The best you can say about Transocean (RIG) is that it has a tin ear for public opinion.
The company’s public response to the Deepwater Horizon disaster in April has been to say 1) It wasn’t our fault and 2) We’re not on the hook for very much money.
Even if true, and there’s a good chance both statements are true, this isn’t exactly how a company that gives a damn responds to what is on a clear path to being the biggest oil spill and oil-related environmental disaster in U.S. history.
And to continue the company’s sure-footed response (if sticking your foot in your mouth is sure-footed, that is), Transocean declared a $1 billion dividend to shareholders as the environmental disaster was still unfolding.
Predictably the dividend payout has raised the wrath of U.S. politicians. Senator Ron Wyden (D.-OR) and 17 colleagues have asked the Department of Justice to launch an investigation into Transocean’s financial transactions casting the dividend payment as an attempt by the company to avoid paying claims arising from the spill. The logic of the Senators’ letter escapes me: If Transocean is found liable for a big payout from the disaster, its $1 billion dividend payout certainly won’t change the size of the judgment. Transocean generated more than $5 billion in cash from operations in 2009 and could raise billions more in the capital markets to pay any conceivable judgment.
The stock dropped $5.28 or almost 9% today on news of the request for an investigation by Justice.
Political grandstanding aside, Wall Street is busy at work trying to figure out how big a hit the company will take from the Deepwater Horizon disaster.
The company, in my opinion, low-balled the potential cost in its conference call on May 6 following the May 5 announcement of first quarter earnings. Transocean cited its contract with BP (BP) that in the company’s reading indemnifies it against loss and its insurance policy that covers the destruction of the rig. The company estimates a 2010 loss of about $200 million related to insurance deductibles, increased insurance premiums, and legal fees.
An analysis by First Securities puts the figure at somewhere between $500 million and $1.3 billion, including $1 billion in payouts in lawsuits. Against that First Securities deducts $560 million in insurance on the rig.
If you believe that estimate, then Transocean is a cheap stock after today’s drop to $53.96. Shares traded at $92.03 on April 20. Given that the company has 320 million shares outstanding that drop adds up to a loss of about $12 billion in market capitalization.
If the $1.3 billion estimate from First Securities is correct, investors are looking at $10.7 billion in market overreaction.
Of course, there’s still the little, so far unresolved issue, of what caused the disaster. That could put a dent in these estimates. If Transocean was in some way negligent and that negligence caused the disaster, then all bets on the size of Transocean’s liability go out the window. For example, in that case you’d expect BP to go after Transocean to recover all or part of its costs.
Today, May 24, FBR Capital raised its rating on Transocean to “outperform” from “market perform.” That’s because after hearing testimony from BP, Transocean, and Halliburton (HAL), the company responsible for pouring the concrete that was supposed to have sealed the well, the Senate released a BP document that, in FBR’s opinion, reduces the likelihood that Transocean was negligent. A crust of frozen hydrates may have fouled the blowout preventer so that it couldn’t seal the well. If that’s the case—and the disaster isn’t the result of faulty equipment or maintenance–Transocean and Cameron International (CAM) would seem to be off the hook for a finding of negligence. That would reduce any potential liability immensely to something like the range that First Securities estimates.
There’s too much real uncertainly here for me to recommend that you load up on Transocean shares. My best estimates say that the stock is undervalued at the current price so I’m not selling it out of Jubak’s Picks today. The disaster is likely to reduce drilling in U.S. coastal waters and that will take some—but not a whole lot–of money out of Transocean’s revenue for the rest of 2010. In its conference call the company said that global demand for ultra deep water rigs remains strong, that demand for deep water rigs is soft, and that demand for jack-up rigs looks like it is headed to a recovery. All that takes my estimate of 2010 earnings down to a little less than $9 a share for 2010 and my target price down to $95 a share from $105.
Harder than estimating earnings is figuring out when the stock might start trading on earnings as opposed to news from the Gulf disaster. I’m pushing out my schedule to May 2011 from November 2010. Remember the Gulf has to get through hurricane season. High winds and tides from any storms will whip oil from the spill into a very dangerous froth.
Full disclosure: I own shares of Transocean in my personal portfolio.
Jaxle, I see your point on attitude. But my understanding is there are not a lot of deep and ultra-deep rigs in existence, and
Rig has the lions share. So if e and ps want to play they don’t have a lotta choice in using rig’s ball.
grindy2424,
If you had only gone down one more thread, you’d have seen my comment where I listed my current positions. But since you asked: SPXU, SDOW, SQQQ, EUO (my largest position), BGZ, TZA, and FAZ.
As you can tell, I’m all in for equity shorts!
I can’t help but think that RIG’s attitude in this mess will turn away future contracts. That throws the confrence call opinions out the window. I think RIG loses a lot of business so Jim, I think your estimates are way too high.
