Keppel Corporation – Is the merger still on the cards?

Just recently, Keppel Corporation announced a huge loss of $506m for FY2020, which resulted in its share price sliding for 6 consecutive days from $5.70 to $4.90 on 1 February 2021. Since then, it has been struggling around the $5.00 level. The loss did not come as a surprise as it had already announced following the release of the mid-year results, 6 months ago, of its huge impairment exercise on its O&M assets that were still carried in Keppel Corporation’s accounting books. The impairment made against the assets (mainly the O&M assets) was about $889m, and that resulted in a loss of $699m for Keppel Corporation in H1 2020. While Keppel Corporation did manage to offset some of its losses after consolidating the FY2020 results, it was not good enough to appease its existing shareholders.

The cut in the final dividend is also no surprise given the existing business environment. With the Covid-19 pandemic still raging across the globe, the business visibility continues to remain dicey, especially true for corporates that rely heavily on huge physical assets and manpower. The O&M division, which used to be the crown jewel just several years ago, has turned into a huge liability. With a business totally dependent on oil price, it can be either an angel or a devil to the company’s financial. With the huge proportion of the global fleet of aircraft grounded for almost a year, and, at best, projected to get slightly better in the next 1-2 years, the prospects of deep-sea oil extraction would continue to remain very obscure.

Given the crash in the oil price following the onset of the Covid-19 pandemic, it came as no surprise that some of the O&M customers decided to ditch the work-in-progress projects, resulting in project cancellations. To date Keppel Corporation still has about ten work-in-progress jobs and another five completed ones that customers did not take deliveries. While they are considered to be ‘assets’ on the accounting books, they are really not assets in reality. They can only be assets when they are completed and perform the function of operating assets. Right now, they are stranded assets that cannot be put into good use. In fact, they are liabilities due to the holding cost involved.

Given the dire situation, and no potential customers in sight, Keppel Corporation has to undertake at its own cost an estimated amount of S$500m to lead the projects to completion. In the meantime, the O&M division will be re-structured into 3 entities:

  • An Op Co – to focus on the design and the engineering of O&M projects.
  • A Rig Co – to focus on the chartering, managing or selling of the oil rigs. This unit is likely to be the business front with customers.
  • Dev Co – This will be the entity to oversee the completion of the incomplete oil-rigs.

It is not difficult to envisage that Dev Co followed by the Rig Co will be scaled down and eventually closed as projects are completed and the rigs are sold out going into the future. I believe the final scenario will take a few years to materialise, highly dependent of the business environment, in particular, the price of crude oil at that time.

In fact, on the wider note, depending on how things finally emerged, at least 2 or even all the three business entities could eventually be merged with Sembcorp Marine. Since the demerger with Sembcorp Industries, Sembcorp Marine has been struggling as a stand-alone entity. Without the assistance from Temasek Holdings (TH) to merge the entities from Keppel Corporation with Sembcorp Marine, it is likely that Sembcorp Marine shares will continue to be in doldrums.

Given that TH partial offer for Keppel Corporation had fallen through after the breach of Material Adverse Clause (MAC) in July 2020, TH may once again come back with a new proposal. Perhaps, this time, instead of taking a controlling stake in Keppel Corp, she may choose to take over the O&M entities. With the current depressed value in oil rigs, it may be a lower cost for TH buy up the entities to merge with Sembcorp Marine instead of the original proposed price tag of $4.08b to take a controlling stake of Keppel corporation. If that is the situation, the existing shareholders of Keppel Corporation would be happy again. Hopefully it is not a dream this time.

Brennen has been investing in the stock market for 30 years. He trains occasionally and is a managing partner for BP Wealth Learning Centre. He is the instructor for two online courses on InvestingNote – Value Investing: The Essential Guide and Value Investing: The Ultimate Guide. He is also the author of the book – “Building Wealth Together Through Stocks” which is available in both soft and hardcopy.

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