Thanks for sharing! Yeah I usually like to keep it simple through common stocks but VAL warrants are definitely a great trade to gain maximum torque on the offshore thesis.
your numbers on your revenue forecast are highly suspect. RIG should not be anywhere near exceeding 8k operating days for YE 2024. 10k+ isn't possible given the economics of this fleet. You just assume that non-idle rigs will not become idle again in the future. I would highly suggest doing unit economics of this co if your going to take a DCF. your valuation will be understated (not a 4 dinger base case). I just wanted to comment this because the assumptions here are extremely enthusiastic, leaning into inaccuracy.
Thanks for the feedback. I agree - I think my projections for utilization were overly aggressive but will likely be somewhat offset by conservatism on the trajectory of day rates. Why do you think 10k+ isn't possible for this fleet?
I like the ideas otherwise here--I've just covered this co. w/ full unit economics and I think this is one of the more opaque co's to model. My 5 year price target is a little over half of yours, so there is still upside imo. I think I have a couple variant views here than you (don't speak too much on cap structure, which I think RIG gets unfair treatment for). Also, i do think the next dayrate cycle idiosyncratically affects RIG fleet. My model shows a 5-10% revenue delta compared to closest comps (the next cycle requires drilling 2000M+ basins in harsh conditions, see West Africa, Norway). But otherwise, I think we see eye-to-eye on this name.
Here are the areas I don't fully see here. these are mostly assumptions in valuation, not fundamental beliefs (including the 10k+):
On utilization: A rig works nearly year-round. The operating days includes days revenue was recorded (the figure you got from RIG 10k?). The implied annual working days of each of these ships is around 340-355 days a year (do this by counting active rigs per day). the working days do not include idle ships. which I think you noted. So the fleet currently has several stacked rigs (i think 8-9)? and a couple idle rigs. All those idle rigs are signed to contract. so their working days will come on soon. the thing is, some of those contracts will not come online this year and will continue to be idle into 2025. An activation should add around 350 days, but I am not sure but there may be some contracts ending. I need to get back on my computer to check what the actual backlog says, but +1400 isn't gonna happen. where do the extra 500 days come? which corresponds to a couple hundred million in revenue? Also, if this happens, where does the other 2000k days come from? Activation of a cold stacked rig costs tons of money. RIG wants to payoff debts. In addition, I don't think they even have enough ships in the fleet to get to that figure. assuming 350*30 is your thought process? gets you over 10k days? Remember some rigs will also become idle, and I don't really see an avenue to reactivating so many rigs. this is barring the fact that ships will come out for service, transport, shipyard, get warmed stacked etc. I mean what you say here could theoretically happen, but I think you and I both agree RIG probably does not have the cash flow to reactivate 3-4+ rigs, let alone will all their rigs operate at full efficiency over the next 5 years.
On working days balancing out dayrates: two problems for this. RIG is more sensitive to working days than dayrates. Also, I have a proprietary forecasting model that forecasts dayrates in full, and I do get a bit more bullish than your hard coded assumptions. But I do think your operating days have a far greater delta on revenue than your dayrate assumptions. In other words--this balances out to juice your revenue by alot.
This is all ignoring that shipyard times and negotiation periods have increased for RIG as shipyard economics are whacked and RIG is aiming for longer contracts (so more negotiation). So you may be able to see why 10k isn't going to happen. I suspect you didn't mean to hardcode this, but operating vs rig days are different. There is a description in RIG footnote.
Also--i think your implied fleetsize does not account for recent sales of ships in Q12024. So you overstate that a bit too, which I know its one but that turns into 9 figure revenue deltas. Operating expenses, etc: operating expenses stay relatively the same no matter what. a good way to think of it is that it costs the same to run a rig, but if dayrates are up you just make more. that being said, given supply chain dynamics they have been large (some may say overstated). But you probably should just forecast as % of revenue here. Don't now how you get to increase in 300 on a 1400 increase in operating days. when a 300 increase creates a similar outcome. the increase in operating expenses should be somewhat proportional. it could be diff depending on whats getting activated. so I could see someone trying to understate. but this is a large understatement. These were the big ones. I think a few others but they shouldnt push your valuation too high. Also--could be wrong on most of this, but I try to read skeptically. so open to change all opinions here.
