Taking a hit from the Gulf disaster

Transocean may have low-balled the potential cost of the Deepwater Horizon debacle.

By Jim J. Jubak May 24, 2010 9:52PM

Jim JubakThe best you can say about Transocean (RIG) is that it has a tin ear for public opinion.

The company's public response to the Deepwater Horizon disaster in April has been to say it wasn't our fault, and we're not on the hook for very much money.

Even if true -- and there's a good chance both statements are true -- this isn't exactly how a company that gives a damn responds to what is becoming the biggest oil-related environmental disaster in U.S. history.

And to continue the company's sure-footed response (if sticking your foot in your mouth is sure-footed, that is), Transocean declared a $1-billion dividend to shareholders as the environmental disaster was still unfolding.

Predictably, the dividend payout has raised the wrath of U.S. politicians. Senator Ron Wyden, D-Ore., and 17 colleagues have asked the Department of Justice to launch an investigation into Transocean's financial transactions, casting the dividend payment as an attempt by the company to avoid paying claims arising from the spill.

The logic of the senators' letter escapes me: If Transocean is found liable for a big payout from the disaster, its $1-billion dividend payout certainly won't change the size of the judgment. Transocean generated more than $5 billion in cash from operations in 2009 and could raise billions more in the capital markets to pay any conceivable judgment. The stock dropped $5.28, or almost 9%, Monday on news of the request for an investigation.

Political grandstanding aside, Wall Street is busy at work trying to figure out how big a hit the company will take from the Deepwater Horizon disaster.

The company, in my opinion, low-balled the potential cost in its May 6 conference call following the announcement of first-quarter earnings. Transocean cited its contract with BP (BP) that, in the company's reading, indemnifies it against loss and its insurance policy that covers the destruction of the rig. The company estimates a 2010 loss of about $200 million related to insurance deductibles, increased insurance premiums, and legal fees.

An analysis by First Securities puts the figure at somewhere between $500 million and $1.3 billion, including $1 billion in payouts on lawsuits. Against that, First Securities deducts $560 million in insurance on the rig.

If you believe that estimate, then Transocean is a cheap stock after Monday's drop to $53.96. Shares traded at $92.03 on April 20. Given that the company has 320 million shares outstanding, that drop adds up to a loss of about $12 billion in market capitalization.

If the $1.3-billion estimate from First Securities is correct, investors are looking at $10.7 billion in market overreaction.

Of course, there's still the little, so far unresolved, issue of what caused the disaster. 

That could put a dent in these estimates: If Transocean was shown to be in some way negligent and that negligence caused the disaster, then all bets on the size of its liability would go out the window. For example, in that case, you'd expect BP to go after Transocean to recover all or part of its costs.

On Monday, FBR Capital raised its rating on Transocean to outperform from market perform. That's because after hearing testimony from BP, Transocean, and Halliburton (HAL), the company responsible for pouring the concrete that was supposed to have sealed the well, the Senate released a BP document that, in FBR's opinion, reduces the likelihood that Transocean was negligent.

A crust of frozen hydrates may have fouled the blowout preventer so that it couldn't seal the well. If that's the case -- and the disaster isn't the result of faulty equipment or maintenance -- Transocean and Cameron International (CAM) would seem to be off the hook for a finding of negligence. That would reduce any potential liability immensely to something like the range that First Securities estimates.

There's too much uncertainly here for me to recommend that you load up on Transocean shares. My best estimates say that the stock is undervalued at the current price, so I'm not selling it out of Jubak's Picks today. The disaster is likely to reduce drilling in U.S. coastal waters, and that will take some -- but not a whole lot of -- money out of Transocean's revenue for the rest of 2010.

In its conference call, the company said that global demand for ultra-deepwater rigs remains strong, that demand for deepwater rigs is soft, and that demand for jack-up rigs looks headed to a recovery.

All that takes my estimate of 2010 earnings down to a little less than $9 a share for 2010 and my target price down to $95 a share from $105.  (For more on how the disaster is re-arranging the U.S. alternative energy sector, see this post).

Harder than estimating earnings is figuring out when the stock might start trading on earnings as opposed to news from the Gulf disaster. I'm pushing out my schedule to May 2011 from  November 2010. 

Remember, the Gulf has to get through hurricane season. High winds and tides from any storms will whip oil from the spill into a very dangerous froth.

At the time of this writing, Jim Jubak owned shares of Transocean in his personal portfolio.  

Tags: BP


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