Transocean Stock Sale Doesn’t End Junk Threat: Corporate Finance

Transocean Stock Sale Doesn’t End Junk Threat
Transocean has lost 54.8 percent of its market value since April 2010, when a surge of explosive gas from the Macondo well off the Louisiana coast killed 11 workers aboard the Deepwater Horizon drilling rig and triggered the worst-ever U.S. maritimeoil spill. Photographer: Derick E. Hingle/Bloomberg

Transocean Ltd.’s decision to raise money through a share offering may fail to prevent the world’s largest offshore driller from being downgraded to junk-bond status, according to rating-company analysts.

Transocean sold $2.5 billion of bonds and issued 29.9 million shares for $1.2 billion as it seeks to buy $1.7 billion in convertible bonds holders can redeem next month. The stock sale was spurred by a Nov. 9 Moody’s Investors Service statement that the Vernier, Switzerland-based firm may lose its investment-grade debt rating because of rising costs and a pending 2012 trial over last year’s Gulf of Mexico disaster, said Geoff Kieburtz, director of energy research at Weeden & Co.

Analysts at Moody’s and Standard & Poor’s aren’t changing their rating or outlooks on the company based on the equity sale. Both companies rate Transocean at their lowest investment grades with “negative” outlooks.

“There are some positive things coming out of this but we don’t necessarily think it’s enough to move the rating or outlook from where they currently stand,” Lawrence Wilkinson, a director at S&P in New York, said in a telephone interview. “It bolsters their liquidity and then it also has the potential to improve their leverage as well.”

Ratings Link

Guy Cantwell, a Houston-based spokesman for Transocean, said it’s against the company’s policies to “comment on market discussions.”

Transocean sold $1 billion of 5.05 percent, five-year notes, $1.2 billion of 6.375 percent, 10-year notes and $300 million of 7.35 percent 30-year senior unsecured debt, according to data compiled by Bloomberg.

The coupons will increase 25 basis points for each level below investment-grade at S&P and Moody’s, according to a person with knowledge of the transaction, who declined to be identified citing lack of authorization to speak publicly. The coupons will increase a maximum of 200 basis points, and the steps will fall away if the company reaches Baa1 by Moody’s and BBB+ by S&P, the person said.

Transocean previously tapped the U.S. corporate bond market in September 2010, issuing $1.1 billion of 4.95 percent, five-year notes and $900 million of 6.5 percent, 10-year debt, Bloomberg data show. The 10-year notes today paid 430 basis points above similar-maturity Treasuries, compared with the 375 basis-point spread in last year’s sale, the data show.

Proceeds from today’s sale will be used to help buy the convertible debt, to refinance commercial paper and for general corporate purposes, the company said today in a statement distributed by Marketwire.

‘Dark Cloud’

Potential liability from the fatal 2010 blowout and oil leak at the Macondo field in the Gulf is a “dark cloud” hanging over Transocean, and that the company needs to show stronger operating performance, according to Stuart Miller, a vice president and senior analyst at Moody’s in New York.

While the equity increase will add liquidity, “it doesn’t tell us what the company’s going to look like at the end of 2012,” Miller said.

Transocean priced 26 million new shares at $40.50 each, or 37.32 Swiss francs at an exchange rate of 0.9215 francs per dollar, the company said in a statement late yesterday. The offering, scheduled to close on Dec. 5, will net the company $1.008 billion, after underwriting discounts, offering expenses and Swiss taxes, according to the statement. Underwriters exercised a 30-day option to buy 3.9 million additional shares.

Maintaining investment-grade ratings may save Transocean $12.8 million in annual interest costs on every $1 billion in new debt. The average yield on Transocean’s bonds prior to yesterday’s announcement was 5.91 percent, compared with the average 7.19 percent on all BB rated bonds, according to Bank of America Merrill Lynch index data.

Swaps Decline

Credit-default-swaps traders, who had pushed the cost of protection to levels indicating Transocean debt already was junk-rated, haven’t returned it to investment-grade status, according to Moody’s Corp.’s capital markets research group. Swaps have implied the bonds should have been Ba1-rated since Nov. 8.

The cost to protect Transocean debt from default dropped to the lowest level since Nov. 18, according to data provider CMA. Credit-default swaps tied to the company’s bonds fell 42.7 basis points to 331.5 basis points yesterday, the data show. They would have to fall to 289 basis points to escape a perceived speculative rating.