P.S. read through again and adding this--i know you didn't use the "rebuild this co" as a basis for valuation like some people do, but I would be warry of this. rebuilding the co. =/= its intrinsic value. its more a statement of where we are in the dayrate cycle, not RIG. Look what Noble is doing. They are buying assets from other smaller drillers at discounts. While rebuilding RIG is worth alot, would these rigs actually sell for their implied rebuild price? Def not.
Sorry for the delay in my response – this past month has been a bit hectic. First off, thank you very much for your detailed feedback. I found this to be very helpful and always welcome pushback, especially from sector specialists since I’m just a generalist trying to capitalize on what I see as an attractive capital cycle opportunity.
I’ll try to address each of your points in sequential order:
On utilization, path to 10k+ operating days:
- My calculation for operating days in each year is (active rigs in year) x (total calendar days) x (revenue efficiency %). So for 2028, I assumed 29 active rigs x 366 calendar days x 96% revenue efficiency = 10,614 days
- To your point, I think I was overly aggressive in not fully appreciating idle time and should factor in some amount of days each year towards warm stacking, mobilization, repairs, etc.
- On implied fleet size, that’s simply the number of total rigs in the fleet – both active and stacked. That has no effect on revenue is just a fleet count. I tied revenue strictly to my assumptions for active rigs.
- I see your point with RIG being more sensitive to changes in operating days than it is to dayrates. Need to be more careful with projecting utilization going forward…
On reactivations and idle rigs:
- I know the fleet composition has changed quite a bit since my post but at the time, I was using YE 2023 numbers
- I assumed the two idle rigs (Discoverer Inspiration and DD3) would both go to work by 2025 and that RIG would reactivate 2 cold-stacked rigs in 2027 and 1 in 2028 for a total of 3 reactivations. Clearly, I’ve been proven wrong on the idle rigs since RIG just announced today the sale of Discoverer Inspiration and DD3. But I don’t think my reactivation assumptions are that heroic.
- In terms of capital for reactivations, per management guidance, I’ve assumed that the clients would have to fully pay for reactivation costs. Not sure if this is a reasonable assumption but if it proves to be the case, there’s less dependency on RIG’s cash flow or balance sheet for future reactivations.
On operating expenses:
- I actually disagree with you here. I tried to drill down to unit economics here and assumed the following OpEx per day costs:
o $145k per day for drillships with >1250 ST hookload capacity
o $140k per day for drillships and semis with <=1250 ST hookload capacity
o $185k per day for HE semis
o For cold stacked costs, I assumed a range of $30k-$40k again depending on the type of rig
- I also baked in an average of ~$500-600M per year in pre-operating, contract prep, and mobilization costs into the O&M expense line but assumed that RIG would get partially reimbursed for these costs by the operators. The reimbursement is what you see under other revenues.
- My thought process here is that O&M expense is actually “overstated” currently as RIG has had a higher number of days lost to mobilization, contract prep and idle time in which it has been paying full active operating costs but not receiving full day rates. As RIG begins its multi-year contracts, we should see some operating leverage here as RIG gets the benefit of a full day-rate while still paying the same O&M per day.
With all that being said, I definitely need to update my model to reflect all the recent changes and factor in greater potential idle time in the forecast period, which would reduce # of operating days. Curious to hear your thoughts on my response.
Sorry, meant to say overstated. Your O&M expenses are similar to mine.
yeah I agree with most of this. I don't think all of my critique was that fair after completing my build for RIG. i think there are really two things that make our valuations disagree. your numbers are in line with my bull case assumptions, probably because base + idleness = my bull:
1.) idle times, reduces revenues pretty substantially. in your 2028-2029 PT, remember that each rig will likely go idle for a fleetwide average of 5-7 months. That's gonna cut down your revenues by alot. probably by 1/4 of your PTs (assuming a 2 year contract, idle times during resigning, and some at the tail end of their contract).
2.) your capital structure assumptions are very very aggressive. do you truly think management is just going to chop through this 9 bil debt?
On reactivation, while that is management guidance, often these tenders will get contracted at less than optimal day-rates in return. So management throws them a bone there, and should get priced into your forecast.
Obviously, you and I both need to adjust models after 9/3 events, but as of now i have this as a 10 dollar stock.
Transocean's bonds show that investors are considering decreasing the downside risk. All issues trade close to par value. Bond traders are the innovators on the market if I can use the Everett adoption curve as an analogy. They sense first where the risk is declining.
