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Transocean - Tete-A-Tete With Petrobras Will Not End Well

A former Petrobras executive linked Transocean to Operation Car Wash.

With its $134B debt load at junk levels, Petrobras is looking for any excuse to cut supplier contracts and lower day rates.

Transocean's Tete-A-Tete with Petrobras will not end well. Investors should avoid the stock.

Petrobras (NYSE:PBR) is embroiled in a corruption scandal -- "Operation Car Wash" -- where executives were accused of providing suppliers with inflated contracts in exchange for kickbacks. Petrobras has reportedly blocked 20 suppliers from doing more work with the oil giant, and Transocean (NYSE:RIG) could be next. Eduardo Musa, a former Petrobras executive, recently linked Transocean to Operation Car Wash:

A former executive at Brazil's state-run oil company has testified to receiving what he says were payments made by someone claiming to be a Transocean agent in exchange for a rig-operation contract from Petrobras. Transocean is investigating the allegations by Eduardo Musa, the former Petrobras executive, and will cooperate with governmental investigations, the company said in a statement Friday.

Transocean hit back against such allegations, but it may be a moot point. Petrobras is in dire straits. The corruption scandal where executives were accused of taking bribes in exchange for inflated supplier contracts has cost the company billions. Petrobras reduced its capital spending plan by 40% in order to stem cash burn. It has also canceled several drilling contracts, including those with Schahin Petroleo and Vantage Drilling (NYSEMKT:VTG), to save on dayrates.

The corruption accusation -- whether true or not -- could result in Petrobras cutting supplier agreements with Transocean. It practically has to. With oil prices off 60% since their Q2 2014 peak, it is now more difficult for the oil giant to repay its $134 billion debt which is at junk levels.

About Transocean

Transocean is one of the better run offshore drilling operations. In Q2 its normalized EBITDA declined by only 6% sequentially versus an 8% decline in revenue. Through cost containment efforts, the company maintained its EBITDA margins in the range of 45%. And by cutting capex, Transocean increased its working capital position to $3.8 billion from $2.7 billion in the previous quarter.

Nonetheless, the corruption allegations could become a PR nightmare for Transocean. Secondly, Petrobras has set out to punish all those involved in the corruption scandal -- real or imagined. This is not good for Transocean. It's cost containment efforts are stellar, but at some point it will not able to continue to cut its way to profitability.

Conclusion

The cost of losing Petrobras business has not been quantified by Transocean. Petrobras has been one of the biggest buyers of offshore equipment and drilling services, so being on its restricted list is never a good thing. Investors should continue to avoid Transocean.


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