While a merger with Keppel O& M stoked excitement in Sembmarine in the past, it is more likely to elicit caution now

 

IF Sembcorp Marine (Sembmarine) was hoping that the possibility of a merger with the offshore and marine (O& M) arm of Keppel Corp would soften the blow of its S$1.5 billion rights issue, it was clearly mistaken.

 

Since it announced the two corporate moves just over a week ago, its already depressed shares have tumbled nearly 35 per cent. The stock closed at 12.5 Singapore cents on Friday.

 

Market talk of a merger between Sembmarine and Keppel O& M has surfaced from time to time, on the premise that it would enable the two companies to better compete for business globally.

 

With the slump in oil prices since 2014, and consequent weakness in Sembmarine and Keppel O& M' s profitability, anticipation that some kind of deal was in the works intensified.

 

Sembmarine had to deny these rumours last year, when it was in the throes of its S$2.1 billion rights issue and demerger from Sembcorp Industries (Sembcorp).

 

" We are not aware of any proposals to merge or privatise Sembmarine," the company stated in an announcement on Aug 6, 2020, in response to questions from investors.

 

Less than a year on, and with another big rights issue to sell to its shareholders, Sembmarine seems to have now decided that the time is ripe for a merger with Keppel O& M.

 

Whatever the long-term strategic merits of a merger, however, it seems clear that public investors do not see such a deal making much of a positive difference to the value of Sembmarine' s shares in the immediate term.

 

As a lay investor myself, what I see is a corporate exercise that is likely to benefit Keppel and Temasek Holdings at the expense of Sembmarine' s minority shareholders.

 

How Temasek got Sembmarine

 

Some background might be useful here.

 

Temasek currently holds a 42.6 per cent stake in Sembmarine, which it obtained as a result of Sembmarine' s S$2.1 billion recapitalisation and demerger from Sembcorp last year.

 

The recapitalisation involved a 5-for-1 rights issue at what was then a deeply discounted price of S$0.20 per share. (The rights price was 76.5 per cent below the last traded price, and 35.1 per cent below the theoretical ex-rights price).

 

Sembcorp, which owned 61 per cent of Sembmarine at the time, provided an undertaking to subscribe for up to S$1.5 billion worth of rights shares. Temasek underwrote the remaining S$0.6 billion of the rights issue.

 

Sembmarine was then demerged from Sembcorp, through a distribution in-specie of Sembcorp' s stake in the recapitalised Sembmarine. Holders of each Sembcorp share received 4.911 shares in Sembmarine.

 

Of the more than 5.35 billion Sembmarine shares that Temasek currently holds, nearly 4.33 billion were obtained through this distribution in-specie. Approximately 1.03 billion shares came from the underwriting deal.

 

In short, Temasek shelled out very little cash for its 42.6 per cent stake in Sembmarine - by my calculations, it effectively paid about S$205.7 million or just over 3.8 cents per share.

 

Temasek also rode a substantial re-rating in Sembcorp, in which it holds a 49.5 per cent stake. Since that recapitalisation and demerger exercise was announced in June last year, Sembcorp' s shares have climbed more than 40 per cent.

 

Sembcorp closed Friday at S$2.15, putting its market capitalisation at S$3.84 billion.

 

Why did Sembcorp perform so well?

 

The stated rationale for the rights issue last year was that Sembmarine faced an " urgent need" to recapitalise, meet liquidity requirements, and strengthen its balance sheet to ride through the prolonged downturn in the O& M sector.

 

In fact, the bulk of the rights proceeds was used to repay a subordinated loan of S$1.5 billion from Sembcorp. And, the demerger effectively unshackled Sembcorp from the uncertain future that Sembmarine faced.

 

Another rights issue

 

Now, Sembmarine is in need of more cash.

 

This time around, it is proposing to raise S$1.5 billion through a 3-for-2 rights issue of new shares at S$0.08 per share. (The rights price is 58.1 per cent below the last traded price, and 35.7 per cent below the theoretical ex-rights price).

 

On a pro forma basis, the rights issue would have reduced Sembmarine' s net gearing as at end-2020 from 0.75 times to 0.25 times. But it would have diluted its net tangible assets per share from 27.45 cents to 15.75 cents.

 

Unlike last year' s cash call, Temasek is putting a substantial amount of money behind this latest rights issue.

 

It has agreed to subscribe for its 42.6 per cent entitlement and excess rights such that its total subscription will be up to 67 per cent of the rights issue - representing a total commitment of up to S$1 billion.

 

DBS Bank is underwriting the remaining 33 per cent of the rights issue.

 

The stated rationale for Sembmarine' s latest rights issue is that the pandemic has been more protracted than expected, resulting in project execution delays. The fresh infusion of cash will enable the company to fulfil its existing commitments and win new projects.

 

Sembmarine also said the rights issue would enable it to hone its technological capabilities and accelerate its pivot towards renewable and clean energy sectors.

 

Yet, the rights issue will probably also position Sembmarine for a potentially cash-depleting merger with Keppel O& M.

 

Merger risks

 

On June 24, the same day Sembmarine unveiled its right issue, Keppel and Sembmarine said they will enter exclusive negotiations to combine Keppel O& M and Sembmarine.

 

The stated aim is to create a company that is better able to capitalise on the growing opportunities in the O& M, renewables and clean energy sectors. Yet, given that Keppel and Sembmarine both count Temasek as their single largest shareholder, investors might be wary of the merger terms being set to achieve some strategic purpose.

 

Keppel said in an announcement on June 24 that it expects to receive shares in the combined entity as well as a cash consideration of up to S$500 million. Keppel also said it intends to distribute to its shareholders all the combined entity shares it receives.

 

Separately, Keppel said it is working with a unit of Temasek to sell Keppel O& M' s legacy completed and uncompleted rigs, as well as associated receivables, to an entity that will be majority owned by external investors.

 

Keppel closed Friday at S$5.41. The stock is up nearly 6 per cent since the merger plans were announced. The company, in which Temasek holds a direct 20.4 per cent stake, has a market capitalisation of S$9.85 billion.

 

To be clear, I am not suggesting that the combination of Sembmarine and Keppel O& M will not eventually create a big, globally competitive shipyard operator.

 

Amid the current over-capacity, however, and with shares in Sembmarine trading well below book value, it seems unlikely that the market will react positively to Sembmarine raising capital and trying to enlarge itself.

 

Investors might be more heartened to see Sembmarine shrinking itself, and perhaps obtaining a premium over book value for assets it puts on the block.

 

It would be interesting to see if Sembmarine changes tack and begins rightsizing itself after merging with Keppel O& M.

 

Whatever the case, that will probably be the moment for bargain hunters to take another look at Sembmarine. While a merger with Keppel O& M stoked excitement in Sembmarine in the past, it is more likely to elicit caution now.