It's something of a pastime in the contract drilling space to speculate about mergers and acquisition activity. The giant tie-up between Transocean (NYSE: RIG ) and GlobalSantaFe in 2007 certainly got minds racing about all sorts of potential combinations. Most rumors put the hard-charging Seadrill (NYSE: SDRL ) in the role of acquirer, with companies like Noble (NYSE: NE ) and Pride International (NYSE: PDE ) thought to be likely prey.
I've been saying for years now that Pride's assets are undermanaged, and that Ensco (NYSE: ESV ) is a best-of-breed operator. It turns out that these are the two companies that have agreed to a merger, and I think it's a pretty perfect pairing for several reasons.
In the offshore drilling arena, bigger is almost certainly better, so long as your fleet quality isn't degraded in the expansion process. Both firms have relatively young and highly capable fleets, especially on the deepwater side. That's the first thing I like about this deal: High-quality assets meet high-quality management (Ensco's CEO and CFO will continue to run the show at the combined company, with other executive appointments to be announced later).
Another thing is the strategic fit. Management couldn't say enough about this on the call, but I don't think they were overselling the point. Ensco and Pride have surprisingly minimal overlap in their operations, both geographically and in their respective customer bases. This will help position the combined company as a go-to service provider across the world's emerging deepwater basins and potentially reduce the downtime that's experienced in mobilizing a rig from one region to another. The low overlap should also help the firms to secure necessary regulatory approvals.
If you forced me to knock this deal on any front, it might be the structure of the transaction. Ensco's $41.30 per share offer for Pride -- to be paid out 37.5% in cash and the rest in Ensco shares -- had the typical effect of taking down the acquirer's share price a peg, while considerably lifting that of the acquiree. Compare this to Transocean and GSF's "merger of equals," which paid out cash to both parties' shareholders. Those stocks simultaneously rose upon the announcement of that merger.
Then again, the amount of debt financing that would have been required to pull off that kind of transaction would have threatened Ensco's desire to maintain an investment-grade credit rating. This may be important not only to fixed-income investors but to clients like Petrobras (NYSE: PBR ) and ExxonMobil (NYSE: XOM ) .
As it's currently structured, Ensco's long-term debt to capitalization ratio should be closely in line with its conservatively financed competitors. Seadrill, the outlier on this front, has opted to use much more debt in its quest to build a modern deepwater and ultra-deepwater fleet. The Ensco/Pride approach is the more prudent one, in my view, but we'll just have to see which strategy bears the most fruit for shareholders in the years to come.