I like single-digit order books for drill ships. If the " long rigs" thesis plays out, the RIG will have (some) pricing power, which means higher NAV for its fleet and improved liquidity.
The stagnating supply of drill ships reminds me of LPG Small/Handysize carriers, ice-class LNG tankers, and capsize bulkers markets. All have an aging global fleet, a single-digit order book, and a lack of available slots for new builds. On the other hand, tonne-mile demand for those vessels is expected to grow.
The energy sector is very volatile, but that volatility presents incredible opportunities for those who are prepared to navigate it. These off-shore drilling companies face huge risks IMO. Fantastic post, deeply researched. While Transocean and Tidewater are solid picks, expanding into other players like Valaris and Noble could strengthen the overall position, given their strong financials and the value they bring to the shallow water market. But then too much exposure in a risky sector. When something seems so complicated and difficult to valuate/examine/forecast I prefer to stay away. But that's just me.
Thanks for the very detailed post. Can I ask why you and many others consider replacement value so relevant in your Transocean analysis? If the ships aren't worth that anymore, how is this relevant to a margin of safety? Genuine question, cheers!
Hey Guy - thanks for reading. The way I think about it is replacement value is the cost of new supply. I don't invest thinking that intrinsic value will appreciate to the replacement cost of the fleet but it gives me a rough sense as to how scarce these assets are and how durable the future cash flows may be.
Wish I could share your optimism. RIG hasn't had positive free cash flow for years. Capex running in the $350m range on top of $300m of interest is too much of a heavy burden. Raised equity in 2021 and 2022. They will probably need to raise more equity going forward in order to stay solvent.
Both oil and RIG are undervalued. Oil is extremely undervalued relative to gold. However, that doesn’t mean they can’t go lower or sideways for longer..
The Valaris warrants are worth a look if you want some torque on that one. Basically a super long dated call option on an offshore bull market.
Thanks for sharing! Yeah I usually like to keep it simple through common stocks but VAL warrants are definitely a great trade to gain maximum torque on the offshore thesis.
your numbers on your revenue forecast are highly suspect. RIG should not be anywhere near exceeding 8k operating days for YE 2024. 10k+ isn't possible given the economics of this fleet. You just assume that non-idle rigs will not become idle again in the future. I would highly suggest doing unit economics of this co if your going to take a DCF. your valuation will be understated (not a 4 dinger base case). I just wanted to comment this because the assumptions here are extremely enthusiastic, leaning into inaccuracy.
Thanks for the feedback. I agree - I think my projections for utilization were overly aggressive but will likely be somewhat offset by conservatism on the trajectory of day rates. Why do you think 10k+ isn't possible for this fleet?
I like the ideas otherwise here--I've just covered this co. w/ full unit economics and I think this is one of the more opaque co's to model. My 5 year price target is a little over half of yours, so there is still upside imo. I think I have a couple variant views here than you (don't speak too much on cap structure, which I think RIG gets unfair treatment for). Also, i do think the next dayrate cycle idiosyncratically affects RIG fleet. My model shows a 5-10% revenue delta compared to closest comps (the next cycle requires drilling 2000M+ basins in harsh conditions, see West Africa, Norway). But otherwise, I think we see eye-to-eye on this name.
Here are the areas I don't fully see here. these are mostly assumptions in valuation, not fundamental beliefs (including the 10k+):
On utilization: A rig works nearly year-round. The operating days includes days revenue was recorded (the figure you got from RIG 10k?). The implied annual working days of each of these ships is around 340-355 days a year (do this by counting active rigs per day). the working days do not include idle ships. which I think you noted. So the fleet currently has several stacked rigs (i think 8-9)? and a couple idle rigs. All those idle rigs are signed to contract. so their working days will come on soon. the thing is, some of those contracts will not come online this year and will continue to be idle into 2025. An activation should add around 350 days, but I am not sure but there may be some contracts ending. I need to get back on my computer to check what the actual backlog says, but +1400 isn't gonna happen. where do the extra 500 days come? which corresponds to a couple hundred million in revenue? Also, if this happens, where does the other 2000k days come from? Activation of a cold stacked rig costs tons of money. RIG wants to payoff debts. In addition, I don't think they even have enough ships in the fleet to get to that figure. assuming 350*30 is your thought process? gets you over 10k days? Remember some rigs will also become idle, and I don't really see an avenue to reactivating so many rigs. this is barring the fact that ships will come out for service, transport, shipyard, get warmed stacked etc. I mean what you say here could theoretically happen, but I think you and I both agree RIG probably does not have the cash flow to reactivate 3-4+ rigs, let alone will all their rigs operate at full efficiency over the next 5 years.
