When Sembcorp Marine and Keppel Corporation (BN4) halted trading on Thursday, we knew something is brewing.
Two major announcements have been made since the trade halt.
Both companies announced a non-binding Memorandum of Understanding (MOU) to discuss a potential merger between Sembcorp Marine and Keppel Corporation’s offshore and marine unit (Keppel O&M).
Details of the merger between Keppel Corp’s O&M arm and Sembcorp Marine has finally been announced on 27 Apr 2022! We analysed the merger and what Keppel and Semcorb Marine shareholders must know here.
In addition to the non-binding MOU, Sembcorp Marine has also announced a massive $1.5billion rights issue to boost its cash balance.
With 2 topics at hand, we will split this article will be split into 2 parts. Firstly, I will discuss what investors can expect from the potential merger and subsequently, the impact of the rights issues.
1 – Sembcorp Marine and Keppel O&M potential merger
First up, let’s look at the businesses of the companies involved.
Overview of Sembcorp Marine
Sembcorp Marine (SGX:S51) is a global player in innovative engineering solution for the Offshore, Marine and Energy industry with facilities in 5 countries, Singapore, Indonesia, UK, Norway and Brazil. More specifically, it is involved in 4 main sectors:
- Rigs & Floaters (Design and construction of high-specification rigs)
- Repairs & Upgrades (Ship repair and upgrading for a wide range of vessels and rigs)
- Offshore Platforms (Strong capabilities in turnkey offshore solution)
- Specialised Shipbuilding (Niche ship design and building of specialised offshore vessels)
In recent years, Sembcorp Marine has increased its focus on renewable and other clean energy solution as it offshore and marine sector faces a downturn caused by the prolonged weakness in oil prices which is further exacerbated by the pandemic.
The image below are some examples of its sustainable products:
Overview of Keppel Corporation
Keppel Corporation (SGX:BN4) is much more diverse as compared to Sembcorp Marine. Keppel Corporation is the parent of Keppel O&M. Its business provides solutions for sustainable urbanisation in 4 key areas:
- Energy & Environment (Keppel Infrastructure, Keppel O&M, Keppel Renewable Energy, as well as the Group’s investment in associate KrisEnergy)
- Urban Development (Keppel Land)
- Connectivity (Keppel Telecommunication and Transportation, which includes M1 telco, multiple logistics buildings and data centres)
- Asset Management
The Potential Merger
Anyone can say they have seen this merger coming, however this merger would not have happened if not for a series of event that happened back last year. Here’s a timeline of key events leading to the potential merger:
- August 2020: Following Keppel Corporation poor financial performance, Temasek scrapped its $3 billion plan to take a controlling stake in Keppel Corporation.
- September 2020: Sembcorp Marine split from its parent, Sembcorp Industries. At that time, Temasek had stepped in to support a $1.5 billion rights issue by Sembcorp Marine.
- Earlier this year, Keppel announced its exit from the rig business following a strategic review. Moving forward, it would stop building offshore drilling platform and focus on clean energy instead.
Now: A potential merger between Sembcorp Marine and Keppel O&M.
Details of Potential Merger: What’s going to happen?
- Sembcorp Marine and Keppel O&M will merge into a combined listed entity. (Excluded in this deal is Keppel O&M’s legacy rigs which will be sold to Kyanite Investment Holdings, a wholly-owned Temasek Holdings unit.)
- Keppel O&M’s renewables projects (eg. wind turbine installation vessel for Dominion Energy) will be transfered to the new combined entity. However, projects that are under Keppel Renewable Energy will stay in Keppel.
- Sembcorp Marine shareholders will receive the share of the combined listed entity in replacement of its existing Sembcorp Marine shares.
- After the combination, Keppel Corporation will receive $500 million in cash plus shares of the combined entity. These shares would then be distributed to Keppel Corporation shareholders.
- Keppel Corporation will cease to be a shareholder of the combined entity.
Well, a merger between these two Temasek backed company is the right way forward in my opinion.
As companies in the shipbuilding and marine sector face a weak outlook, many have already merged to form a larger entity.
Likewise, for Sembcorp Marine and Keppel Corporation, a merged entity would be in a better position to capitalise on growth opportunities, compete for larger contracts and pursue synergies from a combined operation scale.
What this deal means for Sembcorp Marine investors?
This deal is beneficial for Sembcorp marine shareholders.
However, its upcoming rights issues (discussed more below) have and should take precedence over the merger.
What this deal means for Keppel Corporation investors?
For FY2020, Keppel Energy & Environment report a net loss of $1.2 billion, compared to a $101 million net loss in FY2019. (see image below) Its O&M business contributed the bulk of its losses.
As such with the removal of the O&M business, it could be a blessing for its shareholders.
