Why Transocean Should Welcome Carl Icahn With Open Arms

Carl Icahn has won again. On the heels of his Netflix investment where he realized gains of over 400% in around a year , the activist investor followed up with a victory over Transocean , which previously refused Icahn's request to raise its dividend to $4.

On November 11, Transocean compromised with Icahn. The offshore driller raised its annual dividend to $3, agreed to make $800 million in cost cuts, gave Icahn another seat on the board, and shrank the number of overall board seats to 11. 

Transocean also agreed to pursue a master limited partnership for some of its assets sometime in 2014. 

MLP potential
Master limited partnerships, or MLPs, are partnerships that must derive 90% or more of cash flow from natural resources, commodities, or real estate. Because they are partnerships, MLPs do not pay taxes on profit. Most MLPs have stable, predictable cash flows because they operate energy infrastructure necessities such as oil pipelines, terminals, and processing plants. 

About a year ago, Seadrill became the first offshore drilling company to pursue an MLP structure for some of its assets by spinning off Seadrill Partners. Seadrill Partners currently has three tend rigs, two semi-submersible rigs, and one drillship as assets and a 5.18% dividend yield versus Seadrill's 7.91% dividend yield. The lower dividend yield shows that the market values assets in MLPs higher than they do in their former companies. 


Carl Icahn wants Transocean to put some of its assets into MLPs because those assets may be valued higher as well. Transocean could then use the money from the MLP spinoff to increase dividends, build new rigs, or pay down debt, all of which would likely increase the share price. 

Sector is fairly cheap
If Transocean's MLP initiative succeeds in unlocking value, other offshore oil drillers such as Diamond Offshore  and Ensco  may follow suit.

The offshore drilling sector itself is very cheap and could use some catalysts to unlock value.

Transocean trades at a 0.24 forward P/E with 5-year projected EPS growth of 22.7%. Diamond Offshore Drilling trades at a forward P/E of 11 with a 5-year EPS growth of 15%. Ensco has the lowest forward P/E ratio of only 8.5 and has a projected 5-year EPS growth of 14.80%.

The world will need more oil. With the easily accessible oil gone, high oil prices are likely hereto stay. There are 48 billion barrels of oil in the Gulf of Mexico , and 50 billion more in the Brazilian flats. Many fields are not developed and require the kind of deepwater rigs and expertise that only offshore drillers can provide.

The bottom line
Carl Icahn is often portrayed as a ruthless corporate raider. Shareholders of the companies he touches are often affected for better or worse. In Transocean's case, I believe Icahn is effecting positive change.

Transocean does have great promise. It has a large backlog, 27 ultra-deepwater rigs, and great industry expertise. With Carl Icahn's financial engineering, Transocean can realize its full potential. In my opinion, the new 5.5% annualized dividend puts a floor on the stock while the MLP initiative could take Transocean higher. 

Another way to play deepwater drilling
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The article Why Transocean Should Welcome Carl Icahn With Open Arms originally appeared on Fool.com.

Jay Yao has no position in any stocks mentioned. The Motley Fool owns shares of Transocean. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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