Would a Transocean Acquisition of Seadrill be a Mistake? $RIG, $SDRL, $VAL, $NE

Happy New Year!

The team at Substack has encouraged me to engage in a New Year’s Resolution to increase subscriber engagement. This whole influencer career path is a bit new to me, so what the heck.

After seven years of marriage and an old knee injury from a car accident, I find myself 81 pounds over my old varsity athlete weight.

So for the month of January, I will do 1 pushup for every restack and 1 sit up for every like that each writeup receives. If the combined number of likes and restacks reaches certain milestones, it will create a narrowing window of intermittent fasting.

This might be unwise, because I have over 2,300 subscribers. But I’m willing to give it a try. Do your worst. Am I doing subscriber engagement right?

Deepwater Offshore:

But moving on to the reason for the writing, for my first post of the new year, I want to pay tribute to the theme that really got this substack going in the first place, offshore drilling. Special thanks again to

Tommy

Deepwater who has started his own substack,

Deepwater Insight

.

This last year has been terrible for offshore. The old rivalries of trying to choose between Transocean (RIG) or Valaris (VAL), seems to have been completely forgotten as we all watch our portfolios melt down while the Nasdaq makes new highs. Even the higher quality names like Noble (NE) have sold off with the rest. There was nowhere to hide.

Meanwhile, the order books have grown, the backlogs are strong, the industry has consolidated further, the net zero crowd have lost the narrative, everyone seems to understand that oil will be around for a long while, and nobody is even thinking about thinking about building new drillships. So the thesis is completely intact, only the stock prices disagree.

Allegedly the supermajors have budgeted for a large increase in offshore capex for 2026, and those contracts will be negotiated and land sometime in 2025. So unlike 2024, there should be a much steadier stream of good news this year. We can all remember the good times when every new contract announced propelled stock prices higher. There are very good chances that 2025 will be such a year.

In my original writeup on offshore, I preferred Transocean over their competitors. Since that time, some facts have changed. The biggest weakness of Valaris was that the professional management had no strong capitalist to guide decision making. Since that time, John Fredriksen has accumulated about 9.4% of the company.

Now, all three major offshore companies have a strong capitalist to influence decision making. Noble (NE) is about 21% owned by the founding family of Maersk, Valaris (VAL) is 9.4% owned by John Fredriksen, the 80-year old Norwegian shipping billionaire, and Transocean (RIG) is 10.4% owned by Frederik Wilhelm Mohn who sits on the board.

The capital allocation policy of VAL is to focus 100% on buybacks. NE had a blended program with dividends and buybacks, but then engaged in a stock-based acquisition and is now about a third of the way through buying back the issued shares. RIG’s capital allocation policy is an unknown for now as they can only focus on debt repayment as the amortizing portion of their debt consumes all their EBITDA for the moment.

Putting some very rough estimates on market capitalization to replacement cost, at current prices, VAL is trading at 13% of replacement, NE at 18.5% of replacement, RIG at 11% of replacement. If you value the cold stacked assets at zero, those numbers change a bit, but not enough to change the ranking. But if you include RIG’s debt and look at enterprise value as a percentage of replacement cost, VAL becomes the cheapest offshore stock. Seadrill, everyone’s favorite acquisition target, is the most expensive of the bunch already, trading at 19.6% of replacement cost.

I personally am not fond of the jackup market; the supply and demand of jackups is not nearly as tight as the deepwater drillships. About a third of the value of Valaris’ fleet is jackups, meanwhile that number is only 15% for Noble, and Transocean liquidated all of their jackups years ago. I am very fond of the harsh environment, Norway-capable market, as it is projected to be the tightest subsector in terms of supply and demand. It is only in this regard as well as the 8th gen drillships that Transocean has an advantage. Noble and Valaris have no Norway-capable harsh environment rigs.

Seadrill Speculation:

In a previous writeup, after the CEO of Seadrill (SDRL) announced that he was willing to acquire or to be acquired as long as his shareholders were paid a premium, I speculated on who would be the likely acquirer. At that time, since Noble was digesting a recent acquisition, and Transocean is heavily indebted, it appeared Valaris would be the only company with the balance sheet strength to pay even partially in cash for Seadrill, but the management team seemed only interested in share buybacks. Well, that management team does have a history with Seadrill.

John Fredriksen, was the original founder of Seadrill, and Valaris’ current CEO, Anton Dibowitz, was Fredriksen’s representative on Seadrill’s board and a former CEO of Seadrill. So while it is true that Valaris has only been focusing on share buybacks, their leadership team is intimately familiar with the Seadrill fleet, and who knows, perhaps still has some emotional attachment after having their equity wiped out in bankruptcy.

However, there are a lot of hints that Transocean is the likely acquirer of Seadrill. Transocean recently relocated some of their corporate entities to Bermuda, where Seadrill is domiciled. This should facilitate a merger without involving busybody bureaucrats in Switzerland who for some reason would stymie companies trying to acquire more market power. Valaris is already domiciled in Bermuda, however, so they can’t be ruled out entirely.

Seadrill just sold their last jackup. This could have been an independent strategy, or it could have been in preparation for merging with Transocean, who divested of all their jackups years ago. Valaris still maintains a fleet of jackups, so this could be a hint that Valaris is not the Seadrill acquirer.

