Transocean Ltd.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 2/5

Transocean Ltd. is a leading international provider of offshore contract drilling services for oil and gas wells, specializing in ultra-deepwater floaters and harsh environment drillers.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Transocean’s business revolves around providing drilling services using its fleet of offshore rigs for oil and gas exploration and development companies. Its revenue is directly tied to day rates that it charges, and to a lesser extent, reimbursement of project related expenses.

Business Overview

  • Revenue Distribution: Transocean’s revenue stems primarily from contract drilling services, which are provided to a diverse base of oil and gas exploration companies. These contracts are typically based on day rates, meaning the company charges a fixed fee for each day a rig is operational, and performance based contracts, in which the client pays per day as well as pays based on the overall performance metrics of the rig (such as operating efficiency, downtime, etc). These rates can vary with the type of drilling activity (exploration, development, deepwater, harsh environment), and are subject to market conditions. A lesser portion of revenues are due to reimbursable expenses.

  • Industry Trends: The offshore drilling market is highly cyclical and impacted by several key factors. The prices of crude oil and natural gas (and expected future prices) strongly influence the demand for drilling. Higher prices typically spur investment in offshore exploration and production, and vice versa. The offshore drilling industry is dominated by competition for contract drilling from several other companies, and this competition is based on the capabilities of the rigs, price, project management and performance during operations. Moreover, companies are trying to become greener, with less carbon emissions, etc, while achieving all other business objectives (like high efficiency) at the same time.

  • Competitive Landscape: The industry is highly competitive and fragmented. Major competitors include Borr Drilling, Diamond Offshore, Valaris, Noble Corporation, and Seadrill. The contracts are not sticky, with many companies being forced to redeploy rigs if demand in one part of the world weakens. The industry is also very asset intensive, requiring constant reinvestment in the fleet, particularly during times of increased technological innovation and efficiency.

  • What Makes Transocean Different:
    • Transocean is one of the largest players in the ultra-deepwater and harsh-environment drilling spaces, it is one of a few companies that can manage such highly specialised rigs and operations.
    • It has global operations. Many smaller companies are regionally based.
    • Transocean is vertically integrated, providing drilling, engineering, and project management services all under one roof. Many smaller players are more niche.
  • Recent Issues:
    • Transocean has been affected by the recent global downturn in the oil and gas sector with reduced demand for offshore drilling, and the invasion of Ukraine has resulted in higher operating costs.
    • There have been some concerns about the company’s high debt levels and negative free cash flow in the current environment, leading to downgrades by some ratings agencies.

Financial Analysis

  • Revenues: While the company’s quarterly revenues have shown a significant jump over 2022, primarily driven by the acquisition of Transocean Norge (which brought in a large amount of new revenues), the annual contract drilling revenues declined from $2,595 million in 2021 to $2,395 million in 2022, due to rig utilization, which is still weak.
    • Contract drilling revenue was $733M in the three months ending on September 30th 2024, compared to $699M in the three months ending on 30th June 2024 and $671M in the three months ending on March 31st 2024.
    • Transocean is experiencing an increase in contract drilling revenues because of their high-spec, ultra deepwater drilling rigs.
    • However, Transocean’s ability to increase revenues is primarily driven by getting contracts for their existing rigs, and secondly by being able to renew contracts at higher day rates.
  • Profit Margins: Operating margins have improved since the pandemic era, with the company now reporting a slightly positive operating profit of $57 million in Q3 2024. But the company has not been consistently profitable over the past 5 years. While operating margins are improving, they are still extremely volatile, and heavily dependent on contract prices and overall rig utilization.
    • In the three months ended September 30th, 2024, operating expenses are $705M compared to contract drilling revenues of $733M. This, and the small profits that they get for rig utilization is the main reason their profitability is very fragile.
    • Moreover, a large part of the operating expenses are driven by costs that are very hard to control, such as “crews”, “fuel costs”, and “material costs”, making it even more difficult to increase profit margins, if the customer is unwilling to pay higher prices.
    • The company expects a higher operating margin in the coming months because the fleet is operating more efficiently and at better utilization rates with higher day rates in many of the recent contracts.
  • Cash Flows: Cash flow from operations is negative for the last few years, but there is a marked improvement since 2022. Transocean is focusing on reducing long term debt and generating free cash flow to further strengthen its business, but has failed to do so thus far.
    • The cash flow from operations is $241 million for the three months ending September 30 2024, and the cash flow from investing is -$121 million, and cash flow from financing is $490 million.
  • Debt: Transocean is heavily indebted, with more than $7.7 billion in long-term debt as of Q3 2024. The company is trying to deleverage its balance sheet and reduce debt through proceeds from asset sales and new contracts. But still has a long way to go.
    • The company has a significant debt load that limits its financial flexibility and has increased its interest expense in the face of rising interest rates.

