Article on DO, From TheStreet.com.."Diamond's in the Rough Waters of Offshore Drilling
By Mavis Scanlon
Staff Reporter
2/25/99 7:36 AM ET
Depressed oil prices have offshore drillers in a deep funk. But Diamond Offshore (DO:NYSE), with oodles of cash, sees opportunity.
The Houston-based company is seeking acquisitions. Not that James Tisch, chairman and chief executive, is considering buying just for the sake of consolidation, a point he stresses. Tisch, after all, is known as a deep value player.
With an arsenal of greenbacks that tops $600 million, Diamond could be the best-positioned driller to profit from a prolonged slowdown. Observers expect that Diamond will emerge larger and stronger from the current industry malaise.
Credit for Diamond's strong financial standing goes to Tisch, also president and chief operating officer of Diamond's majority shareholder, Loews (LTR:NYSE). Tisch, a Diamond director since Loews bought into a downtrodden offshore drilling industry in 1989, has imposed upon Diamond what company executives are fond of calling "financial discipline." He likes to tell employees the company has "asbestos-lined pockets"; cash doesn't burn a hole through them.
"When things were going well we leaned into the wind and were very reluctant to take on [new rig construction]," Tisch says. "We were concerned that the rates of return would not be high enough. We decided instead to husband our cash and build up financial strength so we can take advantage" of the next downturn.
The downturn is real. Worldwide spending on oil exploration and production is expected to drop at least 25% this year, the industry's largest decline since 1986. The number of rigs drilling worldwide has plummeted from 1998 peaks, leaving a growing surplus of idle rigs. And with an oversupplied crude oil market, producers are reluctant to take on new drilling projects.
So far, however, the offshore drilling industry has been largely immune to the oil patch merger bug. The biggest argument for offshore driller combinations is to gain market share and gain pricing power.
The Mating Game
"Just throw [all the drillers'] names in a hat and pull two out," says Gary Krenek, Diamond's chief financial officer. "That's the latest rumor. There's a lot of speculation, but I believe all the companies are truly looking at each other."
Diamond is geared to deep water, with 31 of its 46 rigs capable of drilling in depths greater than 600 feet. Although its first preference is to grow the deep-water division, "we will look at anything that makes sense from a value standpoint," Krenek says.
Analysts see marital bliss between Diamond and several companies.
Among others, Marine Drilling (MRL:NYSE), Noble Drilling (NE:NYSE) and R&B Falcon (FLC:NYSE) have been mentioned as possible partners. Diamond declined to comment on any possible combinations.
Jan Rask, Marine's President and CEO, is known as an asset trader, making his company a likely takeover candidate, says Matt Conlan, who follows the group at Prudential Securities in Houston. (Conlan has an accumulate rating on the group; Prudential hasn't performed underwriting for Diamond or Marine.) Diamond would get access to the expected revenues from Marine's two deep-water rigs under construction.
Right now, Marine has most of its revenue eggs in those two baskets, Conlan says, since nearly 100% of Marine's 1999 operating income is expected to come from the two rigs. They are scheduled for delivery in April and June.
Diamond's risk in this purchase would be late delivery or possible contract cancellations, says Wes Maat, who follows the group at Deutsche Bank Securities in New York. (He rates Diamond a buy and Marine a hold; Deutsche Bank is not an underwriter for either company).
Marine declined to comment.
Diamond and Noble also would make an intriguing combination, Maat says, due to similarities in operating styles and international fleets. Noble's ideal partner would be a company like Diamond, "with good quality assets, low debt and good management," says Noble spokesman Steve Manz. However, Manz says he is unaware of any discussions between the companies.
A much more aggressive play would be a bid for Falcon, whose shares have lagged as several missteps in the company's own deep-water conversion program have alienated investors. Falcon, with a long-term debt-to-capital ratio of 62%, would benefit by merging with a solid partner, analysts say. A Falcon spokesman was unavailable for comment.
But Tisch says, "more debt makes us less willing to do something."
I'll Do the Buying Here, Thank You Very Much
While several analysts agree that a major merger among the drillers is bound to happen, companies still view themselves as buyers.
In short, management is still unwilling to give up power, Maat at Deutsche Bank says, the same sticking point as five months ago.
"Everyone would like consolidation as long as they are the acquirer," says Diamond's Krenek. So until some companies decide they want to sell, the "prices are still above what we would be comfortable with at this time."
The acquisitions Diamond made to form the company between 1989 and 1996 are examples of the deep values Tisch seeks. Loews initially purchased seven rigs for $48.5 million in 1989. Then, in early 1992, the company acquired nearly 40 rigs for $372 million, about $70 million more than the current price to build one new deep-water rig. Loews' initial investment in the offshore drilling business has blossomed into a $3 billion drilling powerhouse.
Even in 1998's horrible environment, Diamond managed to push up profits. Diamond earned $383.7 million, or $2.66 per share, on revenues of $1.2 billion. In 1997, the company earned $278.6 million, or $1.93 per share, on revenues of $956 million. But the decline projected in worldwide rig activity will take its toll this year. First Call consensus estimates call for a 39% drop in earnings per share, to $1.62, followed by a 2% jump in 2000, to $1.65.
Diamond's financial performance has helped its shares hold up relatively well. Its shares are down about 10% year-to-date. Falcon, at the other extreme, is off 25% this year. Still, Diamond closed Wednesday just a point off its 52-week low, at 21 1/16, off 1 11/16.
Investors' faith in Diamond may pay off if it uses its war chest well in the coming months. Krenek is determined to do so. "We will sit on that cash until we find the right deal," he says."
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