Transocean Seen Pressed on Rating or Dividend: Corporate Finance

Sept. 30 (Bloomberg) — Pressure is growing on Transocean Ltd. to decide among its $1 billion of Carl Icahn-inspired annual dividends, investment-grade bond rating and capital spending, derivatives trading shows.

The offshore driller’s debt securities have been the worst performers in the $4 trillion Bloomberg US Corporate Bond index this quarter as default swaps indicate the biggest deterioration in creditworthiness among peers. Barclays Plc cut its 2015 cash flow forecast for Transocean by 22 percent this month to $2.5 billion, saying the “have-it-all” strategy is unsustainable.

While Transocean has been clinging to its bottom-tier high- grade rating since emerging from its part in the 2010 Gulf of Mexico oil spill, the combination of 5.9 percent owner Icahn’s equity-friendly agitation and weakening demand for its services amid the increasing lure of on-shore production is straining its creditworthiness. The Vernier, Switzerland-based company’s capital spending is set to climb to a five-year high as it invests in improving the quality of its fleet.

“They don’t have a lot of cushion at this rating given the amount of debt they have,” Ben Tsocanos, a Standard & Poor’s credit analyst, said in a telephone interview. “The company has been consistent about staying committed to investment grade and dividends. But if market conditions weaken, they would have to choose.”

Bond Slump

Bonds of the owner of the largest fleet of offshore rigs have slumped 5.6 percent this quarter, Bloomberg index data show. Its $900 million of 6.5 percent notes coming due in November 2020 dropped to 104.3 cents on the dollar on Sept. 22 to yield 5.65 percent, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. That’s the lowest closing level since December 2011.

Transocean, which is rated Baa3 by Moody’s Investors Service and BBB- at S&P, has bond yields that compare with an average of 5 percent on the Bank of America Merrill Lynch BB U.S. High Yield index, which compiles 900 securities and has an effective duration of five years.

“The company’s approach to capital allocation is unchanged,” Pam Easton, a spokeswoman for Transocean, said in an e-mail. Transocean is committed to maintaining an investment- grade balance sheet, invest in its fleet for the long-term and pay a competitive, sustainable dividend, she said.

Negligence Ruling

The price of contracts protecting against a default for five years on the company’s debt increased to about 300 basis points, according to data provider CMA, which is owned by McGraw Hill Financial Inc. and compiles prices quoted by dealers in the privately negotiated market. That means investors would have to pay about $300,000 to protect $10 million of Transocean debt. That compares with a level of 187 basis points at the start of the month.

The company, which owned the Deepwater Horizon drilling rig, was cleared of gross negligence for its role in the 2010 Gulf of Mexico disaster, which resulted in the deaths of 11 workers and caused the largest offshore oil spill in U.S. history, according to a ruling earlier this month.

Slowing Growth

Transocean, which provides offshore contract drilling services, has been affected in an industry where major oil companies are trimming spending budgets and exploration and production companies are looking at on-shore production opportunities, according to Harry Mateer, a New York-based analyst at Barclays. There’s an assessment that their contracts will likely be renewed at lower rates, according to Phil Adams, a bond analyst at Gimme Credit LLC in Chicago.

The driller had $10.5 billion in total debt at the end of last quarter, with more than $4 billion of bonds coming due within four years. The cost for refinancing some of that debt will rise with a lower rating, especially as interest rates are expected to increase as the Federal Reserve prepares to reverse it near-zero benchmark rate measure, according to Mateer.

“I am not convinced it would be the best idea to fall to high yield if they have control over it considering the significant debt coming due in a rising rate environment,” Mateer said in a telephone interview. “We think there’s scope to cut the dividend by half and that would give them added flexibility.”

Mateer lowered the company’s earnings before interest, taxes, depreciation and amortization estimate for 2015 to $2.5 billion from $3.2 billion.

Last year, the company reached an agreement with Icahn to boost its annual dividend to $3 per share from $2.24 after previously rejecting a demand that would have seen the payout at $4 a share. With the stock slumping to an 11-year low last week, the indicated dividend yield climbed to 9.2 percent.

“It is not an option to have your investment grade rating taken away,” David Havens, a CLSA analyst, said in a telephone interview. “I don’t think they can maintain both dividend and rating. One has got to go.”

–With assistance from David Wethe in Houston.

To contact the reporter on this story: Sridhar Natarajan in New York at [e-mail] To contact the editors responsible for this story: Shannon D. Harrington at [e-mail] Richard Bravo, Chapin Wright