If the deal passes through successfully, Keppel Corporation will be able to spin off its O&M business, which could potentially unlock value for its shareholders.
2 – Sembcorp Marine’s Rights Issue 2021
On the same day of the announcement, Sembcorp Marine also proposed a further $1.5 billion rights issue to strengthen its financial position and accelerate its strategic pivot towards renewable and clean energy.
Sembcorp Marine Rights Issue 2021 tl;dr
For every 2 Sembcorp Marine shares, you will be eligible for 3 rights share at the price of $0.08 per share.
At this price, it represents a 58.1% discount from the last transacted price, which is extremely dilutive for investors.
The rights are “renounceable”, which means you can sell your allocated rights if you do not want to subscribe. However, if the past is any indication, I do not think the rights would be very popular and may not be worth much on the open market.
Given the unpopularity of the previous rights issue, the majority could be taken up by Startree Investment Pte Ltd, a subsidiary of Temasek which has committed to subscribe to up to 67% of all the rights. The remaining 33% (if not taken up) will then be underwritten by DBS. This means that Sembcorp Marine is guaranteed to raise the $1.5 billion, it is a matter of who pays for it.
Nonetheless, the rights issue is subjected to shareholders approval. Here’s the timeline that investors of Sembcorp Marine should take note of:
Why another Rights Issue now?
This rights issue is on top of the $2.1 billion rights issue done back in September 2020. $1.5 billion of the $2.1billion raised was used to reduce Sembcorp Marine’s debt to Sembcorp Industries Ltd, while the remaining $0.6 billion was used as working capital.
At $1.5 billion, this rights issue is extremely dilutive especially when you compared it to its current market capitalisation of $2.4 billion (before the announcement).
Four official reasons were given for this rights issue:
- Strengthen Balance Sheet and Liquidity position
The rights issue would allow Sembcorp Marine to reduce its net gearing ratio from 0.75x to 0.25x. This would help reinforce both lenders’ and customers’ confidence.
In addition, it would be able to increase its cash balance from $0.8 billion to $2.3 billion which allows it to meet its projected operational funding needs to end 2022.
- Fulfil existing commitments and win new projects
With more cash, Sembcorp Marine would then be able to bid for higher value and larger-scale projects which could ensure its long term viability.
- Enhance strategic capabilities and R&D to maintain a competitive edge
Having more cash means it can afford to invest for the long term, which is crucial especially since Sembcorp Marine wants to drive growth in the clean energy sector.
- Accelerate strategic pivot into high growth renewable and clean energy segments
Sembcorp Marine also hopes to accelerate its strategic pivot into the high growth renewable and clean energy segment. With this rights issue, it would have greater capability to fund growth and undergo strategic expansion.
Would this be Sembcorp Marine’s last rights issues?
While the rights issue is subjected to shareholders approval, investors are already pricing in this possibility. Its share price has already taken a massive hit on the first day after the announcement.
The question now is, will this be the last rights issue? Or will Sembcorp Marine require more funding in the near future?
If we look back at 2020, Sembcorp Marine’s cash flow from operating activities was -$750 million while its cash flow from investing activity was -$88 million. In total, it burned -$838 million.
While the situation today is not as bad as last year, Sembcorp Marine is still affected by the downturn in the offshore and marine sector.
As such let’s take the average of their 2020 and 2019 cash flow. The estimated cash burn for Sembcorp Marine for this year could be around -$723 million.
At this rate, it is no wonder why Sembcorp Marine with a current cash balance of $0.8 billion would require another funding.
If we assume that Sembcorp Marine continues to burn this much cash each year, the current $1.5 billion rights issue would mean an extension of its runway by 2 years only. As such, another rights issue is probable when the time comes.
What to do?
The potential merger is a piece of welcomed news. However, not all investors are going to be happy with the two announcements.
If you have shares in Sembcorp Marine, you will have a hard decision to make. After the announcement, its share price has already plummeted, leaving most investors no chance to exit at a ‘fair’ price.
On one hand, the merger could bring about great synergy between both companies but on the other, the group will continue to face to impact of the pandemic and a general decline of the Oil and Gas industry. If you are a shareholder, you will have to make a choice yourself as I have no answer too.
If you are an investor of Keppel Corporation, this moved is definitely a blessing. The removal of its O&G sector could smoothen Keppel’s future income which many investors’ favour.
At the time of writing, I do not own any Sembcorp Marine shares nor Keppel Corporation shares. However, moving forward, I may take a look at Keppel’s business.
P.S. for those who prefer to listen/watch, Alvin has also done a video summary:
Zhi Rong Tan’s analysis is always a joy to read. He is objective and presents a clear and easy to understand script for anyone to read. He is a gem.