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Diamond Offshore Drilling: Sector Analysis & Valuation

Explore the company's industry position, SWOT analysis, and financial performance to make an informed investment decision. Learn about Diamond Offshore's history, business models, and geographic distribution to understand its market presence.

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Diamond Offshore Drilling: Sector Analysis & Valuation

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  1. Diamond Offshore Drilling Inc. Katsy DouangvichitTyson BanburyNate EvettMatt Hawk October 28, 2010 http://images.businessweek.com/ss/09/02/0224_safe_dividends/10.htm

  2. Agenda • Company Overview • Industry Overview • Competitors • SWOT Analysis • Porter’s 5 Forces • Valuation • Recommendation

  3. Company Overview Summary • Provides contract drilling services to energy industry • Leader in deepwater drilling for oil and natural gas on a global scale • One of the world’s largest fleets of offshore drilling rigs Basic Info Global Presence • Ticker: DO • Employees: 5,500 • Price: $67.80 • Headquarters: Houston, TX • Gulf of Mexico (GOM) • Mexico • Europe/Africa/Mediterranean • Australasia/Asia/Middle East • South America http://www.diamondoffshore.com/ourCompany/ourcompany_overview.php

  4. Company Overview Portfolio Performance February 2008 • Purchased 100 shares @ $122.90 for a total cost of $12,290 • Give portfolio exposure to oil and drilling sector November 2008 • Purchased 50 shares @ $72.96 for a total cost of $3,648 September 2009 • Written call option exercised, sold 100 shares at adjusted price of $76.25 totaling $7,625 • Strike price adjusted to $76.25 from original strike price of $80.00 due to a special cash dividend of $1.875 paid twice over the holding period of the option • Realized loss of $4,665 As of 10/27/2010 • Diamond Offshore closed at $67.80 • Currently have 50 shares with an unrealized loss of 7.07% • Represents 2.93% of the portfolio

  5. Company Overview Recent Performance • DO stock down 36% since beginning of 2010 • Recently passed 20-day Moving Avg., anticipate crossing 200-day Moving Avg. http://finance.yahoo.com/echarts?s=DO+Interactive#chart1

  6. Company Overview History Diamond Offshore Drilling is formed: • 1980’s – Loews Corp. (diversified holding company) purchases Diamond M Drilling. • 1992 – Diamond M Drilling Co., under Loews ownership, purchases all outstanding stock of ODECO • 1993 – name changed to Diamond Offshore Drilling Inc. • 1995 – began trading on NYSE under symbol “DO” • 1996 – Diamond Offshore acquired Arethusa Ltd. and sold land division Diamond M Onshore to DI Industries Inc. Key Takeaway: Diamond Offshore has a longstanding history in the drilling industry, and all barge, platform, and land rigs acquired in previous transactions have been been sold to focus on offshore drilling http://www.diamondoffshore.com/ourCompany/ourcompany_history.php

  7. Company Overview Business Model – Oil Industry Midstream – Transportation and Refinement Upstream – Exploration and Production Downstream – Distribution and Sales http://www.nwofighters.org/wp-content/uploads/2010/05/oil-rig.jpg http://safetyactconsultants.com/yahoo_site_admin/assets/images/Wast_Oil_Refinery.320175601.jpg http://www.annualreports.com.my/uploads/news/small/9_shell-gas-station-bar-b-cutie.jpg

  8. Company Overview Business Model – Drilling Contracts Exploratory Drilling • Drill wells in previously unexplored areas as directed by customer (operator) Development Drilling & Well Completion • Drill additional wells in areas of successful exploration • Complete wells by preparing them for continued hydrocarbon extraction by operators http://csdms.colorado.edu/wiki/Talk:Marine_Discussion http://www.epmag.com/archives/features/761.htm

  9. Company Overview • Different Categories of Rigs • High Specification Floaters • Drill in water depths greater than 4,000 ft. • Intermediate Submersibles • Drill in water depths less than 4,000 ft. • Jack-ups • Drill in water depths less than 350 ft. • Drivers of revenue • Day Rates • The per day rate Diamond Offshore charges clients for use of rigs • Utilization rates • The percentage of fleet that is currently under contract to clients • Number of rigs • Number of rigs in Diamond Offshore’s fleet • http://www.diamondoffshore.com/ourCompany/ourcompany_offshorerigbasics.php

  10. Company Overview Business Model – Revenue Drivers 1 Averages using 2005-2009 2 Denotes cold-stacked rigs • 85% of revenue comes from Intermediate Semis and High-Spec Floaters • Total Rigs: 46 [6 cold stacked rigs GOM, 1 in Malaysia]

