by Transocean (NYSE:RIG), has filed for an initial public offering to raise up to $350 million. The MLP will hold about a 51% interest in rig companies that own and operate 3 ultra-deepwater drilling rigs located in the U.S. Gulf of Mexico. The company did not disclose the price or the number of units that would be sold. The move to create an MLP is part of Transocean’s deal with activist investor Carl Icahn to end a proxy battle that he launched against the firm last year. We believe that the MLP could allow Transocean to improve its near term liquidity position, in addition to allowing the company greater financial flexibility.

Trefis has a $46 price estimate for Transocean, which is about in line with the current market price.

See Our Complete Analysis of Transocean Stock Here

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MLPs Gaining Popularity In Low Interest Rate Environment

The master limited partnership structure  is often used in the energy infrastructure industry, since it allows companies to avoid paying corporate taxes, while distributing most of their cash flows to investors. This has made MLP offerings popular with investors seeking higher yields in the current low interest rate environment. According to Dealogic, the number of MLP public offerings grew from around 12 in 2012 to about 20 in 2013.  While the MLP structure is typically used to spin off assets such as pipelines that have long term contracts and generate stable cash flows, it has been finding favor among offshore drilling companies as well. For example, Seadrill (NYSE:SDRL), one of Transocean’s chief competitors, adopted this structure to spin off some rigs into a company called Seadrill Partners (NYSE:SDLP). SeaDrill Partners has done well in the market, rising by over 30% since it was listed in 2012. The company presently holds about 9 rigs, up from about 4 rigs when it was founded.

Transocean’s MLP Will Allow For More Financial Flexibility

Transocean Partners will hold about a 51% interest in rig companies that own and operate two ultra-deepwater drillships under contract with Chevron (NYSE:CVX) and one semi-submersible rig contracted to BP (NYSE:BP). All three rigs are located in the U.S. Gulf of Mexico and have an average remaining contract life of about four years. The MLP will also have the first rights over the next five years to acquire stakes in four drillships that Transocean has under construction. [1]

The creation of an MLP could help Transocean in multiple ways. Firstly, the proceeds from the IPO will go to Transocean, giving the company an immediate cash infusion, allowing it to bolster its balance sheet. Secondly, it could give the company a way to move assets off its balance sheet and raise liquidity to fund dividend payments and acquisitions, while still maintaining control of the assets. For instance, Transocean could sell (drop down in MLP terms) some of its rigs to the MLP, which would in turn fund its purchase by selling additional equity units or by issuing debt. Since the MLP should be able to raise capital at lower rates, [2] it could indirectly help to reduce Transocean’s cost of capital. Transocean owns a total of 74 rigs (excluding the three being spun off) and also has about 14 rigs under construction. Many of these rigs have long contracts and will potentially producing stable cash flows, making them ideal for the MLP.

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Notes:
  1. Transocean to Put 3 Deepwater Rigs Into Tax-Free Partnership, Bloomberg, June 2014 []
  2. Benefits of MLPs, Morningstar []