Tickers in this Article: RIG, BP, ESV, SDRL
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.

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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.

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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.

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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.

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