Transocean’s Debt Strategy: A Step In The Right Direction (NYSE:RIG)
Times aren’t easy for Transocean (RIG) or the company’s shareholders. This year has been particularly difficult as volatility in the energy space, largely driven by the COVID-19 pandemic, and the continued decline in the company’s backlog have caused a significant loss of investor confidence. All in all, as I pointed out earlier this year, the company is holding up, but the fact is, it can’t last forever in this environment. Without a turnaround in the industry and/or a way to pay off its debt burden, the company’s long-term prospects are bleak at best. In recent weeks, management has finally taken some actions aimed at strengthening the company’s balance sheet without causing pain to shareholders. While the results of these maneuvers are not what we would like (which is another cause for concern), the improvements made by management are positive for the company’s future development.
Necessary steps in a time of pain
It would be wrong to say that Transocean has been in pain for years. While this year initially looked positive for all energy companies, the COVID-19 pandemic shook things up unexpectedly. Rather than giving Transocean an opportunity to stabilize, the end result has been the company’s continued deterioration. For example, while rig utilization rates were up 10% (66%) in the second quarter of this year compared to the year-ago quarter, average daily rig revenue declined 2.3%. Worse, the backlog continues to fall. In the second quarter of 2019, the backlog totaled $10.16 billion. Today, that number has dropped to $8.89 billion. Not only that, but the company’s debt remains high at $9.14 billion.
To improve its balance sheet, the company initiated a series of financial transactions over the past month. The first of these that I would like to discuss is replacing some notes with some new ones. This was originally announced on August 5th. Briefly, the Company entered into an agreement with a private investor to issue some new 2.5% Senior Guaranteed Exchangeable Notes maturing in 2027 in exchange for some existing 0.5% Exchangeable Notes currently maturing in 2023. The interest rate on the new notes is: yes, five times higher than on the old notes. However, this deal comes with some perks that investors should enjoy.
First off, the obvious difference is the due date. There are currently $863 million in exchangeable notes outstanding. Without a rapid and significant improvement in the offshore drilling industry, Transocean will not be able to pay off the bulk of this debt as it falls due. An alternative is for the holders of the debt to be exchanged for common stock of the company, with $1,000 of par value being exchanged for 97.29756 common shares.
However, management is not swapping the bonds dollar for dollar. For the $355.611 million principal debt it was able to negotiate as part of the transaction, the company’s new notes have a face value of $213.367 million. This works out to $0.60 per dollar. In addition to the new debentures being guaranteed by certain of the company’s subsidiaries (which, once management is done restructuring parts of the company, may offer some additional security to the debenture holders conducting the exchange), they will now receive 162 .1626 common shares for every $1,000 principally upon conversion. This results in the same number of shares that would have issued the original debentures, but reduces the effective price to $6.17 from $10.28 per unit.
This move also gives them more time to exercise the stock option should the company survive over the long term. The higher interest rate will result in $5.33 million in annual interest expense related to the debt included in the swap, compared to $1.78 million previously. This is also a bonus for the debenture holders, but it probably wasn’t the deciding factor. It’s worth noting that on Aug. 10, management announced another swap of this nature, taking $40.9 million of principal debt from the company and issuing $24.6 million of new debt. This will increase annual interest expense by an additional $0.41 million but reduce debt by an additional $16.3 million.
Taken from Transocean
While that transaction went well and managed to reduce the company’s debt by $158.7 million, another, larger deal was a bit bumpy. Earlier this month, management announced plans to swap some notes for others through a takeover bid. Details can be seen in the image above, while in the image below you can see all of the company’s outstanding debts. The goal of this deal is to issue $750 million in new principal debt and offer it in exchange for older debt, for which investors are taking a sizable discount.
Taken from Transocean
On August 24, the company had to revise its previous offer. First off, the two sets of Notes that investors most wanted to offer for sale were the 6.375% (now 8.375%) Senior Notes maturing 2021 and the 3.800% (now 5.800%) Senior Notes maturing 2022 will. The reason these are preferred is that their due dates are the closest. Together they represent $366 million in outstanding debt, but it’s important to remember that the company has an additional $354 million in outstanding debt that is due between now and the date of maturity of both series of notes. The company can only afford to cash in so much of it at once.
Management hasn’t yet provided a breakdown of the takeover bids, but it has spoken out and said it’s changing what holders of those debentures are expected to receive. Originally, the company intended to give holders of these two notes 10% senior guaranteed notes maturing in 2027, and to holders of all other maturities, they wanted to set the interest rate on the notes at 11.50%. You have now raised all note series up to 11.50%.
This interest rate is incredibly high, but it is actually worth it. If the Company received a 100% bid rate on these Notes (but stayed on the $750 million newly issued Notes), the end result would be another $600.60 million in debt reduction, and annual interest expense for the company would decrease by $11.7 million. If instead the notes at the highest discounts are offered in full at face value, the company’s total debt would decrease by $1.22 billion and annual interest expense by $58.64 million. Both scenarios are unlikely, but they show the range of what investors should expect.
No details have been given yet, but we do know that investors have offered $780.4 million in notes. Through a different method, the company received a commitment for an additional US$350 million in notes, bringing the total number of tenders to US$1.13 billion. In exchange, the company will issue its new 2027 Notes, valued at $518 million. The bottom line here is a capital reduction of $612.40 million to date. However, this could change as the company has announced the above changes. We also know that Transocean received an additional $32 million worth of said banknotes in exchange for a party committing to the $350 million principal amount.
Right now, Transocean is in a tough spot, and there’s a real possibility that the company won’t survive this downturn. However, management’s deleveraging strategy appears to be having some effect, with results to date reducing gross debt by $771.1 million. Unfortunately, the company still has a long way to go if it wants to further reduce that debt, but it’s a step in the right direction. It’s worrying that the company had to sweeten the terms of its debenture swap, as it shows a degree of reluctance on the part of investors to agree to a haircut and stay in business longer. Because of this, investors should keep an eye on the final results of the takeover bid to see what all happens.