  11. Company Overview Business Model – Geographic Distribution Total revenue per region $ in millions (% of total revenue) • Reducing exposure to GOM prior to drilling moratorium • Strong 08-09 growth in South America and Australia/Asia/Middle East despite global economic downturn • http://www.diamondoffshore.com/investors/investors_secfiling.php

  12. Industry Overview Macroeconomic Drivers – Global Recovery Source: World Economic Outlook, 2010 http://www.imf.org/external/pubs/ft/weo/2010/01/c1/fig1_2.pdf • Global GDP growth expected to taper gradually after rebound from recession • Translates into gradual increase in demand for oil in near future with expected higher growth in demand after 2015

  13. Industry Overview Macroeconomic Drivers – Key Players • China and India projected to have over 5% GDP growth in 2010-2011(1) • Along with the U.S., Brazil, Russia and Japan, these two countries make up the top six oil-consuming nations • Brazilian government pledges to keep oil supply ahead of growing economy via Petrobras (1) World Economic Outlook, 2010 http://www.imf.org/external/pubs/ft/ weo/2010/01/c2/fig2_1.pdf Source: World Economic Outlook, 2010 http://www.imf.org/external/pubs/ft/ weo/2010/01/c1/fig1_19.pdf

  14. Industry Overview Macroeconomic Drivers – Demand For Oil Barrels of Oil Consumed Daily • Source: https://www.cia.gov/library/publications/ • the-world-factbook/rankorder/2174rank.html,2009 • http://graphics.thomsonreuters.com/10/04/GLB_OILDMND0410.gif

  15. Industry Overview Macroeconomic Drivers – Price of Crude Source: World Economic Outlook, 2010 http://www.imf.org/external/pubs/ft/weo/2010/01/c1/fig1_19.pdf • Oil prices expected to remain around $85 per barrel over near term • Stable price projected due to expectation of meeting increase in oil demand with increased production • Increased production puts upward pressure on rig utilization and day rates, driving up DO’s revenues

  16. Industry Overview April 20, 2010, Deepwater Horizon rig, owned by Transocean Ltd., experiences blowout leading to explosion and largest offshore oil spill in U.S. history. May 28th, government imposes ban on drilling new wells over 500 ft June 21st, Judge Martin Feldman halts moratorium July 12th, second moratorium implemented and scheduled to end November 30th October 12th, drilling ban lifted • Industry Outlook – GOM Moratorium • Impact: • Industry faces increased operating costs due to increased regulation • New standards for Blowout Preventers (BOPs) and cementing wells • Lengthened process to acquire drilling permits • Relocation of 2 DO rigs to international contracts • Slow return to GOM due to new regulations and increased auditing cost

  17. Competitors Noble Corporation • Business strategy is to actively expand international and deepwater drilling through acquisitions, modifications, and upgrades • Fleet has 15 deepwater rigs, 50 Jackups, 4 Drillships • Completed purchase of Frontier Drilling in July 2010 • This increased fleet by 7 rigs to 69 total platforms • 5 more rigs currently under construction • Noble has mobilized 9 rigs from GOM to international markets in the past 5 years • Stock currently trading on NYSE at $34.32 (10/28/2010) • Feb. 26, 2010 10-k – Item 7: Management’s Discussion • Noble Webpage RigFleet Section: http://www.noblecorp.com/Fleet/FleetOverview.asp • Noble Corporation Fleet Status updated 29 September 2010 • http://finance.yahoo.com/q?s=ne

  18. Competitors Ensco • Business is divided into four units • Ulta-deepwater • Asia/Pacific Rim • Europe/Africa • North and South America • Fleet includes 8 deepwater and 40 Jackups • Leverage ratio is lowest among DO, Noble, and Transocean • Rate #1 in safety and reliability by EnergyPoint Research Inc. • Stock currently trading on NYSE at $46.40 (10/28/2010) • http://finance.yahoo.com/q?s=ESV • ENSCO web page Global Operations Section http://www.enscous.com/Global • Operations/Capabilities/default.aspx • ENSCO fleet status report Oct. 13, 2010 • http://seekingalpha.com/article/224240-the-oil-and-gas-industry-s-answers-lie-within

