On September 5, I published an article explaining why I was switching a portion of my Valaris (VAL) holdings for Transocean (RIG) shares. At that time, RIG was trading at $3.08, and Valaris was at $51. Today, RIG is trading at $3.16, and VAL is at $50.45, so even with the dilution and short measurement period, the move has made sense so far.
One reason I initially preferred VAL over RIG when I entered the sector back in March was the risk of shareholder dilution. I wrote the following in my May 8 article on RIG, which concluded that the shares were attractive at $2.45 at the time, but also pointed out this risk.
When I sold some of my VAL to buy RIG, I did so assuming dilution was a thing of the past. After all, the company was demonstrably cash flow positive, it easily met its interest obligations, its bonds traded just under par, debt refinancings appeared to be assured, and the offshore cycle continued to inflect positively.
Clearly, I was wrong.
Yesterday, after the market close, RIG announced a $381.25 million equity offering at $3.05 per share, a 16.2% discount to its closing price of $3.64 that day. The equity offering reflects approximately 11% dilution to existing shareholders.
While 11% dilution doesn’t break my long-term investment thesis—and I continue to prefer RIG over its peers—the fact that I got this wrong calls for reflection on the matter.
Based on everything I’ve seen to date, I don’t believe this equity raise was necessary for the company to meet its debt service obligations. In that context, I see it as an indication that either management is overly cautious, RIG is experiencing cash flow issues, or the 12-to-18-month outlook for the offshore drilling market is deteriorating. I’ll discuss each of these points in turn before highlighting some of the positives of the equity offering.