The bigger question is will 1040 hold? If not looks like time to get a bit more short. Futures look to drop to there
Ed,
I think you had a great read on this drop……. What positions do you have open now? Any shorts?
southof8,
You want to know why you’re not buying? Ok…
You’re looking at discounts from the top. But do you know where the bottom is? Remember, in bear markets, you play off the bottom. We haven’t found the bottom yet.
Anyone looked at the overseas markets this morning? Let’s just say it looks like a bear tsunami heading our way.
if you really believe in 95, that is a must buy stock with its current price. any comments?
Jim, Transocean by contract acts as an independent contractor in relationship to BP. It has the obligations to follow the drilling program as outlined by BP and it is responsible to conduct all the operations in a safe manner. Prior to running casing it is expected that the BOP (blow out preventers) be tested for functionality. If hydrate existed and interfered to a successful closure of the valves the pipe would not be run.
If the BOP test and did not pass muster Transocean will be in for a big liability loss.
As always, I appreciate your good work and follow closely your analyses and insights on markets and economic factors. Thank you very much.
much needed update! thank you!
California hasn’t allowed new drilling in forty years; that aint new. Won’t change either. Rig didn’t go from 47 to 90 because people thought california was all of a sudden gonna start drilling. Again, this is a deflation trade. But why the fear of deflation? What am I missing?
I think the drop in drillers is due to sympathy for RIG and some uncertainty of what Congress will do. But, you also need to look at where all the rigs are located, are they all in the Gulf of Mexico? Probably not. The ones that are not there have nothing to worry about. I thought I read that Brazil had much better offshore regs than we do, but I could be mistaken.
Personally, I’ve increased my holdings in DO a bit and will be looking to add more as they have a big presence outside the Gulf. I’ve avoided RIG in part because of things I’ve read of their safety record taking after their last merger.
Full disclosure: I own DO in my personal portfolio.
The dividend was established in February.
Let me put it this way- there WILL be some kind of new offshore drilling regulations- if there is anymore offshore drilling at all [note CA- bad as the Germans at unilaterally acting w/o official US sanction [the noive!] ;]
Whacking everybody with anything to do with deep drilling is not only fun, but also hip, and politically highly profitable right now. Imagine SP [funny girl!] accusing Mr. Obama of being in cahoots with Big Oil…but the truth is, we all are. It will work out when gas hits about, oh, $5/gal.
so you think this is political fear- fear of what politicians might do?
That’s a tough one for me to swallow, but I do agree that sell first and ask questions later is the mantra of the day after a huge run-up off the bottom last March. But RIG has given up almost that entire gain.
Thanks for the take.
Oops- sorry. I’m not Ed…
southof8
Maybe not as crazy as it looks, probably no ww conspiracy at work here: Besides all the bad press, every pol on the planet wants to take a hunk out of every driller, and no one knows what THEY are going to come up with. Investors don’t have any idea what may be coming in legislation- everywhere. And probably a goodly number are thinking one of two other ways: “What AM I doing in oil drilling [Waht can I tell the kids?]?” or “Happened to them, it could happen to me.”
That said, “fear gone panic” is like “when the blood runs in the streets”- almost. When absolutely no one will touch them, it will be a good time to buy these drillers. If Buffet does, or JJ, I’d bale right in too.
This is crazy. The WSJ had a post today showing all the drillers and related companies that had dropped 20% or more just since April 20. This seems more the deflation trade than specific to the Horizon fire or, more generally, drillers.
Is it possible the European banks’ balance sheets are still larded down with toxic MBS? As bad as Greece and Spain’s finances look, they’re not subprime borrowers taking out 105% of the hyped psuedo-equity times five condos that brought the banks down and the world to its knees.
There’s gotta be an explanation for the deflation scare beyond the PIIGS’ sovereign debt. At worst, the Euro zone has a few fewer members. Even if the EURO goes the way of the gold standard, how does that result in deflation?
This is fear gone panic. Can someone please educate me? RIG has peeled off what, $12 billion in market cap in a month? In a world where all of the future oil will be found in places very few companies can get to, RIG being one of them?
Ed, tell me again why we’re not buying the drillers at whopping discounts.
But, but, but Obama is not going to put up with CEO’s and executives passing the buck. What have you done, Transocean? You’ve surely released the wrath of Obama. Repent and take full blame immediately. Father Obama is not going to put up with this anymore. “Republicans caused everything. Republicans, republicans, republicans. Bush caused this entire mess. Republicans, Bush, Cheney, republicans, republicans, republicans. There’s enough blame to go around and I’m not going to put up with anymore finger pointing”.
Gotta love the politicians, especially when they start talking like daddy.
Jim,
Is it possible that the current price of oil has some psychological effect on the price of Transocean stock?