October 4, 2017 / 9:10 PM / a year ago

Fitch Rates Transocean Inc.'s Unsecured Guaranteed Notes 'BB/RR2'

(The following statement was released by the rating agency) CHICAGO, October 04 (Fitch) Fitch Ratings has assigned a 'BB/RR2' rating to Transocean Inc.'s (NYSE: RIG) issuance of unsecured guaranteed notes due 2026. Proceeds from the notes will be used to repay or redeem the 2017 and 2018 maturities and for general corporate purposes. The notes will rank pari passu with Transocean's existing unsecured guaranteed debt. Fitch recognizes that the notes offering will increase forecasted base case consolidated gross debt metrics around 0.5x, but consolidated net leverage metrics will remain relatively unchanged over the next few years. Fitch's base case, on a pro forma basis for the announced notes and Songa Offshore transactions, results in debt/EBITDA of 7.2x and 5.6x on a gross and net debt basis, respectively, in 2018. Fitch believes the access to capital markets and, as a consequence, increased cash position, should help moderate the medium-term probability of default. Another consideration is that the transaction further supports credit facility renegotiation prospects. KEY RATING DRIVERS Songa Transaction Supports Strategic Financial Initiatives: Transocean recently announced the acquisition of Songa Offshore, which owns seven harsh-environment, ultra-deepwater floaters (three stacked), for a total enterprise value of approximately $3.4 billion. The four working rigs are under long-term contracts with Statoil, favorably providing approximately $4.1 billion of backlog. Fitch believes the transaction supports the company's strategic and financial initiatives by high-grading assets with a core offshore customer in an operationally attractive region, while improving the forecasted leverage profile. Weak Offshore Rig Market: Fitch continues to believe the offshore driller recovery will be protracted with an estimated recovery inflection point of second-half 2018. In addition, Fitch anticipates the floater market rebalance will be more orderly than the jackup market. The shorter-cycle, lower break-even cost of shallow water projects suggests the jackup market will realize an earlier uptick in demand, which is beginning to materialize. However, the more diversified operator and customer base, as well as relatively low rig carrying costs, indicate tendering will be more competitive, making material day-rate increases elusive without a strong demand recovery or considerable scrapping activity. The longer-cycle, higher gross development cost of deepwater projects is anticipated to result in a demand lag. However, Fitch believes the more concentrated floater customer base will result in a demand-driven floater recovery with preference toward larger, established drillers. Another consideration is the relatively high rig carry-cost, which will financially force some market participants to retire uncompetitive floaters. Day rates are anticipated to remain challenged and range-bound reflecting the market imbalance and economics required to reactivate stacked rigs. Consolidation is likely necessary for rig supply to better align with the lower expected mid-cycle rig demand. However, drillers seem reluctant to take meaningful steps toward consolidation given the uncertain timing of an offshore recovery, wide bid-ask spreads, a general need to use dilutive equity currency, and liquidity and balance sheet risks. Fitch has observed some consolidation activity but believes that the proposed acquisition funding and backlog of Songa Offshore mitigates some of these consolidation considerations. Positive FCF; Widening Metrics: Fitch's base case projects that Transocean, on a pro forma basis for the announced notes and Songa Offshore transactions, will be approximately $325 million and $500 million FCF positive in 2017 and 2018, respectively. Fitch's base case, on a pro forma basis for the announced notes and Songa Offshore transactions, results in debt/EBITDA of 7.2x and 5.6x on a gross and net debt basis, respectively, in 2018. Fitch recognizes that the secured notes, as well as any potential future secured note issuances, structurally subordinate contracted cash flows to service corporate debt and believes that adjusted corporate leverage metrics, excluding rig secured debt and associated cash flows, could rise above the consolidated metrics. Security Supports Notes Ratings: Fitch's corporate recovery analysis uses an $875 million sustainable, post-default EBITDA reflecting the potential for additional rig fleet rationalization and a prolonged period of challenged and range-bound day rates. Fitch assumed a relatively conservative 5x EBITDA multiple that considers recent market transactions and historical distressed asset sales. The estimated going concern value was discounted by 15% for administrative and priority claims given the large, global nature of the company's asset base. The distributable value was allocated to the guaranteed unsecured and unsecured debt, plus any assumed corporate unsecured recovery claims associated with