JUL 22, 2020 02:38 PM

THE massive two-part proposal that will see Sembcorp Industries (SCI) and Sembcorp Marine (SMM) parting ways will meet the loss-making marine unit&rsquo s &ldquo critical&rdquo liquidity needs, strengthen both companies&rsquo financial positions and is in the best interest of shareholders.

This is according to the boards and management teams of SCI and SMM on Wednesday, as they responded to questions from the Securities Investors Association (Singapore), or Sias.

In June, the two firms  proposed a S$2.1 billion recapitalisation  for SMM as well as a demerger from each other, which will result in Temasek Holdings having a direct stake in the marine arm.

Sias had asked, among other things,  why they were undertaking the corporate action now, while economic conditions were poor.

The companies on Wednesday replied that they had earlier been exploring multiple options to recapitalise SMM. The transaction was then proposed shortly after both the Covid-19 situation and the sudden drop in oil prices had triggered the immediate need for funds.

DECIDING SAY

Meanwhile, SMM clarified that its independent shareholders will have the deciding say in whether the rights issue will proceed.

This is because these shareholders will be the only ones voting on the whitewash resolution, which is inter-conditional with the rights issue resolution. If the whitewash resolution is not approved, the rights issue will not proceed even if its resolution was approved.

Sias had asked how the proposal&rsquo s structure gives SMM&rsquo s public shareholders an actual say in the matter, given that SCI owns 61 per cent of SMM and has undertaken to vote in favour of the rights issue, which requires a simple majority to be greenlit. 

All SCI directors who hold shares in SMM will abstain from voting on the whitewash resolution.

REFINANCING

SMM also said that continuing to add debt is not a long-term solution, as this will further burden its balance sheet with higher gearing and interest payments at a time when its cash flow and financial flexibility are still constrained by the &ldquo challenging market dynamics and outlook&rdquo .

The SMM group&rsquo s current balance sheet is already highly geared, and obtaining support from banks to maintain its current loan facilities is already &ldquo challenging&rdquo , it noted.

&ldquo To request banks to provide additional loan facilities is therefore not realistic and also unlikely to be sufficient to meet our liquidity needs.&rdquo

This was in response to Sias&rsquo question as to whether SMM will consider taking on new debt given that interest rates have fallen substantially in recent months.

&lsquo A NEW WAY FORWARD&rsquo

If approved, the rights issue will allow the SMM group to &ldquo chart a new way forward&rdquo by improving its cash position and strengthening the balance sheet.

This will enable SMM to fund ongoing commitments, help the group compete for new high-value projects and ensure long-term viability, it said.

Under &ldquo general corporate purposes&rdquo , the group will also use some of the S$0.6 billion raised to fund its research and development efforts, and strengthen core engineering and execution capabilities that will drive future growth initiatives.

In the immediate term, SMM will focus on completing ongoing projects. To date, none of them have been cancelled. 

Over the longer term, the company will diversify into clean energy growth areas, such as offshore wind, and expand into its established segments, such as the gas value chain.

While all of SMM&rsquo s business segments have been affected by the current challenging business conditions, the repair and upgrades segment has remained profitable and generated over S$600 million in revenue for FY2019. SMM said it will continue to grow this segment.

SUBORDINATED LOAN

SCI clarified that under the proposal, it will not &ldquo write off&rdquo the S$1.5 billion outstanding principal loaned to SMM. Instead, the debt will be converted into an equity stake in SMM via the rights issue. Sias had asked how writing off a related party&rsquo s debt will benefit SCI. If the debt were indeed written off, SCI would not have received any consideration in return.

SCI last year extended a S$2 billion subordinated loan to SMM, of which the S$1.5 billion amount has been drawn down, amid the prolonged and severe downturn in the offshore and marine industry. 

The Covid-19 pandemic and the oil price collapse worsened the situation this year, and thus SMM expects losses to continue in the foreseeable quarters. 

&ldquo The settlement of the subordinated loan through the rights issue substantially recapitalises SMM&rsquo s business, materially reducing its debt servicing obligations and putting it in a strong position to ride out the current crisis as well as enhancing its competitiveness in the sector,&rdquo SCI said.

It added that the settlement also provides value to SCI, in the form of SMM shares. All SCI shareholders will benefit as well, as they will get the flexibility to calibrate their holdings in both companies once there is a clean demerger of SMM after the loan settlement and distribution.

BALANCE SHEET

Sias argued that SCI&rsquo s reduced debt post-transaction may be driven by accounting treatment rather than expected economic improvements to its business.

In response, SCI pointed out that a deconsolidation of SMM will bring &ldquo tangible&rdquo benefits, as the improved debt position will open opportunities for more debt financing, and is not simply accounting treatment.

If the transaction goes through, SCI will no longer need to set aside the remaining S$0.5 billion commitment under the S$2 billion subordinated loan, given that this remaining commitment will be cancelled.

&ldquo New demand patterns emerging in the energy sector require us to focus on competing effectively and developing more sustainable business models,&rdquo SCI said on Wednesday. With a less constrained balance sheet, SCI will be better placed to pursue some of the opportunities to serve Asian markets where there is burgeoning demand for sustainable solutions, it added.

The expected improvements in SCI&rsquo s financial metrics - including the earnings per share, return on equity and net debt-to-Ebitda (earnings before interest, taxes, depreciation and amortisation) ratio - will provide headroom for more resources to be made available, such as through the raising of more debt.

With an increased strategic focus on the energy and urban pillars after the proposed distribution, SCI will be able to allocate capital and resources solely to these businesses, it said. For instance, in the renewable energy sector, the company will be able to leverage innovative technologies to compete and grow.

SCI also replied that the demerger will deliver a &ldquo clearer investment proposition&rdquo to its shareholders, and this may lead to a positive re-rating of SCI&rsquo s equity value and appeal to equity investors focused on the energy and urban space. Sias had asked for specifics on the expected improvement to shareholder value when SCI transforms into a focused energy and urban company. 

SCI and SMM will seek their shareholders&rsquo approval for the transaction at extraordinary general meetings, which are expected to take place around end-August and early September.