On working days balancing out dayrates: two problems for this. RIG is more sensitive to working days than dayrates. Also, I have a proprietary forecasting model that forecasts dayrates in full, and I do get a bit more bullish than your hard coded assumptions. But I do think your operating days have a far greater delta on revenue than your dayrate assumptions. In other words--this balances out to juice your revenue by alot.
This is all ignoring that shipyard times and negotiation periods have increased for RIG as shipyard economics are whacked and RIG is aiming for longer contracts (so more negotiation). So you may be able to see why 10k isn't going to happen. I suspect you didn't mean to hardcode this, but operating vs rig days are different. There is a description in RIG footnote.
Also--i think your implied fleetsize does not account for recent sales of ships in Q12024. So you overstate that a bit too, which I know its one but that turns into 9 figure revenue deltas. Operating expenses, etc: operating expenses stay relatively the same no matter what. a good way to think of it is that it costs the same to run a rig, but if dayrates are up you just make more. that being said, given supply chain dynamics they have been large (some may say overstated). But you probably should just forecast as % of revenue here. Don't now how you get to increase in 300 on a 1400 increase in operating days. when a 300 increase creates a similar outcome. the increase in operating expenses should be somewhat proportional. it could be diff depending on whats getting activated. so I could see someone trying to understate. but this is a large understatement. These were the big ones. I think a few others but they shouldnt push your valuation too high. Also--could be wrong on most of this, but I try to read skeptically. so open to change all opinions here.
P.S. read through again and adding this--i know you didn't use the "rebuild this co" as a basis for valuation like some people do, but I would be warry of this. rebuilding the co. =/= its intrinsic value. its more a statement of where we are in the dayrate cycle, not RIG. Look what Noble is doing. They are buying assets from other smaller drillers at discounts. While rebuilding RIG is worth alot, would these rigs actually sell for their implied rebuild price? Def not.
Sorry for the delay in my response – this past month has been a bit hectic. First off, thank you very much for your detailed feedback. I found this to be very helpful and always welcome pushback, especially from sector specialists since I’m just a generalist trying to capitalize on what I see as an attractive capital cycle opportunity.
I’ll try to address each of your points in sequential order:
On utilization, path to 10k+ operating days:
- My calculation for operating days in each year is (active rigs in year) x (total calendar days) x (revenue efficiency %). So for 2028, I assumed 29 active rigs x 366 calendar days x 96% revenue efficiency = 10,614 days
- To your point, I think I was overly aggressive in not fully appreciating idle time and should factor in some amount of days each year towards warm stacking, mobilization, repairs, etc.
- On implied fleet size, that’s simply the number of total rigs in the fleet – both active and stacked. That has no effect on revenue is just a fleet count. I tied revenue strictly to my assumptions for active rigs.
- I see your point with RIG being more sensitive to changes in operating days than it is to dayrates. Need to be more careful with projecting utilization going forward…
On reactivations and idle rigs:
- I know the fleet composition has changed quite a bit since my post but at the time, I was using YE 2023 numbers
- I assumed the two idle rigs (Discoverer Inspiration and DD3) would both go to work by 2025 and that RIG would reactivate 2 cold-stacked rigs in 2027 and 1 in 2028 for a total of 3 reactivations. Clearly, I’ve been proven wrong on the idle rigs since RIG just announced today the sale of Discoverer Inspiration and DD3. But I don’t think my reactivation assumptions are that heroic.
- In terms of capital for reactivations, per management guidance, I’ve assumed that the clients would have to fully pay for reactivation costs. Not sure if this is a reasonable assumption but if it proves to be the case, there’s less dependency on RIG’s cash flow or balance sheet for future reactivations.
On operating expenses:
- I actually disagree with you here. I tried to drill down to unit economics here and assumed the following OpEx per day costs:
o $145k per day for drillships with >1250 ST hookload capacity
o $140k per day for drillships and semis with <=1250 ST hookload capacity
o $185k per day for HE semis
o For cold stacked costs, I assumed a range of $30k-$40k again depending on the type of rig
- I also baked in an average of ~$500-600M per year in pre-operating, contract prep, and mobilization costs into the O&M expense line but assumed that RIG would get partially reimbursed for these costs by the operators. The reimbursement is what you see under other revenues.
