Schlumberger-Transocean Deal Could Spur Related Mergers

The spinoff and subsequent merger, announced today, will create the world's largest offshore contract driller.
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It happened with Big Oil in recent months and with oil services last year. Now, with Monday's announcement that

Schlumberger

(SLB) - Get Report

will spin off its offshore drilling unit and merge it with

Transocean Offshore

(RIG) - Get Report

, it looks like merger fever has come to the fragmented offshore drilling industry.

Monday's move, which will create the world's largest offshore contract driller, is sure to cause chief executives at other contract drilling companies to quickly begin pondering whether they too need to bulk up for competitive reasons.

Among the companies expected to feel at least some pressure to counterattack are

Diamond Offshore

(DO) - Get Report

,

Noble Drilling

(NE) - Get Report

and

R&B Falcon

(FLC) - Get Report

.

The merger "is a first step in a chain of consolidation which needs to take place," says Bill Herbert, head of oil-service research at

Howard Weil Labouisse & Friedrichs

in Houston. It shows that Schlumberger believes steps need to be taken to counteract excess capacity in the drilling market, Herbert says. Howard Weil doesn't rate stocks and hasn't performed underwriting for Schlumberger or Transocean.

Currently, 44 rigs are under construction. And over the next couple of years, the supply of high-specification drillships and semisubmersible, or floating, rigs will double, Herbert says. And these rigs are coming out into a bad market. "The problem is that participants in deep water have too much capacity for them to realize any meaningful pricing leverage in the near term," he adds. "That's a major hurdle."

In addition, there's a belief that bigger is better when it comes to dealing with major international customers, especially those that have themselves added size.

"I think it's pretty clear from conversations with big oil companies that they would really like to ... have one or two drilling companies they deal with on a worldwide basis," says Jim Marquez, a principal at the

Bayou Fund

in Greenwich, Conn., and a Transocean shareholder. "This is something that is just sorely needed. If you have two or three more

deals on top of this one,

the industry ends up with more pricing power."

In a conference call, Michael Talbert, Transocean's chairman and chief executive, pointed out that the combined company would offer both big and small oil companies a range of services they wouldn't be able to get elsewhere.

Transocean Sedco Forex

, as the new company will be called, will have operations in every major drilling market in the world, from the Gulf of Mexico to the North Sea to West Africa and Southeast Asia.

"The merger of Transocean Offshore and Sedco Forex Offshore is advantageous due to the rising capital costs for new rig construction, the increasing size and needs of our customers, the expanding geographic diversity of offshore drilling and the technical challenges posed by new deep-water drilling activities," Talbert said in a statement.

The merger agreement also contains a provision for a global alliance between Schlumberger and the new company to offer customers drilling services with Schlumberger's integrated oilfield services.

Transocean Sedco Forex will have 75 rigs, including 24 rigs capable of operating in water depths of 3,000 feet. The average age of the new company's fleet will be nine years, compared with 18 years for other drillers, Talbert said on the call.

Schlumberger shareholders, who will own 52% of Transocean Sedco Forex, are expected to receive one newly issued Transocean Sedco Forex share for every five Schlumberger shares they hold. Transocean shareholders, who will not be exchanging their shares, will hold 48% of the new company, or 101 million shares as of June 30. The 109 million new shares to be issued for the transaction are valued at $3.2 billion using Transocean's July 9 closing price. The total market capitalization of the new company stands at $6.2 billion, the fourth-largest oil-service company.

Until this deal, there were three or four players of similar size and heft, says Dan Pickering, vice president and head of research at

Simmons & Co.

, a Houston investment bank concentrating on energy.

"Now you've got one that's twice as big as everyone," Pickering says. That will force other companies "to think about where they stand competitively," he says. "If you have one player that gets so big, you have to decide if you want to lead that effort or follow it. Everyone has to decide whether to be a buyer or a seller." Simmons doesn't rate stocks. It is currently advising Transocean in the transaction; it hasn't performed underwriting for Schlumberger.

Indeed, "sometimes it takes a little bit of a catalyst," says Paul Loyd, chairman and chief executive of R&B Falcon. "What we've said and what we believe is the industry needs more mergers. We certainly hope the trend continues."

Some companies, however, are downplaying the deal's wider significance.

"We think we are of sufficient size to compete," says Larry Dickerson, Diamond's president and chief operating officer. In a market that's recovering, "we don't feel we have to be larger just to be larger."

Noble couldn't be reached for comment.