By: Lee Chin Wai aka (The) Boring Investor
Chin Wai has been investing for over 20 years. He was introduced to the stock market even earlier by his father and has witnessed the Oct 1987 crash and the 1997/98 Asian Financial Crisis. He himself has survived the 2000-2003 dot.com/ Sep-11/ SARS crisis and the 2007/08 Global Financial Crisis. He has a Masters degree in Applied Finance and passed all 3 levels of the CFA exams. Chin Wai blogs at (The) Boring Investor (www.boringinvestor.blogspot.com).
This is a question that the market always speculates about.
It is also speculation that I occasionally engage in. Sometimes, I am bemused by such speculations.
Speculating on a merger is akin to saying that a particular boy and girl are a match made in heavens, without asking either of them whether they are interested in each other!
Let’s begin with SembCorp Marine first.
What SembCorp Marine Needs?
As you would have known, orders for oil rigs, semi-submersibles and drillships dried up after the collapse of oil prices in mid 2014. Figure 1 below shows the net order book for SembCorp Marine from 2011 till 2018.
At the peak in 2012, just before the collapse of oil prices in mid 2014, SembCorp Marine had a net order book of $12.73B. This has since dropped to $6.21B in 2018. The latest net order book as at Jun 2019 is only $5.27B. Excluding the Sete Brasil orders which are now suspended, the net order book as at Jun 2019 is only $2.14B.
Needless to say, SembCorp Marine requires more orders to sustain its business, especially as it has just shifted to a bigger and more advanced yard, the Tuas Boulevard Yard.
Would merging with Keppel Corp bring more business to SembCorp Marine? By right, a larger, combined company would be able to garner more orders from customers. However, the issue inflicting the entire Oil & Gas industry is the low oil prices brought on by competition from shale oil. SembCorp Marine customers are also suffering from the low oil prices, thus reducing demand for oil rigs and the likes.
Furthermore, prior to the oil price collapse in mid 2014, SembCorp Marine had never encountered difficulties in winning orders, so it does not need to become bigger by merging with Keppel Corp to win more orders.
Figure 2 below shows the amount of cash and borrowings that SembCorp Marine has from 2011 to 2018.
As you can see, the amount of cash has declined from $1.99B in 2011 to $0.84B in 2018. On the other hand, borrowings have skyrocketed from $0.04B to $4.23B over the same period. Where did the money go to? Figure 3 below shows where the money went to.
Money could be used to invest in new plants, invest in companies (associates and Joint Ventures), buy new technologies (which show up as goodwill/ intangibles in the balance sheet), or tied up as working capital.
It is common knowledge that SembCorp Marine has faced challenges in getting its customers to take delivery of their orders and pay up promptly as the entire Oil & Gas industry is facing challenges. This is reflected in the increase in net working capital excluding cash, which rose from -$0.78B in 2011 to $1.48B in 2018. The increase is $2.26B over the 7-year period.
However, what is more surprising is the increase in Plant, Property and Equipment (PPE) over the same period. PPE went up from $1.03B in 2011 to $4.18B in 2018. The increase over the 7-year period is $3.15B, which is even more than the increase in net working capital of $2.26B.
The investments in associates, JVs and intangibles have remained relatively constant, ranging from a high of $0.52B in 2014 to a low of $0.25B in 2017, as SembCorp Marine sold some of its investments to fund the increase in PPE and working capital.
Thus, besides the increase in working capital tied up due to the downturn in the Oil & Gas industry, SembCorp Marine has also been investing in new capacity, namely its Tuas Boulevard Yard, just before the severe Oil & Gas downturn began.
Considering that the current net order book is low, you have to wonder how is SembCorp Marine going to find additional cash to support increases in working capital that come with new orders!
So, SembCorp Marine is short of money, but it does not necessarily have to come from Keppel Corp via a merger. As we shall see later, Keppel Corp is also not flushed with cash.
Cash can come from many different sources, including its parent, SembCorp Industries. In Jun this year, SembCorp Industries provided a $2.0B loan facility to SembCorp Marine. This will be used by SembCorp Marine to retire $1.5B of loans, with the remaining $0.5B used as working capital (see SembCorp Marine’s announcement).
Interestingly, SembCorp Industries also does not have all the funds for this loan facility, so they issued $1.5B of bonds, with the remaining $0.5B coming from existing resources and facilities.
Temasek is one of the investors of the bonds.
What Keppel Corp Doesn’t Need?
Figure 4 below shows the net order book and annual revenue of Keppel Corp’s Offshore & Marine (O&M) division.
Like SembCorp Marine, Keppel Corp has seen a decline in both net order book and annual revenue in its O&M division. The net order book has dropped from a peak of $14.24B in 2013 to $4.35B in 2018 (note: Keppel Corp has excluded the Sete Brasil orders from the net order book from 2016 onwards), while its annual revenue has dropped from $8.56B in 2014 to $1.88B in 2018. Its existing capacity is certainly capable of supporting much higher order books than it has currently. Thus, Keppel Corp does not need the additional capacity from SembCorp Marine.
2. Tainted Reputation
Both SembCorp Marine and Keppel Corp were active in chasing orders from Brazil. SembCorp Marine won orders for 7 drillships while Keppel Corp won orders for 6 semi-submersibles. Work on these orders has been been suspended as the client, Sete Brasil, stopped making progressive payments from Nov 2014 onwards. Both companies were alleged to be involved in illegal payments via agents.
In Dec 2017, Keppel Corp reached a global resolution with the authorities in US, Brazil and Singapore over the issue and was fined a total of $570M. On the other hand, SembCorp Marine has neither been cleared of all wrongdoings nor reached a similar resolution with the authorities to date (see the latest news on this matter). Having paid a heavy fine to put the issue behind it, there is no reason for Keppel Corp to want to be mired in the corruption allegations again.
At the current share price of $1.26, taking over SembCorp Marine will cost Keppel Corp $2.63B. In addition, Keppel Corp has to assume SembCorp Marine’s net debt of $3.33B. As at end Jun 2019, Keppel Corp’s net debt is $9.47B, representing a net gearing ratio of 0.82 times. Taking over SembCorp Marine would have increased Keppel Corp’s net debts to $15.43B, pushing its net gearing ratio to 1.33 times.
SembCorp Marine needs orders and money, which Keppel Corp is not able to provide. On the other hand, Keppel Corp does not need the additional capacity, corruption allegations and debts that SembCorp Marine brings. This suggests that Keppel Corp is unlikely to take over SembCorp Marine, no matter how compatible the market thinks they are.
As things stand now, SembCorp Marine is not an attractive takeover target for Keppel Corp. It needs to resolve the corruption allegations and perhaps also raise some cash to pare down the debts.
What is the clearest sign that a boy does not wish to marry a girl?
It is when he goes off to marry another girl instead! Well, that was what Keppel Corp did when it bought M1 for $1.23B in collaboration with SPH in Apr 2019.
P.S. I am vested in Keppel Corp.