Keppel Corporation & Sembcorp Marine

  1. The memorandum of Understanding (MOUs)

As many have expected, Keppel Corporation (Keppel) and Sembcorp Marine (SMM) have finally decided to combine their resources and expertise that they have built up in the offshore and marine (O&M) space. The combined entity (temporarily named as Combined Entity (CE)) would have an enlarged pool of resources and facilities, to bid not just for O&M projects, but also other alternative energy projects in the clean and renewable energy sector. The Memorandum of Understanding (MOU) was signed last week. The final details will be worked out in the next few months. In principle, CE shall still be public-listed and SMM shareholders shall hold the shares of CE. In the meantime, with the injection of the on-going projects and resources, Keppel will be entitled to cash and shares of CE up to $500m. To fund for the ‘purchase’ of the facilities and expertise from Keppel for a price-tag of $500m, SMM will be raising a 3-for-2 rights issue of about $1.5b from existing SMM shareholders. The rest of the fund will be shall remain as working capital for future projects. According to Keppel, the shares of CE shall be eventually distributed to her shareholders as dividend in specie. (In the light of this development, I read it that after the whole exercise, SMM might eventually be removed and its shares be replaced by CE shares which I shall discuss in the text below.) As it is, if everything goes on as planned, the final scenario shall be existing Keppel and SMM shareholders, including Temasek Holdings (TH) holding the shares of CE shares.

Separately, Keppel also had an MOU with Kyanite (a subsidiary unit of TH) to look for external investor(s) to co-own a separate rig company (Rig Co), of which Keppel is expected to take a minority shareholding. Rig Co will hold the stranded assets and manage the receivables to be transferred from Keppel. The total assets, making up of about 15 completed ones and uncompleted rig as well as the receivables worth about $3.8b (comprising $2.9b of stranded assets and $0.9b of receivables). Short of a ready investor at this time and the funding to complete the uncompleted oil rigs, it is also likely to take another few months, at least to end 2021, before anything concrete can be cobbled out.

As mentioned by Keppel, the two MOUs are inter-conditional, and therefore have to be worked upon concurrently.

2. Keppel shareholders

While many details have not been worked out, the scenario for Keppel appear to be clearer. In the Keppel-Kyanite MOU, Keppel is the sponsor for the assets to be injected into Rig Co, of which Keppel is expected to take a minority shareholding. In the Keppel-SMM MOU, Keppel is sponsoring the fixed yards assets and O&M expertise into the joint-venture, CE, together with SMM. In a simple analogy, it is akin to sponsoring its respective movable operating assets and fixed properties into two separate Real Estate Investment Trusts (REIT), and take a shareholding in both of them. Although the stranded rigs and receivables may worth $3.8b carried on Keppel’s books, it is not unexpected that a steep impairment on the assets have to be carried out during the negotiation with the potential buyer Reg Co investor. However, it is still too early to make any meaningful inference. It depends very much on the operational environment at the point of discussion. In this respect, it is hoped that the oil price continues to rise or at least stay at this level. As to the estimated funding to complete the uncompleted oil rigs, it comes indirectly from SMM shareholders  through the coming $1.5b rights shares issue. In the way, it helps Keppel complete the projects without the need for additional funds, such as bank borrowing, or bond issues or rights shares issues.

In the MOU with SMM, a little headway seemed to have been cobbled out, enabling Keppel to earn a return of up to $500m in cash and CE shares. If everything goes according to plan, Keppel shall become the shareholder in Rig Co and CE. Overall, it should be positive for Keppel as it takes steps to reduce its exposure in the O&M space without much losses. It may even stand to recoup part of its past investments if oil prices continue to stay, at least, at this level.

3. Sembcorp Marine (SMM) shareholders

The impact on IMM appears to be trickier. To begin with, SMM shareholders have to swallow a bitter pill for the coming 3-for-2 rights issue to raise a fund of $1.5b. In fact, this is a 2nd hit for SMM shareholders. Just 12 months ago, the company had to raise a 5-to-1 rights issue amounting to $2.1b. In both exercises, they were extremely dilutive and fell within the space of just one year apart.  In other words, SMM shareholders have been hit twice within a year.  