Bond Prices

The share-sale announcement provided an immediate benefit to existing bondholders. Transocean’s $900 million of 6.5 percent notes due in November 2020, rated Baa3 by Moody’s and BBB- by S&P, rose 0.9 cent yesterday to 100.5 cents on the dollar to yield 6.42 percent, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

The debt declined 1.1 cents today, to 99.4 cents on the dollar, for a yield of 6.58 percent, Trace data show. The increase in yield came as overall interest rates rose after the Federal Reserve and five other central banks agreed to cut the cost of dollar funding for European banks. The extra yield investors demanded to own the Transocean bonds instead of comparable-maturity Treasuries rose to 4.5 percentage points from 4.43 percentage points yesterday.

Credit swaps, which typically fall as investor confidence improves and rise as it deteriorates, pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

‘Taking a Hit’

The company’s stock tumbled 9.4 percent yesterday to $41.63, the lowest price in seven years. The plunge surpassed the trough reached on June 9, 2010, amid an intensifying U.S. government probe into the disaster aboard a Transocean-owned rig at a BP Plc oil well. It recovered 2.9 percent today, rising to $42.85 amid a 4.3 percent rise in the S&P 500 index.

“Shareholders are taking a hit,” Kieburtz said. “We’re hard-pressed to get comfortable with this stock at this point.”

Transocean has lost 53.4 percent of its market value since April 2010, when a surge of explosive gas from the Macondo well off the Louisiana coast killed 11 workers aboard the Deepwater Horizon drilling rig and triggered the worst-ever U.S. maritime oil spill. The company is facing tens of billions of dollars in potential claims and penalties related to the catastrophe’s environmental and economic fallout.

Equipment Delays

“They have been open in the past year that the investment-grade rating is important to them, and so this is a move that puts their money where their mouth is, so to speak,” said Brian Gibbons, a New York-based senior oil and gas analyst at CreditSights Inc. “This is a very favorable and unexpected development.”

Transocean has been beset by delays in obtaining gear to meet tougher safety regulations that have idled rigs in shipyards longer than expected, boosting operating costs and contributing to a record third-quarter loss for the company, Kieburtz said yesterday in a telephone interview from Greenwich, Connecticut.

Manufacturing bottlenecks and shipyard delays continue to plague Transocean’s fleet and will cost an estimated $160 million to $200 million during the current quarter, the company said in a prospectus for the equity sale.

“There are things the company can do that are within their control, which include reducing costs, selling assets, reducing discretionary capital expenditures, or reducing their dividend policy,” Miller said. Those “are the major issues we’ve identified as quick fixes that are under their control.”

Equity Dilution

The share sale will bloat outstanding shares by as much as 8.9 percent and dilute the equity by more than the $1 billion of dividends Transocean has promised for the 12-month period ending in February, said Todd Scholl, a Houston-based analyst at Clarkson Capital Markets LLC.

After spending $1.4 billion in cash for Norwegian rig owner Aker Drilling ASA last month, the company probably only had about $1.8 billion left available, just enough to cover the costs of repurchasing the convertible notes, Scholl said. The dilution of shares means the Aker transaction won’t be accretive to earnings until sometime in 2013, he said, rather than immediately, as Transocean Chief Executive Officer Steven Newman predicted during a conference call with analysts when the deal was announced in August.

Maintain Dividend

“I’m surprised they went this route but it looks like they really wanted to protect their credit rating,” Scholl said in a telephone interview. “It’s definitely at the expense of the shareholders.”

Morningstar Inc. analyst Stephen Ellis said the share sale is negative for equity investors, though it “should help preserve Transocean’s investment-grade rating.” The issuance also may aid the company in maintaining its 79-cent quarterly dividend, he wrote.

Transocean’s board has authorized up to $2.5 billion in long-term financing “in the near future,” according to the prospectus. The company expects to seek between $1 billion and $2 billion in one or more offerings, the proceeds of which will be used to cover any portion of the convertible notes repurchase not financed by the share issuance, as well as for general corporate expenses, the filing said.

The drilling company said in the prospectus that it’s seeking waivers from holders of $600 million in assumed Aker debt that comes due on Dec. 30.

“They probably would have preferred to do a straight bond offering rather than an equity offering, but the market was neither readily available for that kind of an issue and I think they were also being responsive to the concerns of one or more of the rating agencies,” said Philip Adams, a Chicago-based analyst at Gimme Credit LLC.

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