Holding On to Transocean

 | Nov 30, 2011 | 7:42 AM EST
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When Baker Hughes (BHI) rallied strongly, Transocean (RIG) lagged. While Anadarko (APC) cut a deal with BP (BP) to settle out Macondo liabilities, Transocean continued to aver its indemnity to the event and refused to talk about settlement with BP. The company preferred to go to court and fight it out, starting this February.

The signs were around, and I ignored them. Instead, I continued to believe in the fundamental thesis for Transocean, by far the largest deepwater offshore rig owner and lease operation in the world. I tended to ignore the market signals, buying shares as they lagged the benchmarks and thinking I was getting value.

Now I'm paying for it.

On Tuesday Transocean announced a 26 million share secondary offering designed to raise cash, surprising shareholders and sending the stock plummeting. This isn't what the company said it would do. But, faced with further cash outlays related to upgrading older rigs for fresh blowout preventers and the downtime required to do it, its purchase of Aker Drilling now became an anchor around its fiscal neck.

It's shoddy management.

That's particularly so because Transocean is raising money by issuing shares at their 52-week low, diluting common holders and raising the minimum for their needs. At $40.50 a share, the secondary will be snapped up by the syndicate, but will also leave one helluva headache.

OK, what now? What do you do with a stock that has fooled you? What do you do with a position that is cratering?

Your first job is to dispassionately reevaluate your thesis and decide if it is still intact. Sometimes events on the ground just turn your ideas on their head. If that happens, you have no choice but to bite the bullet. You admit you got the thesis wrong, along with the market action, and you sell.

I don't see that here.

Transocean is still a franchise business, with 45 floaters capable of working in 7500-foot waters and beneath. No other company has more than a handful of these. Day rates on these monster floaters continue to ratchet higher, and are now at more than $500,000 a day. Morgan Stanley estimates sub-sea capital expenditure through 2017 will exceed $300 billion -- that's billion with a "B." No one is better-equipped to capture a bigger share of that expenditure than Transocean.

The bottom line is that conventional oil supplies are mature and declining, and offshore supplies will necessarily continue to expand, and at continually higher prices for extraction.

The bottom line for the stock is different, however. A pressure secondary offering issued while the stock is on its lows -- one designed to also save the corporate bond rating from sinking into junk territory -- is not the best prescription for a V-shaped bottom, if you get my drift. These are shares that are not going to just turn around from here and march themselves back to $60 in the next few months. Yet, shares are just far too cheap to sell.

Here's what I'm going to do: I'm going to price some January $50 calls, looking for a dollar, but knowing that I'll have to wait for a small kick-back in the stock in order to get that. Then I'm going to wait for two announcements: one that will either cut or outright suspend the dividend, which I expect, and another analysis of the Macondo case as it begins in February. That's because, even though the indications are that Transocean will be held financially blameless for Macondo by the courts, at this point a bad verdict with a multi-billion dollar liability to BP will sink the company. What I will expect is that the announcement of the dividend slash will mark the lows the stock will see. If it doesn't, we'll have to turn tail and run.

I'm going to live with a bad position. There's a skill set in doing that -- one you will also need, if you are a trader, in order to be successful.                                                           

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