Moody's Ups Transocean Offshore

Moody's Investors Service upgraded the senior unsecured debt ratings of Transocean Offshore, Inc. to A3 from Baa1 to reflect the significant benefits that the company will likely derive from its pending merger with Sedco Forex Holdings Limited (Sedco). The rating action ends a review of Transocean's ratings initiated on July 12, 1999 in response to the company's announcement that it had signed a definitive agreement under which Sedco, the offshore contract drilling business of Schlumberger Limited, will be spun off and combined promptly with Transocean through the issuance of approximately $3.2 billion of Transocean stock and the assumption of about $435 million of debt. The combined company will be known as Transocean Sedco Forex. The merger has been approved by both companies' shareholders and is expected to close by December 31, 1999. The rating outlook is stable. Ratings upgraded are Transocean Offshore's senior unsecured notes and debentures to A3 from Baa1, its bank debt rating to A3 from Baa1, and its shelf registration for senior unsecured debt/subordinated debt/preferred stock to (P)A3/(P)Baa1/(P)"Baa1" from (P)Baa1/(P)Baa2/(P)"baa2." The benefits of the combination for Transocean include a substantially larger fleet of offshore drilling units, increased market share, a more diversified rig fleet, both geographically and in terms of rig type, and enhanced technical expertise in deepwater drilling. With 75 drilling rigs, Transocean Sedco Forex will be the world's largest offshore drilling contractor in terms of number of offshore rigs, floating rigs, and deepwater rigs. About one-third of the company's drilling rigs (including newbuildings) will be capable of drilling in water depths greater than 3,000 feet. The company will also be the fourth largest oil field service company in terms of market capitalization. The company's increased size should improve its access to capital, as well as its ability to withstand periodic downturns in the drilling cycle. The combination will also provide Transocean with a market presence in West Africa and the Far East, which it had lacked previously. Improved geographic diversification and a more broad-based rig fleet should enhance the stability of the company's earnings and cash flow, as weak market conditions in one region or sector will likely be at least partially mitigated by stronger performance in others. A large number of firm drilling contracts will also help Transocean Sedco Forex maintain a relatively strong financial position during periods of low rig utilization and weaker day rates. Excluding Sedco's four rigs that are currently under construction, Moody's notes that the average maturity of Sedco's drilling contracts is shorter than Transocean's, which implies somewhat greater earnings volatility during the different phases of the drilling cycle. However, Sedco has demonstrated that it can remain profitable even during periods of weak day rates because of its relatively low cost structure. The A3 rating assumes that management will continue its conservative operating and financial policies. The combined entity's debt to book capitalization ratio will likely be in the range of 20-25% upon consummation of the merger. However, Moody's notes that Transocean's assets are expected to be subject to asset write-ups upon closing of the transaction, which will likely make historical comparisons more difficult. In addition, Moody's expects that the combined company's financial leverage will likely increase above current levels from time to time as management enters into contracts for new drilling rigs and funds all or a portion of such newbuildings with debt. The combined construction program of Transocean and Sedco, which includes six new drilling rigs, is expected to be completed by year-end 2000. Management has stated that the construction of any new drilling rigs in the future will be supported by long-term contracts. However, Moody's believes that there is still a risk that such contracts could be either amended (through a reduction in day rate and/or contract maturity) or cancelled outright during downturns in the drilling cycle due to construction delays, unsatisfactory rig performance, or other reasons, even if such contracts contain no explicit cancellation provisions. In addition, many of the new technologies and/or processes expected to be employed in deepwater drilling have not yet been tested. Moody's believes that Transocean has a strong track record in technological innovation and implementation. However, to some extent, the uncertainties surrounding the success of cutting edge drilling technology and processes should be factored into Transocean's ratings.