Description

• Background: Transocean functionally securitized a number of long-term drill rig contracts with high quality counter-parties by putting the operational drill rig and the contract into an SPV and issuing debt out of that entity.  The documents underpinning that SPV debt have better protections and tighter covenants than typical high yield which include: the bonds amortize 5% of original face value semi-annually; (ii) no other debt can be issued out the SPV and the collateral in the SPV cannot be secured by other liens; (iii) a cash debt service reserve (escrow cash) must be maintained in the SPV equal to 6 months of principal plus interest payments; (iv) maintenace covenants which trap cash for the benefit of bond holders in the SPV if breached
• Shell Contract: this bond has a fixed-day rate contract with Shell (AA- credit risk) expiring in May'26 (17 months after bond maturity).  The NPV 10% of the remaining contract cash flows (i.e. revenue less expenses) is currently equal to approximately 140% of the outstanding bond principal.  The value of this asset alone underwrites the value of the bonds
• Escrow Cash: pursuant to the DSCR (described above) there is currently $45M of escrow cash at the SPV which cannot be distributed.  This is equal to approximately 13% of the outstanding bond principal 
• Drill-Rig: regardless of how bearish you are on offshore drillers this is a 12,000 Ultra Deeepwater drill ship.  It should be worth more than $0.  Pick a number and insert it and that adds further to the collateral
• Guarantee: the bonds also benefit from a guarantee from Transocean.  Arguably this isn't worth much as in the event of a default at Transocean recovery will likely be poor (Transocean long-dated unsecured credit is trading in the mid-30s currently as a reference point) but it is still there and could offer some recovery in the event there are surplus assets available for General Unsecured Creditors
• Recovery: Adding the contract, the cash and the drillship gets you >150% of par as recovery (assuming the drillship is worth zero and the guarantee is worth zero you still get >150%).  The bond amortizes which improves recovery / lowers capital at risk as this rolls forward.  Because the bond has already amortized 40% of original principal (i.e. 60% of original remains outstanding) the actual amortization is currently 8.3% for the next amortization (5% / 60% = 8.3%) and this continues to increase over time
• Liquidity: Transocean has $2.7bn of liquidity at 30-Sep-20.  The contract backlog (generally with credit-worth counter-parties) provides EBITDA and cash flow visability for the next couple of years and indicates the company conservatively has at least 12 months of runway.  More aggressive estimates (including estimates from the compay) suggest the company has liquidity through 2022 and into 2023

Why Does The Opportunity Exist: 

• Pretty much the entire drill ship industry is going through restructuring / bankruptcy at the moment - there is a dearth of investors wanting to deploy capital in this space
• Transocean will also likely need to file for bankruptcy at some point which may put off some investors (note: the company is adamant they will not file in the near term and probably has liquidity to avoid filing for at least 12 months (the company would argue longer)).  The bonds are unlikely to suffer any impairment in bankruptcy but some investors may not be willing or able to hold bonds through this
• Transocean has been the subject of a lawsuit from Whitebox and Pimco alleging an event of default on certain of Transocean's bonds.  If the company had lost this litigation it would very likely have resulted in the company needing to file for bankruptcy.  The court ruled on the case yesterday in the company's favour 

Catalyst

• Near term bankruptcy risk has diminished post court ruling
• Conintued Liability management and liquidity creation from the company further extending runway
• Continued amortization of bonds further reducing risk of capital impairment