Some marriages are based on the chance encounters of opposites. But the recent pairing of offshore drillers Global Marine and Santa Fe International-now GlobalSantaFe Corp.-is the marriage of two long-familiar equals with common cultures, strategies and roots. In 1946, Continental, Union, Shell and Superior oil companies formed the CUSS Group to establish the feasibility of drilling offshore California. A decade later, that group evolved into Global Marine Drilling Co. In 1964, Global Marine reorganized and went public through a stock and debenture offering, severing its ties with the last remaining participant in CUSS-Union Oil. Concurrently in 1946, 62 of Union Oil's drilling-department employees put up $250,000 of their own money, borrowed another $600,000 from a bank, and a year later, completed the leveraged buyout of Union Oil's drilling business. That new entity ultimately became Santa Fe International. "The two companies, both coming out of Union Oil, talked almost since their inception about a merger, but those talks didn't get serious until three years ago," says Robert E. Rose, chairman of the new Houston-based GlobalSantaFe (NYSE: GSF). Says Sted Garber, GlobalSantaFe president and chief executive officer, "The more we peeled the layers of our respective organizations, each of us saw very similar cultures and operating philosophies, a very complementary suite of assets and the ability, by combining, to serve our customers on a truly global basis with virtually every type of premium drilling equipment that exists." Still, because it's hard to wring a lot of costs from service-industry amalgams, the financials had to work. Last fall, they did. "Amid a declining market for oil-service stocks, we reached a point where the relative value of Santa Fe International and Global Marine shares was also very close to the projected earnings contributions of each company to a combined entity," says Garber, a former investment banker who holds an MBA from UCLA. "It was then we knew we could get a merger done." Another event aided the timing: the accounting rules governing mergers changed. On one hand, pooling-of-interests accounting went away. That was bad news because under that method of accounting, merging companies only had to add together the historical, depreciated cost of assets on their balance sheets; they didn't have to account for goodwill or write up assets to fair market value. The good news was that the more onerous purchase-accounting rules governing mergers also changed-for the better. Under earlier purchase-accounting rules, goodwill-an amount paid over the appraised or fair market value of an asset-had to be put on the balance sheet of a newly merged entity, then amortized over many years, which could be highly dilutive to the earnings of a new entity. Under the new purchase-accounting rules, goodwill goes on the balance sheet of a newly merged company but isn't amortized; therefore, there's no earnings dilution encumbering the new entity. Rose, with an MBA from Southern Methodist University, Dallas, notes that because of where the market cycle was last fall, asset values weren't as high as they had been a year earlier. "Consequently, we didn't have to write up assets as much as we would have had to in 2000; therefore, our deprecation expense wasn't as great as it might have been. So the stars aligned for this deal to be completed in November." Under the terms of the then $5-billion, stock-for-stock merger, each Global Marine common share was converted to 0.665 share of the new company; Santa Fe International shares were converted one-for-one. (The new company has 242 million diluted shares outstanding currently.) From an accounting standpoint, Global Marine was the surviving entity; from a legal perspective, Cayman Islands-registered Santa Fe International was the survivor. What can GlobalSantaFe do that its two legacy companies couldn't separately? "Serve customers better in every global market," says Garber. "What oil and gas companies want today are contractors that can offer them any type of rig anywhere in the world, with the knowledge that they'll get consistent, safe and efficient service." Global Marine brought to the table an extensive fleet of deepwater drillships, semisubmersibles and jackups working in the Gulf of Mexico, West Africa and the North Sea. Santa Fe International added complementary offshore and onshore rig assets in the Middle East and Southeast Asia, as well as overlapping assets in the North Sea and West Africa. GlobalSantaFe operates more than 100 rigs worldwide, including its own fleet of 59 offshore rigs of every class and 31 land-drilling rigs. Also, it provides drilling-management services in the Gulf of Mexico and the North Sea. In addition, GlobalSantaFe-recently $6.8 billion in market capitalization-stock is now highly liquid, so more institutional investors can own it. And, it has a strong balance sheet, with a debt-to-capitalization ratio of 18%. Says Garber, who once handled mergers and acquisitions for Getty Oil, "Financial conservatism is very important for any company hoping to take advantage of the growth opportunities that come along in this business, including future acquisitions." The company expects savings of $25 million by year-end, making it better able to increase shareholder value, says Rose. "That's important if we're going to become the offshore-drilling stock of choice for investors." In 1999 and 2000, Global Marine's return on equity (ROE) was 8.2% and 9.5%, respectively; Santa Fe International's was 11.6% and 7.5%. Michael K. LaMotte, managing director and oil-services and -equipment analyst for JPMorgan Securities in Dallas, estimates the company this year will earn a 9.8% return on shareholder equity of $4.4 billion. That's based on estimated 2002 earnings of $1.80 per share. "In a richer dayrate environment, the company has the potential to earn as much as $3.90 per share-without any change in its asset or capital base-and achieve an ROE closer to 25%." For first-quarter 2002, dayrates for its 300-foot-plus jackup rigs in the Gulf of Mexico are expected to average $28,000 while those for its less-than-300-foot jackups will average $17,000. A year earlier, when natural gas prices were climbing, those same rig classes were commanding average dayrates of $51,000 and $45,000, respectively. "Whether the gas markets will bounce back by third- or fourth-quarter 2002, we don't know," says Garber. "But as production falls and demand picks up, you're going to see a sharp snapback in gas prices and dayrates." Rose notes that the depletion rate on gas wells in the Gulf of Mexico is greater than 35%. "That means those wells are effectively draining reservoirs every three years. So we've got to continue drilling just to offset depletion-and more so as demand increases." The company can ride out the cyclical tide and doldrums of the current gas market, since it's in almost all offshore markets worldwide, the majority of which are providing solid support for earnings. For its deepwater floaters, the company in first-quarter 2002 expects average dayrates of $165,000; for its smaller floaters, $80,000. And for its heavy-duty, harsh-environment jackups-such as those in the North Sea-the driller anticipates receiving $110,000 per day, with its other international jackups averaging $50,000 to $60,000. "While many people have been saying that the North Sea is on the decline, that's actually going to be our strongest market this year, as the major oils move ahead with drilling projects that are economic even at $14 to $16 oil," says Garber. "However, the greatest growth area for us going forward will be the Gulf of Mexico-once gas demand snaps back-simply because current dayrates there are so weak." What may also help the company as it moves through the choppy commodity-price waters of 2002 is the fact that three members of Kuwait Petroleum Corp., which owns 18% of GlobalSantaFe, sit on the company's board. "Having at our table one of the world's largest national oil companies, whose government is part of OPEC, allows us some added insight into [that cartel] and its thinking," says Rose. But the biggest challenge facing GlobalSantaFe and other drillers isn't commodity pricing. Explains Garber, "Because of the volatility of our industry, we've lost a lot of good people. And for the same reason, we haven't been able to attract qualified personnel." In the face of this, the company has taken a number of steps to hold on to the 8,500 employees it has, mainly on rigs, worldwide. "Our pay and benefits are within the top quartile of the service industry," he says. "Also, we extensively train and promote our people, such that they realize they've got a strong career path and upward mobility within our organization." Another step: during downturns, the company has in place a bump-back program to retain key employees. The way it works: drillers are bumped back to derrick men and derrick men are bumped to roughnecks-but they continue to be paid at their previous job levels for up to six months. "That historically has gotten them and the company through any downturn," explains Rose. "We find this more preferential than laying off crews, as many companies do, then rehiring people when rig activity picks up again." Wall Street's perception of GlobalSantaFe? Garber says, "It wants to be sure we don't fall on our face, in terms of efficiently executing this merger-that we understand our financials, that we don't have to constantly change our earnings outlook as some other merged drillers have. To allay these concerns, we're probably going to have to put a quarter or two without any surprises." Back in mid-1999, JPMorgan's LaMotte was already sure this merger would be good for both companies. "They not only had similar backgrounds, cultures and approaches to the business, but also very complementary assets and geographical strengths. What has now been created is a company that can provide offshore-drilling equipment in any market worldwide, without having to set up appropriate land-based infrastructure and marketing resources." LaMotte, who has a Buy rating on GSF with a 12-month stock-price target of $39, says larger-cap companies like GlobalSantaFe have historically received premium valuations. "That's a function of greater trading liquidity and the fact that more funds can invest in such a driller because of its size. But it's also a function of GSF's greater cash flow stability. Its diversity of geography and asset base provides more continuity and less volatility-and that tends to lead to higher multiples of EBITDA [earnings before interest, taxes, depreciation and amortization]." Santa Fe International came to the merger with two-thirds of its drilling days in 2002 secured by contracts. Meanwhile, Global Marine brought exposure to the Gulf of Mexico market, where investors are looking to increase their own exposure because they believe dayrates there have bottomed and will rise throughout 2002, LaMotte says. "The company's size and scope also mean greater access to capital, which is essential for growth. Its new jackups, for instance, cost $125 million each while its semisubmersibles cost $285 million." The company currently has a new jackup and semisubmersible in different phases of construction, has committed to build one more of each rig class, and has options to build four more jackups and two semis. Ken Sill, Houston-based director of equity research for Credit Suisse First Boston, says, "The merger created another go-to name in the oil-service universe, with excellent assets and above-average earnings visibility. This company will have better geographic balance and marketing flexibility than either predecessor company, and the stock could trade at expanded multiples based on improved liquidity." He rates GSF a Strong Buy, with a 12-month price target of $34. Based on traditional multiples, GlobalSantaFe has the most attractive valuation within its peer group, Sill adds. Using 2002 estimates, as of early February, the stock was trading at 17.7 times earnings, 10.5 times cash flow, and an enterprise value (equity plus debt)/EBITDA multiple of 9.6. Comparatively, its peers were trading at an average of 24 times earnings, 12.5 times cash flow and 10.5 times enterprise value/EBITDA, he says. In addition, the stock was trading at 83% of estimated replacement-cost value versus an estimated pro forma, full-cycle trading range of 38% to 194% of replacement cost value, he says. "Compared to its peers, GSF has one of the most attractive risk/reward profiles."

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