Did Billionaire Carl Icahn Spot an Opportunity at Transocean?

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Transocean LTD (NYSE:RIG)’s stock actually initially recovered after the Deepwater Horizon disaster, nearly reaching its pre-spill levels in the first quarter of 2011. However, the stock is down 32% in the last two years as the S&P 500 has risen over 10%; we think this is partly due to poor investor sentiment from Deepwater Horizon, partly due to financial obligations from the disaster, but primarily due to actually poorer business conditions. The stock is correlated to oil prices, since higher oil prices make offshore drilling more economical (it is considerably more expensive to drill offshore than onshore) and as a contract driller- particularly in deepwater- Transocean is tied to drilling activity.

Now reports are coming in, generally from the company itself, that billionaire activist investor Carl Icahn has bought close to 2% of the outstanding shares and may move up to a 3% stake. At its current price, Transocean’s market capitalization is $20 billion; by our math, that would make the driller one of his 10 largest stock holdings. Find more of Icahn’s favorite stocks. This is a big move for Icahn since he hadn’t owned any shares at all at the end of September, according to his 13F filing.

ICAHN CAPITAL LPA number of other billionaires’ hedge funds reported sizable positions in Transocean in their 13F filings for the third quarter of 2012. Leon Cooperman’s Omega Advisors, for example, increased its holdings by 19% to a little over 3 million shares (see Cooperman’s stock picks). SAC Capital Advisors, managed by billionaire Steve Cohen, cut its stake during the quarter but still reported a position of 1.9 million shares (check out more stocks Cohen likes). Citadel Investment Group owned 1.6 million shares (research more stocks Citadel owns); that fund is managed by billionaire Ken Griffin.

Transocean’s revenue was up 23% in the third quarter of 2012 compared to the same period in the previous year. Analyst expectations are for $4.83 per share in earnings this year, which would result in a 2013 earnings multiple of 11. The Street also has high expectations for the following several years, with Transocean’s five-year PEG ratio being 0.5. Note that this means that the company could fall short of analyst consensus and still prove a good value at the current price as long as it experiences some earnings growth. We would be worried, however, that the glut in oil due to onshore production (including from shale and other unconventional sources) will keep oil prices from rising very much, and so keep offshore activity cool for at least the next few years. If investors are interested in following Icahn, and are attracted by the bullish sell-side, that is a point they should look into before making a decision.

Transocean’s peers also have low P/E multiples:

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