On the last earnings call, Transocean hinted that they are potentially interested in deleveraging through acquisitions, stating that they could take on 10-15 drillships without increasing overhead costs due to their existing onshore support network. Coincidentally, Seadrill has a fleet of 11 drillships and another 4 cold-stacked. Also on that call, Transocean’s management stated that they could return capital to shareholders once debt to EBITDA was down to 3.5x, which could be accomplished through an acquisition. Perhaps to prepare investors for the bittersweet dilution of a stock based acquisition by appeasing them with the start of a share repurchase program.

Also, Bloomberg reported that there are rumors that Transocean is in talks to acquire Seadrill. So if I had to vote, it would seem like an open secret that RIG is going to acquire SDRL. It still isn’t impossible that Valaris is the eventual buyer, but odds are low. The problem from here would be the valuation. An acquisition target needs a premium, and since RIG has no cash, they can only pay with stock, and RIG’s stock is in the dumpster.

Transocean’s market capitalization is $3.28 billion, but Seadrill’s is $2.51 billion. Transocean has a $9 billion backlog, Seadrill has a $4 billion backlog. Transocean has, not including cold stacked rigs, 17 deepwater drillships, two of them 8th gen, and 7 harsh environment semisubmersibles. Seadrill has, also not including cold stacked rigs, 10 deepwater drillships and 1 harsh environment semisubmersible. Transocean has trailing twelve month revenue of $3.3 billion compared to Seadrill’s $1.5 billion. If a stock based acquisition were to take place, the dilution to RIG shareholders due to the valuation gap and the premium typically paid to an acquisition target would be substantial.

At current market capitalization, if a 15% premium were paid to Seadrill shareholders, a stock based acquisition of Seadrill would result in a 47% dilution of RIG shareholders. That would come in exchange for a 31% larger active fleet, but none of the additional ships would be 8th Gen or 7th Gen plus. And the only harsh environment semisub doesn’t appear to be Norway capable.

It is possible, for example, that a component of the acquisition structure would be to disperse Seadrill’s $800 million balance sheet cash to Seadrill shareholders in order to lower the purchase price and decrease the total dilution that Transocean would face. It might also be possible to include some sort of earnout provision to lower the upfront cost in exchange for more consideration later. I hope that Transocean’s management gets creative, because that is a lot of potential dilution if there are no attempts to mitigate it.

Could Transocean fetch a higher multiple because of the acquisition? There are always the potential synergies, RIG’s management claims they can handle the operations of the entire SDRL fleet without increasing onshore operational capabilities. Then there is the market power, with such a concentrated market, could RIG get those higher day rates? Even if RIG can’t use the additional market power to increase their own day rates, SDRL’s day rates are about 20% below what Transocean contracts for on similar ships. A full two years after the acquisition when existing contracts roll off, RIG’s management could potentially get better contracts for SDRL’s assets.

Adding Seadrill’s four cold stacked rigs to Transocean’s eight would make them the clear cold stacked leader. Naysayers claim that ships cold stacked for more than five years will never come back online. I am not ruling out the possibility of a reactivation starting in 2025 to begin work in 2026, but I don’t mind valuing all cost stacked ships at zero for now.

Adding up the projected EBITDA of a combined entity, without any potential synergies or cost cutting, it is still a long distance to management’s guidance of returning capital to shareholders once EBITDA is more than 3.5x long term debt. Long term debt is over $6.5 billion, but combined EBITDA is only a bit over $1 billion. If Transocean’s management is counting on a multiple rerating in order to justify the acquisition, without immediate share buybacks, the multiple rerating might be hard to achieve.

The combined entity would likely soon be net income positive, and that would have the possibility for multiple expansion, but it is not conclusive whether or not the market would respond positively to news of this acquisition. Transocean would be far and away the market size and technology leader, and that might come with its own multiple rerating, but that is hardly guaranteed. The fears regarding the sustainability of Transocean’s debt would be relieved, but that would have happened by 2026 organically through the contracted backlog day rate increases.

Conclusion:

If I were not already a Transocean shareholder with a cost basis significantly below the current price, I’m not certain I would buy it here. Seadrill, as a self-proclaimed acquisition target could be preferable. Who wouldn’t want to have a quick 15% to 20% premium through getting acquired? If you are deploying capital today, the same amount of money spent on Seadrill would probably eventually be more shares of Transocean than if you bought the Transocean with that money initially.

If I were approaching the offshore sector with fresh eyes, and no capital gains tax to pay from switching, I might choose to go 50/50 Noble and Seadrill, knowing that in a reasonable amount of time my Seadrill shares would become Transocean shares, but converted favorably. I would still pass on Valaris despite the cheap price, I just am not crazy about the jackup market in the same way that I am crazy about the deepwater and harsh environment markets.

Transocean might have a bumpy road ahead for it. But eventually, it is still probably on its way to over $25 a share for this cycle. I still am confident my patience will be rewarded. But I am not confident the market will view this potential merger favorably at first.

On a recent podcast with

The ROI Club

, we discussed some options strategies regarding selling long-dated puts. One offshore idea was so attractive, I am going to share it below. Since it was Ben’s idea first, it’s going behind the paywall.