While the rights issues are critical for the survival of SMM, they are really no joy for SMM shareholders. Imagine if an SMM shareholder had 1000 shares before the 1st right issue, the share quantity would have been blown to 15,000 shares if he subscribed to the rights share issues in both exercises. Assuming that he had bought 1000 shares several years ago at the cost of $$1.50 per share ($1.50 was considered to be relatively inexpensive compared to about $4-$5 during its peak period), the total investment and his average share price would have been $3,220 and $0.215 respectively (see table below), ignoring the time value of money over the last few years. The share price at yesterday’s close was $0.125, which is more than 40% lower his average cost price and additional $1,720 poorer (1.167 times the original investment).

4. Going forward

Based on the share price movement of Keppel, the euphoria seemed to have died down following Monday’s close at $5.60. In fact, by yesterday’s close price of $5.41, it landed almost the same close price after the trading halt was lifted on Friday, 25 June 2021. Short of information of the new Reg Co and the new developments in the CE, not much can be expected of its share price in the near term.

The share price of SMM seemed to be more interesting. One day after the trading halt, the price declined sharply from $0.191 to $0.139. For the next three days in the week that followed, it continued to slide, closing at $0.12 on Wednesday. On Thursday, it was up at $0.123. By Friday 3 July, the share price was $0.125, a premium of about 36% over the forthcoming rights share price. I believe, by now,  buyers are buying on the dip in hope to pick up the rights issue. Any new buyers at this price would have an average cost of about $0.098 without excess rights. With a 36% premium over the rights price, there should be sufficient interest for the right shares. Unlike the 1st tranche of the rights shares issue, when the bulk of the funds ($1.5b) went to paying the debts owed to its ex-parent Sembcorp Industry, the coming rights exercise of $1.5b is expected to put into better use. It would be used for paying $500m to Keppel for the purchase of Keppel yard assets and expertise, leaving about $1b for SMM’s  working capital. This should provide a broader leeway for more projects going forward.

Based on the closing price of SMM, its market capitalization is about $1.51b. It is grossly below the value of the mega yard that she is going to inherit. However, value does not translate to earnings. It is expected that in the next 2 quarters and, maybe more, that SMM will still be suffering losses. If SMM is still not able to win sufficient projects, the share price may even fall below the rights share price at $0.08 cents. Ultimately, it is still very dependent on external factors, in particular, the crude oil price, which it has no control of.

With the current shares issue of about 12.56 billion shares, the coming SMM rights share issue shall see another 18.8 billion shares in the market, resulting in a total of 31.4 billion shares in the float. As a matter of opinion, it may be that SMM be removed and replaced by the CE (whose name is not known today) through shares consolidation and shares-swap. After all, SMM is no longer related to Sembcorp Industry like in the previous parent-subsidiary relationship.

5. Taking a position

In the light of this, I decide to make a small market purchase of the SMM shares. Should I take the rights issue, my average price for SMM shares should be slightly below 10 cents, given I do not have earlier exposure to SMM stock. It is not a bad price to start with. After all, I had made a small profit when I bought SMM when it fell from $0.20 after the 1st rights issue to slightly above $0.12 before creeping back to $0.20. However, nothing is guaranteed as the stock price can still fall below 8-cents after the 2nd rights issue if it does not thread carefully going forward.

After all, I will eventually have some CE shares as dividend in specie given that I am holding some Keppel stocks. In all likelihood, I will end up with small odd lots of CE stocks, which would make it extremely difficult to sell if things do not go right. While the market is still negative about SMM, it may be timely to pick up some SMM shares. If SMM shares were to be consolidated into CE shares according to my speculation, it is probably meaningful to pick up some SMM shares now. Unlike the earlier SMM shareholders, my losses going into the future should be quite contained. Certainly, it is not going to make me rich enough to present me a ticket to be with Jeff Bezos in the 1st space flight, but I think a few ‘hamcheepeng’ for Sunday breakfast may be possible. After all, buying stocks is not about all gains and no risk. It is how we take calculated risks and manage them according to our risk tolerance.

I hope I have fully answered to a member of InvestingNote.com why I went ahead to buy some SMM shares at this juncture.

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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