It has been a rough few years for deepwater drilling specialist Transocean (NYSE:RIG). In addition to a recent cyclical downturn in offshore drilling, the company seemed to fall behind a bit with its fleet and started losing business because of unexpected downtime issues. Worst of all, however, was the terrible BP (NYSE:BP) Deepwater Horizon/Macondo rig accident and the substantial financial liabilities that the company incurred for its role in the accident.

Now, however, things seem to be turning around. The company has taken steps to improve its fleet and rates are back on the way up. Most importantly, at least in the near term, Transocean has reached a very favorable settlement with the Department of Justice for its Macondo liabilities, suggesting that the company is close to having this matter behind it.

Guide To Oil And Gas Plays: We've got your comprehensive guide to oil and gas shales in North America.

A Favorable Settlement with the DOJ
Transocean announced on Thursday that it had reached an agreement with the U.S. Department of Justice concerning its financial liabilities in the Macondo accident. In exchange for pleading guilty to one misdemeanor violation of the Clean Water Act and paying $1.4 billion in fines, penalties and recoveries, the DOJ will consider the matter closed.

As a technical matter, $1 billion of the $1.4 billion will go toward civil penalties under the Clean Water Act. Moreover, the company will have five years to pay this amount, with most due in the earlier part of that period. With $6 billion in cash on hand (though a net debt position of nearly $8 billion), Transocean should have no trouble paying this amount.

This represents a pretty sizable win. While the theoretical penalties under the CWA could have gone over $17 billion, nobody expected that. Instead, Street expectations were in the neighborhood of $2 billion to $3 billion. Given that the company had accrued $1.5 billion for this settlement, I find it interesting that the actual settlement came in even below that low amount.

SEE: Protect Your Company From Employee Lawsuits

But It's not over Yet ...
This doesn't end all of Transocean's obligations. First, there is still a comment and approval process to go through with this DOJ settlement, though it seems unlikely to be derailed. After this, the company still has outstanding issues with the Natural Resource Damage Assessment (NRDA) and Plaintiffs' Steering Committee (PSC).

It seems unlikely that the amounts tied to settling with the NRDA are going to be large. A district court has already ruled that Transocean is not liable for subsurface discharge, so Transocean's liability is tied to the spill of diesel from the rig's fuel tanks.

Resolving matters with the PSC is likely to be more challenging. The PSC proposed a settlement amount of over $1.5 billion, which Transocean apparently rejected out of hand. Given that the PSC has yet to win a court judgment proving gross negligence, they will likely have to settle for a less ambitious amount (or take their chances in court). It's worth noting that the company has about $450 million accrued/reserved to handle these outstanding NRDA and PSC claims.

Investors should also realize that further wrangling between Transocean and its insurance companies could develop. Insurance policies often have exclusions in cases where policyholders acknowledge criminal fault, so I'm not sure if Transocean's plea in the DOJ settlement has any bearing on the insurance recoveries it can expect.

SEE: The Importance Of Corporate Transparency

Back to Business ... and Business Is Getting Better
With most of the Macondo liabilities now fenced in, Transocean can go back to being more about its prospects in deepwater drilling. Fortunately, the company's prospects are looking pretty good. About 20% of its fleet comes up for renewal this year, and Transocean, Ensco (NYSE:ESV), SeaDrill (NYSE:SDRL) and Noble (NYSE:NE) have been seeing improving dayrates. Almost as important, it looks like Transocean has adjusted its fleet and moved past its outsized downtime issues.

The Bottom Line
Transocean seems about 30% undervalued on the basis of historical EV/EBITDA multiples, and I don't see any reason why the stock should trade at such a large discount. It's also worth noting that the first four or five months of the year are typically good months for energy service stocks. So Transocean stock could be in the right place at the right time. While I continue to prefer equipment companies such as National Oilwell Varco (NYSE:NOV) for the long term, I have to admit that Transocean looks like at least an interesting potential trade today.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

Related Articles
  1. Investing

    How to Ballast a Portfolio with Bonds

    If January and early February performance is any guide, there’s a new normal in financial markets today: Heightened volatility.
  2. Stock Analysis

    Performance Review: Emerging Markets Equities in 2015

    Find out why emerging markets struggled in 2015 and why a half-decade long trend of poor returns is proving optimistic growth investors wrong.
  3. Investing News

    Today's Sell-off: Are We in a Margin Liquidation?

    If we're in market liquidation, is it good news or bad news? That party depends on your timeframe.
  4. Investing News

    Bank Stocks: Time to Buy or Avoid? (WFC, JPM, C)

    Bank stocks have been pounded. Is this the right time to buy or should they be avoided?
  5. Stock Analysis

    Why the Bullish Are Turning Bearish

    Banks are reducing their targets for the S&P 500 for 2016. Here's why.
  6. Stock Analysis

    How to Find Quality Stocks Amid the Wreckage

    Finding companies with good earnings and hitting on all cylinders in this environment, although possible, is not easy.
  7. Stock Analysis

    The Top 5 Platinum Penny Stocks for 2016 (PLG, XPL)

    Examine five penny stocks in the platinum mining business that investors may wish to consider adding to their investment portfolios for 2016.
  8. Investing News

    What You Can Learn from Carl Icahn's Mistakes

    Carl Icahn has been a stellar performer in the investment world for decades, but following his lead these days could be dangerous.
  9. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  10. Fundamental Analysis

    4 Predictions for Oil in 2016

    Learn four predictions for oil markets in 2016 including where prices are heading and the key fundamental factors driving the market.
RELATED FAQS
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
COMPANIES IN THIS ARTICLE
Trading Center