With an Icahn Deal in Hand, is Transocean a Buy?

Activist investor Carl Icahn has forced significant changes on Transocean (RIG 2.07%). So, the question immediately becomes whether the largest, albeit perhaps the most "snakebitten," of the major offshore drilling contractors should move up appreciably among its peers -- including Diamond Offshore (DO) and Ensco (VAL) -- as a candidate for Foolish portfolios.

We awoke Monday to a pair of post-midnight tweets sent by Icahn. Together, they disclosed his new agreement with Transocean. The first Twitter message said only that one of his lieutenants, Vincent Intrieri, would become the second member of the Icahn team to be added to the Transocean board. The other is current member Samuel Merksamer.

You've gotta know when to hold 'em
Transocean also agreed to increase its dividend to $3 per share, up from $2.24 but less than the $4 Icahn had sought. The board's size will be cut from 14 to 11, and the company will also double down on its cost-cutting measures in an effort to hike its margin by $800 million. And, as my Foolish colleague Travis Hoium noted on Monday, perhaps the most important move would be a 2014 IPO for a master limited partnership, which would contain a portion of Transocean's current assets.

The market clearly liked what Transocean and Icahn had cooked up, or, more accurately, what Icahn had demanded and what company had largely accepted. Transocean's shares rose by 4% following the announcement. It's important to add, however, that they'd risen by 11% in the previous three trading days. Sure, the company had reported earnings on Thursday that beat the per-share consensus expectation by nearly 30%, but it could also be that news of the deal had dribbled out in advance of the formal announcement.

Lingering woes
Much of Icahn's handiwork will take time to be felt. In the meantime, most of the weaknesses that he obviously felt justified his intervention will continue to hinder the company. For instance, while Transocean has more rigs than any of its competitors, it also has more dated rigs. It's sold several, especially antique jack-ups and low-spec floaters. And it has new ones under construction, both high-specification jack-ups and ultra-deepwater drillships. But all cost more than your average Honda Civic, and Transocean's balance sheet isn't the most pristine in the group.

While the potential fines or expenses from the April 2010 Gulf of Mexico disaster are less a sword of Damocles hanging over the driller than was the case a year or two ago, they're still the subject of lingering uncertainty. The second phase of a federal trial in New Orleans has been completed, however, and there just might be some light emerging at the proverbial end of the litigation tunnel.

That's not to say that others in the group don't have problems. In its most recent quarter, Diamond Offshore took charges totaling $93 million pre-tax related to nonpayment for its services by a pair of customers.

Important metrics
There are some key metrics where Transocean falls short of Diamond Offshore and Ensco. Let's take a look:

Sources: Yahoo! Finance and TMF calculations

As you can see, Transocean is hardly undervalued on the price-to-earnings or enterprise-value-to-EBITDA fronts -- the latter being an important metric for capital-intensive companies. Its operating margin is less than half that of Ensco and just more than half of Diamond Offshore. And its balance sheet is far more leveraged than those of the other two companies, a factor that won't be relieved by the impending dividend increase.

Staying with the subject of dividends, it's noteworthy that while Diamond's forward yield is far lower than the others, its board regularly sweetens the pot with $0.75 per-share special quarterly cash payouts, thereby boosting its trailing yield to 3.50%. Transocean's yield will obviously increase with the implementation of the new rate (it'd be about 5.40% at today's share price). But Ensco's rate is hardly chopped liver.

Foolish takeaway
Over the past two years, Transocean shares are up by an anemic 6.8%, Diamond's have slid by nearly 12%, and Ensco's are about 17.5% higher. I must confess to being both a Transocean shareholder (from those thrilling days of yesteryear) and, once upon a time, a junior officer of a Diamond Offshore predecessor. But today I'm somewhat jaundiced about the entire group, and wouldn't recommend more than a small position in just one of the companies.

As the drillers stack up, that one company wouldn't be Transocean, even though it is likely to strengthen in the years ahead. I currently by far favor Ensco for its healthy margins, valuation, solid balance sheet, robust dividends, and growing set of new rigs.