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Author: TMFGebinr Big gold star, 5000 posts Old School Fool Supernova Phoenix 1
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Subject: Re: A bit more on MUE Date: 11/2/2010 1:44 PM
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I'm curious to know how your valuation analysis of RIG stacked up against ATW? Is RIG that much better of a bargain right now?

Hi Dave,

Through the expectations lens, Transocean is much the better value. Here are the corresponding numbers:

                            RIG      ATW
TTM FCF $2,946 $75 M (TTM to 6/30/10 for both)
# shares 318.9 64.4 M
Share price $62.90 $32.77
Discount rate 15% 15%
Expected growth 1-5 yrs 0.4% 29.5%
Expected growth 6-10 yrs* 0.2% 14.8%
Terminal growth** 0.0% 0.0% (kept the same between the two)
*While 1-5 years is varied by the Excel Solver, 6-10 years is set to half of the 1-5 years value.
**Terminal growth is usually set at 0% or 2.5%.

So, the market is expecting much more growth in FCF for Atwood than for Transocean at current prices (last night's close). That reflects, in my opinion, the uncertainty for liability currently weighing on Transocean's stock.

A note on liabilities and losses from legal wrangling. These fall under the category known as contingent liabilities. These are potential obligations that depend on a future event arising from a past event, such as a lawsuit. Accounting for a contingent liability depends on the likelihood that the future event will occur and the ability to estimate any future amount owed. It comes in three categories:

1) The future event is probable and the amount owed can be reasonably estimated. This is recorded on the balance sheet as a liability. Examples include vacation pay (expenses payable) and warranties.

2) The future event is remote (unlikely). These are not recorded and they are not disclosed in the financial statements.

3) The future event has a likelihood somewhere between the two extremes, that is it is reasonably possible. This is disclosed in the footnotes, but not on the balance sheet. For lawsuits, "a potential claim is recorded in the accounts only if payment for damages is probable and the amount can be reasonably estimated. If the potential claim cannot be reasonably estimated or is less than probable but reasonably possible, it is disclosed." (Financial Accounting, Wild, 3rd ed, pg 364) You can follow the progress of a lawsuit by looking at the footnotes. Only when it becomes pretty clear that the company will lose will it begin to take charges to set aside funds for paying out.

In other words, the market can speculate all it wants, but I expect that Transocean won't take a hit on earnings and it won't set up a liability account to pay lawsuits and fines for the Gulf incidence unless and until the payment becomes probable and the amount can be reasonably estimated. And the settling of the lawsuits and court cases could (and I expect, will) take years. While that will weigh down the stock in the near term (next year, maybe two), as it becomes clearer that the court battles will take a long time (and those expenses can be estimated more clearly), the market will become more comfortable again and the price should rise. Especially if the company actually grows FCF faster than is currently expected.

The question then arises, why did BP set aside the money it did and why did they take another $7.7 B hit on earnings this last quarter? In its case, I presume for two related reasons. Management feels that they have a better view on what is likely to be owed and the U.S. government forced it to.

Cheers,
Jim
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