the secured debt, based on relative security, The secured debt recovery uses a $60 million sustainable, post-default EBITDA reflecting contract performance and renegotiation risks during a weak offshore rig market environment and a 5x multiple. The senior unsecured guaranteed notes (BB/RR2) have structural seniority given the guarantee by Transocean Ltd. and Transocean Inc. subsidiaries that indirectly own substantially all of the group assets. The Transocean Phoenix 2 and Transocean Proteus secured debt ratings (BB-/RR3) consider the structural seniority of the notes given the lien on the Deepwater Thalassa and Proteus and certain other assets related to the rigs, as well as guarantees by Transocean Ltd., Transocean Inc., and a wholly owned indirect subsidiary that owns each respective ultra-deepwater (UDW) rig, operating under a 10-year Shell (AA-/Negative Outlook) contract. Fitch views the guarantee as an additional (secondary) payment support that is essentially a payment-put to the extent the contracted cash flows are insufficient to repay the secured notes. The supportive contract features, strong operating history, and favorable contract performance history between Transocean and Shell provide a level of confidence in the UDW rigs' ability to independently meet its annual debt service. However, contract performance and renegotiation as well as refinance risks remain. DERIVATION SUMMARY Transocean's ratings are supported by its market position as one of the largest global offshore drillers with a strong backlog ($10.2 billion as of July 25, 2017; pro forma $14.3 billion) and exclusively floater-focused rig fleet (pro forma 49 total rigs with 19 stacked) largely contracted with financially stronger international oil companies. The size and length of the company's backlog contrasts sharply with peers that generally have smaller backlogs which exhibited considerable declines in the 2018-2019 timeframe. This favorable backlog profile provides substantial financial flexibility during a deep cyclical downturn. Transocean has also proactively high-graded and focused its fleet via rationalization (39 floaters removed from the marketed fleet as of Sept. 22, 2017), divestiture (jackup fleet), and M&A (pending Songa Offshore acquisition; 4 contracted 'Cat-D' and 3 stacked harsh-environment, semisubmersible rigs) activities. While several peers have also taken steps to competitively position their fleets, Transocean has generally taken a more robust view of its fleet that seems to support their strategic, operational, and financial goals. Nevertheless, Transocean, generally consistent with its offshore rig peers, has a considerable debt burden and continued need to generate and conserve liquidity given the weak offshore rig-market outlook, unfavorable capital market conditions, heightened maturities profile, and newbuild capex commitments. Fitch recognizes, however, that the company is among the only offshore drillers that is managing its long-term capital structure through-the-cycle, as well as increasing its exposure to contractually linked amortizing debt. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: --Brent oil price that trends up from $52.50/barrel in 2017 to a longer-term price of $57.50/barrel; --Pro forma contracted backlog is forecast to remain intact with no material renegotiations; --Market day-rates assumed to be at or near cash breakeven levels; --Fleet composition considers announced rig retirements and attempts to adjust for uncompetitive rigs due to their technological obsolescence, undifferentiated market position, or cost-prohibitive through-the-cycle economics; --Capital expenditures of approximately $500 million, $165 million, and $190 million in 2017, 2018, and 2019, respectively, plus Songa Offshore spending generally consistent with recent levels over the next couple of years; --Songa Offshore acquisition completed by YE2017 assuming the announced transaction funding, including approximately $660 million convertible bond, $540 million Transocean equity, and $480 million cash; --No additional Shell UDW secured debt issuances. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action For an Upgrade to 'BB-': --Demonstrated commitment by management to lower gross debt levels; --Mid-cycle debt/EBITDA of below 5.0x on a sustained basis; --Further progress in implementing the company's asset strategy to focus on the high-specification and UDW markets. To Resolve the Negative Outlook at 'B+': --Demonstrated ability to secure tenders that constructively contribute to the backlog and cash flows signalling the company's ability to manage the industry's re-contracting risk and bridge its financial profile through-the-cycle; --Continued progress toward generating and preserving liquidity; --Mid-cycle debt/EBITDA of 5.0x-5.5x on a sustained basis. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action --Failure to manage FCF, repay near-term maturities, and retain adequate liquidity over the next few years; --Additional issuance of secured debt that structurally subordinates contracted newbuild cash flows resulting in materially lower corporate cash flows; --Material, sustained declines in rig utilization and day rates signaling a heightened level of re-contracting and recovery risk; --Mid-cycle debt/EBITDA around 6.0x on a sustained basis. LIQUIDITY Adequate Liquidity Profile: Transocean has cash and cash equivalents of approximately $2.5 billion as of June 30, 2017 and restricted cash of $537 million, some of which is held as cash collateral for the Eksportfinans Loans and for security of certain other credit arrangements. Pro forma cash and equivalents, including cash consideration for the Songa Offshore transaction, is approximately $2 billion as of June 30, 2017. The company has the potential for additional cash associated with the monetization of the two to-be-delivered Shell newbuild rigs (recent Shell secured debt transactions resulted in approximately $600 million and $625 million per rig). Supplemental liquidity is provided by the company's $3 billion senior unsecured revolving credit facility due June 2019. The company had $3 billion in available borrowing capacity on this facility as of June 30, 2017. Fitch believes Transocean has solid credit facility renegotiation prospects given its cash position, manageable maturity profile, and secured debt capacity (Fitch-calculated secured debt capacity of around $200 million; pro forma of about $500 million following the Songa acquisition). Proactive Maturity Management: Transocean has annual senior unsecured notes maturities equal to approximately $152 million, $401 million, $292 million, and $332 million in 2017, 2018, 2020, and 2021, respectively. These represent the company's 2.5% senior notes due October 2017, 6% senior notes due March 2018, 7.375% senior notes due April 2018, 6.5% senior notes due November 2020, and 6.375% senior notes due December 2021. Proceeds from the announced notes offering will be used to repay or redeem the 2017 and 2018 maturities. This excludes rig-level secured debt principal amortization that effectively has contract-linked payments. Management has been proactively tendering and repurchasing debt in the open market over the past couple of years in an effort to incrementally improve the near-term liquidity and maturity profiles by reducing interest payments and, in some instances, capture a par discount. Headroom Under Current Covenants: Transocean, as provided in its bank credit agreement, is currently subject to a maximum debt-to-tangible capitalization ratio of 0.6x (0.34x as of June 30, 2017), excluding intangible asset impairments and certain other items. Other customary covenants consist of lien limitations and transaction restrictions. Additionally, the Shell UDW secured notes contain covenants that limit the ability of the borrowing subsidiaries to declare or pay dividends, and impose a maximum collateral rig leverage ratio of 5.75x (less than 5x as of June 30, 2017). Manageable Other Liabilities: Transocean maintains several defined benefit pension plans, both funded and unfunded, in the U.S. and abroad. As of Dec. 31, 2016, the company's funded status was negative $351 million. Fitch considers the level of pension obligations to be manageable, on a mid-cycle basis, and the U.S. benefits freeze helps to alleviate any future pension-related credit risks. Other contingent obligations primarily comprise newbuild purchase commitments and service agreement obligations totaling approximately $1.5 billion on a multi-year, undiscounted basis as of Dec. 31, 2016, adjusting for the transfer of jackup obligations. The vast majority of the post-2017 newbuild purchase obligations are associated with the current 2020 delivery of the uncontracted UDW rigs, which the industry has demonstrated an ability to defer. FULL LIST OF RATING ACTIONS Fitch has assigned the following rating: Transocean Inc. --Senior unsecured guaranteed notes at 'BB/RR2'. Fitch currently rates Transocean as follows: Transocean Ltd. --Long-Term IDR 'B+'. Transocean Inc. --Long-Term IDR 'B+'; --Senior unsecured guaranteed notes 'BB/RR2'; --Senior unsecured notes/debentures 'B/RR5'; --Senior unsecured bank facility 'B/RR5'; --Senior unsecured convertible bond 'B(EXP)/RR5'. Global Santa Fe Inc. --Long-Term IDR 'B+'; --Senior unsecured notes 'B/RR5'. Transocean Phoenix 2 Limited --Long-Term IDR 'B+'; --Senior secured notes 'BB-/RR3'. Transocean Proteus Limited --Long-Term IDR 'B+'; --Senior secured notes 'BB-/RR3'. The Rating Outlook is Negative. Contact: Primary Analyst Dino Kritikos Senior Director +1-312-368-3150 Fitch Ratings, Inc. 70 W Madison St Chicago, IL 60602 Secondary Analyst Joan Isi Okogun Senior Director +1-212-908-0384 Committee Chairperson Michael Paladino, CFA Managing Director +1-212-908-9113 Date of Relevant Rating Committee: Aug. 16, 2017 Summary of Financial Statement Adjustments - Fitch has made no material adjustments that are not disclosed within the company's public filings. . Media Relations: Alyssa Castelli, New York, Tel: +1 (212) 908 0540, Email: alyssa.castelli@fitchratings.com. 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