News Quickie: July 24, 2007
The merger of Transocean (RIG) and Global
Santa Fe (GSF) was remarkable on a number of levels. First, it's pretty
close to a true merger, a nearly extinct animal on Wall Street. While
RIG has about twice the capitalization of GSF, and while RIG will
be the name partner, the resulting company will be owned pretty much
in proportion to the existing ownership.
The more interesting thing in terms of energy investing is that as
the first major recapitalization in the deep water drilling segment,
the deal marks the start of financial engineering and value creation
in this sector. A significant result will be the distribution of $15
billion to stockholders of both companies.
“The $15 billion cash payment allows us to achieve a more appropriate capital structure and deliver immediate value to our combined shareholders,” GlobalSantaFe’s Marshall said on Monday.
In effect this transaction is a mini-LBO. I
say “mini” because if KKR had done the deal, the leverage
would have been much greater. But even this moderate amount of leverage
should be very beneficial to stockholders (not to mention allowing
the company’s managements to breathe easier). Cash flow visibility
in the deep water drilling area has never been better, so leveraging
that cash flow will add significant value to these shares.
I wrote a piece called Drillers and Service
Companies on 6/7/07 (posted in the “Ideas” area on
the web site.) In it I compared the prospects for this group with
the historical rise of cable television equities because of the similarities
in their cash flow growth prospects. I forecasted consolidation and
leveraged buyouts for the drilling and service sector. I also said
that eventually such actions would mark a top and indicate a time
to sell. I want to be more clear about this now.
The RIG/GSF merger does not indicate a top. It is only the start of
a trend that has more to go. The market has mistakenly continued to
treat the Drillers and Service Companies — and particularly
those involved in deep ocean work — in their historical manner
as cyclical businesses. Yes, the group has been cyclical and in the
future there will still be an element of cyclicality as new capacity
comes on stream. But the constant rise in the price of oil over the
long term going forward means that in future decades there will be
no end to the growth in drilling, particularly in deep waters (which
make up 70% of the earth’s surface). Even as diminishing returns
cause each drill ship to produce less and less oil, the rising oil
price will make more drilling economical. That, my friends, is called
secular growth.
So at 10 times or less projected '08 earnings (not to mention a lower
multiple of cash flow), the drillers are still cheap. And for RIG
and GSF, with new leverage applied to their in-the-bag growth over
the next few years, the current price looks even more attractive.
When we see these companies selling at 20 and 30 times projected earnings,
and when KKR and their ilk own some of them, that may be the time
to sell.