Description

Marine Drilling (MRL) has agreed to merge, share for share, with Pride International (PDE). MRL’s share price over the coming 6 months should reflect (1) changes in the perceived long term price of oil, (2) the price of the Oil Service group relative to the price of oil, (3) progress in the PDE/MRL merger, (4) investors’ perceptions concerning synergy and the earnings of the combined company, and, (5) the valuation multiple accorded the new combined company relative to the oil service group.

1 – The December 2002 crude oil contract (CLU2-Bloomberg) represents the world’s tradable view of long term oil prices. The contract has been steadily creeping higher over the past 6 months and is now back to the $25 high reached in late 2000. We have no argument with this world view. In short, the macro-oil environment appears to be positive for MRL.

2 – The Oil Service Index (OSX) has recently pulled back about 15% from the highs. The pull-back has been attributed to increased US energy inventory levels. We view the weakness in OSX vs. CLU2 as a temporary (arbitragable) imbalance, and view the OSX as being 10% undervalued relative to CLU2.

3 – This is a “no premium’ deal. Therefore, there is only a minute spread between MRL and PDE that runs 2%-3%. Upon completion of the merger (perhaps 10/30/01), MRL holders should capture perhaps 2 points of this spread. More importantly, management of the combined company will do a road show to explain the added value of the combined business.

3’ – In the 2 weeks prior to the merger announcement, PDE shares rallied about 15% based on a rumor that NBR was preparing to bid for PDE. When the merger was announced, MRL shares fell about 10% below their pre-deal price. In the unlikely event of a bust, we see modest if any downside risk.

4 – Direct synergies are likely to be limited. PDE projects $10mm reduction in overhead. Lower borrowing costs and improved utilization my make the total direct synergies about 5% to EPS.

5 – Based on estimated 2002 EBITDA, comparable Enterprise value/EBITDA multiples are ESV & RDC -7x, GLM & SDC -8x, RIG & NE 9x. PDE is currently 6x. PDE trades for a very poor multiple partly because of its small size and leveraged balance sheet. The merger should improve these two parameters (market share improves to #2 in relevant markets) and produce a moderately higher multiple. In addition, the merger will further consolidate the low end of the jackup market and my produce some better pricing. We anticipate a 0.5x-1.0x point EBITDA multiple expansion. This would add 10%-20% to MRL’s valuation.

In sum, we are trying to capture a number of value layers. 10% from the OSX vs. crude, 2% from the deal spread, 5% from earnings accretion, and 10%-20% from relative multiple expansion. In total, our objective is 30% in 6 months.

Current 2002 consensus estimates for the combined PDE/MRL are revenues=$2.0 billion, EBITDA=$900mm, EPS=$2.80 assuming 160mm shares out. Total net debt should be $1.6 billion. Enterprise/EBIDA=6x. P/E=9x. Current group average multiples on estimated 2002 numbers are Entity value/EBITDA=8x, P/E=14x

Catalyst

The pending MRL/PDE merger should create value over a 6 month time frame.