Icahn’s Transocean Buy Pushes Offshore Driller Toward Partnership

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January 15, 2013

Jan. 16 (Bloomberg) — Carl Icahn’s new stake in Transocean Ltd. may raise pressure on the world’s largest offshore driller to split off some of its rigs into a tax-advantaged partnership as the billionaire investor seeks to boost his investment’s value.

Transocean’s announcement earlier this week that Icahn had bought 1.56 percent of its shares and was seeking regulators’ permission to own more than 3 percent stirred a debate in the investment community as the activist investor known for shaking up companies remained silent about his intentions. Icahn, 76, is jumping in less than two weeks after Transocean agreed to pay the U.S. $1.4 billion to settle its liability in the 2010 Gulf of Mexico oil spill.

With the company already in turnaround mode — the shares have led peers with a 34 percent gain over the past year — some investors and analysts said they expect Icahn to push for Transocean to create a master limited partnership, or MLP, to raise cash for the parent company and spur growth with its tax- free structure. It would be the second drilling-rig partnership after Stavanger, Norway-based Seadrill Ltd. spun off assets to create Seadrill Partners LLC in October.

“I would guess he’s going after an MLP because there aren’t a whole lot of other levers to pull,” Joe Hill, an analyst at Tudor Pickering Holt & Co. in Houston said in a telephone interview.

Icahn didn’t return repeated calls and e-mails to his office requesting comment on his Transocean investment.

Under Consideration

Transocean said it was studying the possibility of forming an MLP when asked about it after Seadrill’s spinoff.

“It’s certainly interesting,” Greg Cauthen, the company’s former interim chief financial officer, told analysts and investors Nov. 6. “It’s something we have and will continue to look at, but we’ve not come to any conclusions at this time.” Cauthen was succeeded a week later by Esa Ikaeheimonen, previously the chief financial officer at Seadrill, a move that was announced in September.

Transocean isn’t saying much about the Icahn investment, other than an e-mailed statement Jan. 14 that it “looks forward” to talking with him. Icahn notified the company that he’s seeking regulatory approval to potentially acquire shares worth more than $682.1 million, Transocean said in a statement on its website the day before.

Creditors’ Concern

The move by an activist investor known for pushing companies for change added enough uncertainty to concern creditors, with Transocean bonds reversing gains posted after its oil spill settlement was announced Jan. 3. The company’s $1 billion of 6.8 percent notes due March 2038 fell 2 cents to 121 cents on the dollar, yielding 5.27 percent at 4:31 p.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

The rig contractor has made progress in shoring up its balance sheet after losing more than half its market value following the April 2010 oil spill, Collin Gerry, an analyst at Raymond James said in a telephone interview. Earnings before interest, tax, depreciation and amortization are expected to almost double in 2012 to $3.39 billion from $1.85 billion a year earlier, according to 39 analysts’ estimates compiled by Bloomberg. The Ebitda is expected to climb another 39 percent over the next two years, and for the first time since 2008, the company is expected to increase revenue in 2012 to $9.7 billion.

Transocean also is improving its fleet, having sold most of its standardized shallow-water drilling rigs for $1.05 billion, and started building nine new rigs, most of which should be able to command some of the highest day rates in the industry and work in waters as deep as 12,000 feet.

Macondo Settlement

The settlement with the U.S. Justice Department over Transocean’s role in the explosion of the Macondo well and subsequent oil spill calls for the company to pay $1.4 billion over five years, a payment schedule that Argus Research analyst Phil Weiss said in a Jan. 9 note to investors was “certainly manageable.”

After turning in the best performance among peers on the Philadelphia Oil Service Sector Index over the past year, the company still has room to grow. The stock is trading at about 85 percent of the company’s net-asset value, compared with the 10- year average of more than 100 percent for the industry group, West said. Transocean fell 0.07 percent to $53.89 at the close of New York trading yesterday.
“It’s extremely undervalued, which is a classic Icahn trade,” said Laurence Balter, who helps manage $100 million, including Transocean shares, at Oracle Investment Research in Fox Island, Washington.

CVR Partnership

CVR Energy Inc., an oil refiner Icahn took control of last year after winning a proxy fight with management, is scheduled to hold a $520 million initial public offering today to create an MLP with the company’s two oil refineries. Icahn is poised to double his $2 billion investment in CVR thanks to the restructuring and cheaper U.S. oil that has widened profit margins for refiners.
CVR reached $53.19 at the close of New York trading yesterday, the highest since the company was taken public in 2007 by Goldman Sachs Group Inc.

Master-limited partnerships pay no U.S. corporate income tax and distribute cash to holders of partnership units, which are traded like shares in a public corporation. MLPs are usually controlled by a general partner that retains a share of the units and receives a portion of the income. Retail investors have favored the MLP model in the pipeline industry because they tend to pay steady dividends tied to long-term contracts that are often akin to rent.

MLP Expansion

In the past year, more oil and natural gas producers and refiners have been attracted to the model. Now, with most major rig owners mulling the idea, Scott Gruber, an analyst at Sanford Bernstein dubbed the topic “MLP Mania?” in a note just after Seadrill announced the IPO launch of Seadrill Partners.

Seadrill gave its partnership a partial interest in four drilling rigs with long-term contracts operating in North America and West Africa. Since it began trading Oct. 18, the parent company has fallen 10 percent while Seadrill Partners has climbed 26 percent.
Transocean is viewed as under-valued compared to Seadrill at the time of its spinoff, James West, an analyst at Barclays Capital said in a telephone interview. So shares may gain with the cash from an MLP’s unit distributions and improved forecasting for cash-flow from long-term rig contracts, he said.

Still, the arguments for a Transocean MLP are less convincing, according to Tudor Pickering’s Hill.

Value Questions

“It’s fine to do one as an experiment, but I’m a little skeptical they’re going to get a big value uplift from doing one,” Hill said.
Balter sees an MLP structure as a quick boost to shares of the parent company in the beginning, though ultimately a “cop out” because the structure may take away some of the best assets from the larger company, he said.

“I would not be surprised to see them go the MLP route,” Balter said. “But I would be disappointed that the industry is trending this way, just for the sake of raising the share price.”

Alternatively, Icahn may just focus on pushing the company to cut costs, reduce debt, sell older vessels and reinstitute the dividend, Gruber said.

“A year ago, you could see some incremental pockets of value in squeezing some stuff out, but now some of those have been resolved and you’re left wondering, ’What’s left for him to really change?” Gerry said. “Maybe it’s the MLP structure.”

– David Wethe, Copyright 2013 Bloomberg.

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