Moat Assessment: 2/5

Transocean’s moat rating has been reduced to 2/5, from a previous estimate of 3/5 as the company is experiencing a decline in its ability to generate higher returns than competitors. While Transocean has previously been able to maintain its ROIC at levels which are above the industry average, it has not been able to do so over the past few years.

  • Limited Competitive Advantages: While Transocean is one of the largest offshore drilling companies with experience in ultra-deepwater and harsh environments, these advantages are not unassailable as the technology has become widely available to many other competitors, and it is easier for competitors to move into this area of the market.
  • Lack of Barriers to Entry: There are few barriers to entry in the offshore drilling industry as high upfront capital cost does not provide much of a barrier, as many companies use specialized financing and project funding to buy assets. Moreover, there are no stickiness from the customers towards any particular company, and they are likely to switch if other companies have lower prices or better contract offers.
  • Commoditized Services: Contract drilling is largely a commodity service, with limited differentiation and few reasons for customers to switch or pay a higher price. If a company has a few specialized technologies, it is very easily copied or replicated by its peers.

Risks to the Moat and Business Resilience

  • Cyclicality of the Industry: The industry is highly cyclical and tied to the price of oil and gas. This exposes Transocean to significant fluctuations in demand and pricing, making future revenue generation unpredictable.
  • Technological Disruption: There is a rapid pace of technological change within the industry. Companies are forced to reinvest in new technologies to avoid becoming obsolete and it is very difficult to maintain a first mover advantage, which can erode profit margins rapidly.
  • Financial Risks: A large debt burden limits the company’s financial flexibility and ability to withstand extended periods of low oil prices. While the company is managing to pay off debt slowly, it is still a large burden.
  • Operational Risks: The company is at risk of accidents during operations, which may result in significant damage to the rigs and loss of contract revenue.
  • Regulatory Risks: Various countries and regions may pass laws which may have negative impact on future prospects.

Understandability Rating: 3/5

While the core concept of providing offshore drilling services is straightforward, understanding the intricacies of the company’s operations and its industry is relatively complex.

  • Complex Operations: The drilling business is technically complex, involving specialized equipment and personnel. Transocean operates in many difficult environments, requiring an in-depth understanding of engineering, planning and management.
  • Cyclical Business: The impact of the global economy, oil and gas prices, and geopolitics makes the business’ financial forecasts difficult to gauge, as revenues and profits are based on contract prices and utilization of rigs, which can change wildly based on external factors.
  • Complex Financial Statements: Transocean’s financial statements can be difficult to interpret for new investors because of the huge amount of off balance sheet liabilities, and a mix of different types of contracts. Furthermore, the company does not present cash flows in an easily understandable format.

Balance Sheet Health: 2/5

Transocean’s balance sheet is of particular concern because of high debt levels and negative cash flow. It could get into solvency issues in a longer downturn.

  • High Debt Levels: As mentioned earlier, the company has very high debt which limits it financially and makes it vulnerable to any downturn in the market.
  • Negative Free Cash Flow: While the company is managing to improve its cash flow from operations, it’s free cash flow is negative. This puts additional pressure on the company and might affect its solvency in a longer downturn.
  • Limited Financial Flexibility: There are limited avenues for the company to raise new capital due to high debt level and current market conditions.
  • Inconsistent Profits: Earnings are extremely volatile and difficult to predict, since they are driven by global events which are hard to predict.