  19. Competitors Transocean • World’s largest offshore driller with 114 rigs • Only 23 deepwater rigs, 65 Jackups • Less emphasis on deepwater specialization • Implicated in the April 2010 Deepwater Horizon oil rig explosion in GOM • Reputation has suffered as a result • Ranked last among drillers in 2008 and 2009 for job quality • Merged with GlobalSantaFe in 2007 • Stock currently trading on NYSE at $64.16 (10/28/2010) • http://finance.yahoo.com/q?s=rig • Transocean 2010 Fleet Directory Brochure • www.reuters.com/article/idUSN0322326220100603 • http://seekingalpha.com/article/224240-the-oil-and-gas-industry-s-answers-lie-within • www.deepwater.com/fw/main/Merger-307.html

  20. Competitors Recent Performance Source: Yahoo! Finance http://finance.yahoo.com/echarts?s=DO+Interactive#chart4:symbol=do;range=20081028, 20100927;compare=esv+ne+rig+^gspc;indicator=volume;charttype=line;crosshair=on;ohlcvalues=0;logscale=on; source=undefined • Strong divergence at outset of GOM disaster • Ensco and Noble have less exposure to deepwater drilling • Anticipate DO recovery in future despite increased U.S. drilling regulations due to continued further global diversification

  21. Competitors Diamond Offshore – How They Differentiate • DO has larger percent of floaters in fleet due to customers’ demand for high-tech, efficient rigs • Floaters not limited to shallow drilling • Floaters can withstand harsher weather and sea conditions • Historically, DO has paid out significantly more in dividends than its competitors • From 2006-2009, DO paid out $17.88 while the closest competitor Transocean paid out only $1.58 • Reason to believe DO will increase dividend in future since it remains a key part of their long-term value creation • 2009 Annual Report Item 1: Business – The Fleet • Diamond Offshore Web page Offshore Rig Basics • Seeking Alpha Diamond Offshore Drilling Q2 2010 Earnings Call Transcript

  22. Competitors Rig & Financials Comparison http://www.diamondoffshore.com/ourFleet/rigStatus.php

  23. SWOT Analysis Firm Factors

  24. SWOT Analysis Industry Factors

  25. Porter’s 5 Forces Threat of New Entrants (Low): The oil drilling industry requires highly specialized workers to operate the machinery. Since the equipment is so expensive and the labor is costly, any newcomers to the industry would have to be well capitalized. Power of Suppliers (Medium): The rig builders have more bargaining power when the price of oil is high and there is increased drilling activity, and thus increased demand for drilling platforms. When the price of oil is low, there is not a lot of demand for rigs, so the builders have little power. Power of Buyers (Medium): Since oil is a commodity, the buyers can go with the company that will drill for the lowest contracted day rate. However, there are only a limited number of drillers with the capability to drill at extreme depths, so the buyers have to go with one of them. Threat of Substitutes (Low): There are many alternatives to oil and natural gas including coal, solar, and wind power. Coal is already well established in the market place while other alternative technologies are still far too inefficient to compete over the next decade. Industry Rivalry (High): There are high exit barriers due to the costs of the rigs and the lack of alternative uses for them. Therefore, companies want to stay in the industry, increasing rivalry. Bids to get contracts is very competitive and lowest cost wins the bid.

  26. Valuation – Base Case Discount Value • CAPM Cost of Equity = 8.12% • Annualized ROI (1999-2001)= 35.40% - Used for 2010-2016 FCF’s • Annualized ROI (2005-2010)= 19.33% - Used for Terminal FCF • Cost of Debt = 5.4% • Discount rates = 19.31% (2010-2016) • 12.37% (Terminal) • http://finance.yahoo.com/echarts?s=DO+Interactive#chart4:symbol=do;range=20081028,20100927;compare= • esv+ne+rig+^gspc;indicator=volume;charttype=line;crosshair=on;ohlcvalues=0;logscale=on;source • The estimated 2010 -2016 future rate of return to investor was chosen based upon the assumption of future moderate growth similar to that of growth of DO during 1999-2001

  27. Valuation DCF Valuation

  28. Valuation Sensitivity Analysis

  29. Ratio Valuation Triangulation

  30. Bad Scenario Assumes DO experiences another stretch of suppressed revenue streams • Dayrates and Utilizations rates decline • Increased regulatory costs decrease margins • Do not begin to pick up until 2014

  31. Good Scenario Oil prices rise sharply Dayrates and utilization rates rise rapidly Emerging markets spur global demand for oil in deepwater Moratorium has little lasting effect on GOM

  32. Recommendation Suggested Action: • Current Price: $67.80 • DCF Value: $81.89 • Triangulation: $78.52 • We recommend that we purchase 100 shares of Diamond Offshore

  33. Diamond Offshore Drilling Inc. http://images.businessweek.com/ss/09/02/0224_safe_dividends/10.htm October 28, 2010

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