RIG & GSF – Let’s do the math
As a GSF shareholder, I was very interested in the merger news this morning and spent most of my non-smoking breaks and lunch hour trying to make sense of the deal and put a value on it.
In case you haven’t heard, Transocean (RIG) and Global Santa Fe (GSF) announced a merger deal this morning. The merged company will be called Transocean, Inc. and trade under the RIG symbol. Shareholders in the present RIG will get 0.6996 new shares and $33.03 in cash for each of their old shares. GSF shareholders will get 0.4757 shares in the new company and $22.46 for each of their shares. The new Transocean will have 318 million shares outstanding and the cash payouts will be financed by a $15 billion, one-year bridge loan. That bridge loan will be refinanced by “a mix of bank loans and debt securities” according to the news release posted on the GSF Investor Relations web page. The deal is expected to close by the end of 2007.
I decided to approach this by attempting to put a valuation on the new company, then backtrack to what that means for current shares of GSF and RIG.
Step one was to get a handle on 2008 earnings estimates for the new company. For 2008 GSF is expected to earn $9.16 per share and has about 228 million shares outstanding, giving about $2.1 billion. RIG is expected to earn $11.46 per share and has about 288 million shares out giving $3.3 billion.
So the new RIG is expected to earn $5.4 billion in 2008. But we also need to subtract out the debt servicing costs for the new $15 billion bridge loan. I couldn't find terms for that loan, but I used $1 billion, about a 6% interest rate, for 2008. $4.4 billion in earnings over 318 million shares results in $13.81 per share.
As of Friday’s close, RIG traded at a PE of about 9.7 and GSF at 8.2 times 2008 earnings. At RIG’s PE, the new company would be valued at $133.5 per share and at the average of the two PE’s it would be $123.40 per share.
There also needs to be a discount applied for the debt servicing associated with the $15 billion loan from 2009 forward. Without knowing the terms, it’s tough to value that, but the present value of the stream of debt service would have to be pretty close to the $15 billion loan amount, spread over the 318 million shares we get a hit of about $45 per share. I’m not sure I’ve done this right, so any of you accountant types please chime in with corrections.
If I use the RIG PE and assume I’ve been too harsh with the loan discount, the value on a fully discounted share of new RIG comes out somewhere around $100. Granted, it's slanted toward the high end, but it also makes the rest of the math easy.
Under this set of assumptions, a current share of GSF would be valued at:
$47.57 for the partial new RIG share + $22.46 in cash = $70.03
And a current RIG share should be worth:
$69.96 for the partial new RIG share + $33.03 in cash = $102.99
Even without including a discount for the loan servicing in the outyears, a share of GSF would be worth $81.20 - $86 depending on which PE is applied. The low end is nearly what it traded for today and you still need to apply some discount for the payment stream servicing that $15 billion loan.
I have not included anything for cost savings from the combined operations. The GSF press release indicates they’re expecting $100-$150 million per year by 2010, so it's not going to be a huge contributor to the bottom line. I also haven’t included any factor for additional pricing the combined company may be able to squeeze out - that could be significant.
As a result of the new projected debt levels, Fitch Ratings downgraded Transocean from A- to BBB+.
I believe this deal would make a lot more sense without the big loan and cash-out, or if the loan proceeds were being used to expand the business, make an acquisition or something more productive than just passing it out to shareholders. I just don’t see how you create value by leveraging up to effectively pay a special dividend.
Bottom line – I sold my GSF today at $78.85 and ended my CAPS pick. I still like the offshore drillers and will consider buying GSF (or RIG) again if the prices come down to the low 70's or the equivalent in RIG.
Please feel free to add your comments and let me know what I’m missing here or how you would value this deal differently.