Drillers' Merger Prospects Sink as Rising Oil Prices Buoy Shares
By Mavis Scanlon
Staff Reporter
9/7/99 9:07 AM ET
Schlumberger's (SLB:NYSE) July 12 announcement that it would spin off its offshore drilling unit and merge it with Transocean Offshore (RIG:NYSE) was just the beginning, or so it seemed.
News of that deal, the first major merger in the fragmented offshore contract drilling industry since R&B Falcon's (FLC:NYSE) December buy of Cliffs Drilling, fueled talk that others would surely follow. Companies such as Noble Drilling (NE:NYSE), Global Marine (GLM:NYSE), Diamond Offshore (DO:NYSE) and Marine Drilling (MRL:NYSE) were mentioned as likely candidates.
Lately, however, even the talk of deals has died, a victim of higher oil prices that in turn have boosted stock prices and made the drillers' predicament less dire. Prices of many drilling stocks have nearly doubled in the past few months.
David Thompson, who follows the energy sector at Colonial Management Associates in Boston, sums up the current sentiment this way: For a driller with its stock trading at 13, "why would I sell out at 15 a share when managements are increasingly confident that we're in a new up cycle?" With every rig that goes back to work, cash flows improve. "The need to sell is getting less every day," adds Thompson.
Maybe. Still, despite the sighs of relief in corporate suites, the industry could use some consolidation, especially among shallow-water fleets, says Scott Gill, an analyst at Simmons in Houston. "Maybe the expectation is we'd see a bunch [of deals] in rapid-fire succession, but in reality it never happens that quickly," Gill says.
A larger fleet is more competitive on a global basis and in niche markets. Furthermore, the thesis goes, fewer players would show more rig-pricing discipline, perhaps reducing the temptation to cut rates in an effort to ensure market share. In the last downturn, rates for shallow-water, or jack-up drilling rigs, slid to about $17,000 per day from near $70,000 in a matter of months.
But the recovering market complicates things. The single-biggest issue involves assigning a value to a company's assets, says Bob Rose, Global Marine's chairman, president and chief executive. This crops up in any industry, of course, but asset values are moving targets for the drillers, which have fluctuating daily rental rates.
And in an improving market, two companies may differ materially in their outlook on just how much improving fundamentals may affect rental rates, and hence revenue, income and valuation.
For instance, Global Marine has two deep-water drill ships nearing completion that will be in the market next year, Rose says.
"To value Global on its current earnings is unfair to shareholders," he says. "You really have to look at what the two companies will contribute in the future. And the most difficult aspect [of closing a deal] is agreeing on what the future contributions of two companies will be and therefore what the relative ownership percentages of the combined company will be. There has to be some adjustment to account for greater earnings potential."
Global continues to talk to various companies about joining forces, but Rose declined to provide specifics.
If and when the next deal gets done, says Gill at Simmons, don't use past premiums as a benchmark. Even with shares soaring, some companies have more upside left in the stock prices than others, he says. For example, at about 15 Pride International (PDE:NYSE) trades at less than half of its peak price of late 1997. Pride representatives couldn't be reached for comment. (Simmons doesn't rate stocks, and hasn't done recent underwriting for Pride.) Diamond, however, at 37 1/2, trades at 60% of its peak price. Diamond declined to comment. (Simmons hasn't done underwriting for Diamond.)
So Diamond has less upside than Pride, which has traded poorly due to balance sheet concerns and problems with its rig-construction program, Gill says. "If I'm an acquirer of Diamond I would probably not put a big premium on [it]. If Pride is acquired there could be a premium."
Rose at Global Marine says there is a 50-50 chance of another deal getting done before the year ends. For Global, it's a question of valuation. "Are our shareholders better off after this combination than if we did nothing? If we can't answer that question with a resounding 'yes' then we're better off not doing the deal."
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