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rd80 (99.11)

RIG & GSF – Let’s do the math

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July 23, 2007 – Comments (3)

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.

Fool On.

3 Comments – Post Your Own

#1) On July 26, 2007 at 10:49 PM, rd80 (99.11) wrote:

Went though this again and realized I missed the tax implications of the loan. From the income statements, it looks like both RIG and GSH pay about 15% of their earnings in taxes. Since the debt service would lower earnings, it also lowers the tax payments.

It doesn't change things much, and I'm not sure I'm doing the loan discounting or the tax implications correctly.

However, I started nibbiling back at GSF below 75 today.

At todays close, GSF at 75 is a slightly better buy than RIG at 112.  GSF gets you newco a little cheaper, you'll get two small divvy payments between now and the end of the year that RIG doesn't pay, and there's always the possibility that someone will come along and make an offer for GSF.

Fellow Fools - Anyone care to chime in on assumptions to use for discounting the outyear debt servicing payments or how to handle the tax implications of the $15b loan?

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#2) On July 28, 2007 at 3:47 AM, OMGitsadam (60.07) wrote:

I've been really interested in finding out what the combined company would be valued at, so I was excited to see this blog.

Your math makes sense for a while, but I think you lost it with your explanation of the $15 billion loan.  I see it to be much more likely that when all is said and done the valuation will be just about dead on with where RIG is now.  After all, that's why they conjured up this merger structure.

While I do think it would have been best to sell both of these stocks right after this merger was announced and wait it out a while, at the current prices (after the big drops this week) I believe GSF and RIG are both extraordinary deals.  Even better are DO, NE, and ESV. 

With that said, go out and buy some underwater drillers this coming week if you don't own any right now.  Someone just dropped a lump of gold on the ground...you might as well pick it up. 

 

 

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#3) On July 28, 2007 at 10:12 AM, rd80 (99.11) wrote:

Thanks for the comment.  I agree that the offshore drillers are still cheap.

I lost myself a bit trying to factor in the $15 bill loan.  For 2008 it's relatively easy, newRIG will need to pay something on the order of $1 bill in interest. Factor in an assumed 15% for the reduction in taxes and you subtract $850 mil from the combined earnings to get an earnings forecast for newRIG. I forgot to make an allowance for the tax implications in my original post. Not sure 15% is correct, but it's close to the overall tax rate paid by both companies over the past 4 quarters.

The outyears are much tougher to deal with because I don't have longer term earnings estimates and don't know what the debt terms will be. But, just to get a data point if you assume 6.5% over 10 years, newRIG needs to pay out a litte over $2 bil per year to service the debt.

The analysts and market makers must have some kind of cash flow models they're using to value RIG and GSF. Those models now need to be adjusted to account for the new expense of servicing the $15 bill debt.

I've been tweaking my calcs a bit and think the newRIG should be worth about 105-110 per share. That would value GSF at low to mid 73's - right about where it closed Fri - and RIG at mid to hi 107's. FWIW, I think those numbers will go up when the drillers report next week.

I like the drillers and the combined company, but I still think this would be a smarter deal without the $15 bill loan and cash payout. 

As noted in the update to my post, I started buying back my GSF position. 

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