- My thought process here is that O&M expense is actually “overstated” currently as RIG has had a higher number of days lost to mobilization, contract prep and idle time in which it has been paying full active operating costs but not receiving full day rates. As RIG begins its multi-year contracts, we should see some operating leverage here as RIG gets the benefit of a full day-rate while still paying the same O&M per day.
With all that being said, I definitely need to update my model to reflect all the recent changes and factor in greater potential idle time in the forecast period, which would reduce # of operating days. Curious to hear your thoughts on my response.
Sorry, meant to say overstated. Your O&M expenses are similar to mine.
yeah I agree with most of this. I don't think all of my critique was that fair after completing my build for RIG. i think there are really two things that make our valuations disagree. your numbers are in line with my bull case assumptions, probably because base + idleness = my bull:
1.) idle times, reduces revenues pretty substantially. in your 2028-2029 PT, remember that each rig will likely go idle for a fleetwide average of 5-7 months. That's gonna cut down your revenues by alot. probably by 1/4 of your PTs (assuming a 2 year contract, idle times during resigning, and some at the tail end of their contract).
2.) your capital structure assumptions are very very aggressive. do you truly think management is just going to chop through this 9 bil debt?
On reactivation, while that is management guidance, often these tenders will get contracted at less than optimal day-rates in return. So management throws them a bone there, and should get priced into your forecast.
Obviously, you and I both need to adjust models after 9/3 events, but as of now i have this as a 10 dollar stock.
also, this guy has a similar valuation to me given EVs: https://whitelightcapital.substack.com/p/deep-dive-transocean-long. i have lower debt assumptions than you guys. but your gonna need a 20k+ EV to be getting that high over 20 bucks.
Great article Tuan!
I think you’d laid out the thesis well with a few key points that are hardly mentioned from the NE and VAL camps:
1) RIG’s backlog continues to grow. They’re highly desired by their customers.
2) Superior management. Companies are willing to pay a little more for their service. That’s what also attracted me to RIG instead of the other two.
Thanks Peter! Appreciate the kind words :)
Exceptional article. Thanks for sharing.
Transocean's bonds show that investors are considering decreasing the downside risk. All issues trade close to par value. Bond traders are the innovators on the market if I can use the Everett adoption curve as an analogy. They sense first where the risk is declining.
I like single-digit order books for drill ships. If the " long rigs" thesis plays out, the RIG will have (some) pricing power, which means higher NAV for its fleet and improved liquidity.
The stagnating supply of drill ships reminds me of LPG Small/Handysize carriers, ice-class LNG tankers, and capsize bulkers markets. All have an aging global fleet, a single-digit order book, and a lack of available slots for new builds. On the other hand, tonne-mile demand for those vessels is expected to grow.
The energy sector is very volatile, but that volatility presents incredible opportunities for those who are prepared to navigate it. These off-shore drilling companies face huge risks IMO. Fantastic post, deeply researched. While Transocean and Tidewater are solid picks, expanding into other players like Valaris and Noble could strengthen the overall position, given their strong financials and the value they bring to the shallow water market. But then too much exposure in a risky sector. When something seems so complicated and difficult to valuate/examine/forecast I prefer to stay away. But that's just me.
Thanks for the very detailed post. Can I ask why you and many others consider replacement value so relevant in your Transocean analysis? If the ships aren't worth that anymore, how is this relevant to a margin of safety? Genuine question, cheers!
Hey Guy - thanks for reading. The way I think about it is replacement value is the cost of new supply. I don't invest thinking that intrinsic value will appreciate to the replacement cost of the fleet but it gives me a rough sense as to how scarce these assets are and how durable the future cash flows may be.
Wish I could share your optimism. RIG hasn't had positive free cash flow for years. Capex running in the $350m range on top of $300m of interest is too much of a heavy burden. Raised equity in 2021 and 2022. They will probably need to raise more equity going forward in order to stay solvent.
Both oil and RIG are undervalued. Oil is extremely undervalued relative to gold. However, that doesn’t mean they can’t go lower or sideways for longer..