Merger between Keppel Corp and Sembcorp Marine finally taking place
Both Keppel and Sembcorp Marine requested for their share prices to be halted before the start of market trading on 24 June. According to the Straits Times report quoting sources from Reuters, both companies are in the process of kicking off talks to explore combining their struggling Offshore and Marine (O&M) businesses.
This merger between both their O&M entities is long overdue. I have commented previously that Keppel divesting its O&M assets, with the blessing of key shareholder Temasek will be the key catalyst that is needed to propel its share price higher.
After the market closes on 24 June 2021, both companies announced that they will be signing a non-binding MOUs in connection with the proposed combination of Keppel O&M and Sembcorp Marine.
The announcement can be found here.
Before I go into the details of the MOU, a quick background of what happened over the past year. For those who are interested, you can check out the video here as well.
The background
When Keppel first announced back in 2020 that it was looking to restructure the company, hope was in the air that the company would seek to divest its O&M entity and merge it with Sembcorp Marine, just like what Sembcorp Industries did previously.
Alas, the company disappointed the street when on 28 Jan 2021, alongside the announcement of its full-year 2020 results, Keppel highlighted that it will do an organic restructuring of its rig-building business, exiting its offshore rig building business and also progressively exit low-value-adding repairs. This doesn’t change the status co.
All it meant was that less emphasis and resources would be channeled towards its O&M business. In addition, the restructuring requires the Group to pump in an additional S$500m into the development company for the completion of unfinished rigs, thus further sapping the Group’s cash flow.
I highlighted back in January 2021 in this article:
“What Keppel is currently doing is essentially in “preparation” for that “still-yet-to-be-announced” merger that pools the knowledge and resources of both companies into a single enlarged corporation that will be able to better position itself to compete against the South Koreans and Chinese yards
I still believe that a merger might still materialize down the road. The question however is when that might be?”
I decided to pare my stake in Keppel then as the timeline of their O&M divestment and subsequent merger with Sembcorp Marine was no longer clear.
Details of the MOU
There are 2 key points:
- Keppel will be looking to combine Keppel O&M together with Sembcorp Marine, with the latter now being the combined entity.
- Keppel will sell its legacy rigs completed and uncompleted and associated receivables to a separate Asset Co which would be majority-owned by external investors (80%) while Keppel retain not more than 20%
Both proposed transactions will be inter-conditional and pursued concurrently.
These transactions will be earnings accretive to Keppel Corp (more on this later) for the current financial year and if completed, Keppel Corp will receive shares in the Combined Entity (aka Sembcorp Marine) and a cash consideration of up to S$500m.
Keppel will look to distribute to its shareholders the shares of the combined entity by way of distribution in specie.
So the combined entity will essentially be the enlarged Sembcorp Marine and the company will remain a listed company.
It is still uncertain how Sembcorp Marine will fund the S$500m payment to Keppel Corp (likely through the S$1.5bn in gross proceeds that Sembcorp Marine announced it will be raising through a rights issuance) and how many shares of the enlarged entity Keppel will be entitled to.
How will Keppel’s price react?
The deal is likely going to be POSITIVE for Keppel’s share price.
This is the CATALYST that everyone has been waiting for. A merger between Keppel O&M and Sembcorp Marine to form an enlarged entity that can compete on the global front.
With this formation, Keppel will be now more of a Property or “Urban Development” player vs. having an offshore position.
Now the question is: Is the S$500m payment + shares of the enlarged entity (not sure how much shares Keppel will be entitled to) a good deal?
Let’s take a look at how some of the brokerage companies value Keppel.
According to both UOB Kay Hian and CIMB which have a Target price of $6.37 and $6.40 on the counter respectively, both brokerage houses pegged the value of Keppel’s O&M entity at $0.05-$0.34/share respectively in deriving their target prices.
That essentially means that the value of its O&M business has largely not been factored in by the street.
What that again means is that almost any price which Keppel gets for its O&M business will be a PLUS for the Group.
In its FY2020 financial statement, Keppel stated that the net asset for its O&M division is NEGATIVE $658m vs. FY2019 restated net asset of +$703m. Even if Keppel is to divest away its O&M division at $0, it will still be a positive for the Group in terms of a revaluation gain from this divestment (which has a negative figure in its balance sheet).
This is why Keppel highlighted in this MOU announcement that the deal will be earnings accretive for the Group as it will be able to able to “remove” this negative value from its balance sheet.
Concurrently, the net debt level of the Group will also fall which is another positive, although the overall gearing level (net debt/equity funds) will not change much.
Back in Aug 2020, when I wrote about the Sembcorp Demerger deal being passed and what Temasek’s plan might be, I highlighted that Keppel O&M division was then valued at just 0.18x P/B according to CIMB, with a book value of ($1.77bn). This means that its O&M division was valued at just about S$320m based on its then share price of S$4.88.
I reckon that it should be worth at least 0.4x P/B (where Sembcorp Marine was trading then) which implies a “fair valuation” of roughly S$640m for its O&M division.
Keppel is now receiving S$500m in cash plus an unknown amount of the enlarged Sembcorp Marine shares. With Sembcorp Marine now boasting a valuation of S$2.4bn (with the enlarged entity likely having a larger market cap), unless Keppel’s shareholders are entitled to less than 8-10% of the enlarged entity, it is most likely one where the divestment is a better deal to existing Keppel’s shareholders vs. a status co scenario.
For S$500m, this equates to S$0.275/Keppel share based on an outstanding share base of 1.82bn. I expect its share price to at least appreciate to S$5.40-S$5.50 when the counter starts trading and the positive momentum should carry, with investors/speculators anticipating another “windfall” when the number of shares in the combined entity is confirmed.
This is just my rough estimation and there are other asset values not accounted for, such as the completed/uncompleted rigs that are not part of the merger deal with Sembcorp Marine and will instead be injected into a separate company to be funded by external parties.
What does it mean for Sembcorp Marine’s share price
On one hand, it is good that Sembcorp Marine will now have access to Keppel O&M resources, talent, and IP, etc. However, on the other hand, Sembcorp Marine also announced that it will be issuing rights shares for gross proceeds of S$1.5bn to fund the acquisition as well as for other working capital purposes.
This will likely be a negative event for the company. Hence, I reckon that the market will likely be selling off Sembcorp Marine’s shares as a result of the rights issuance.
Conclusion
This is just my preliminary assessment of the deal and by no means should it be taken as a call to action to BUY or SELL Keppel.
I believe is a positive development for Keppel, one which the street has been anticipating for years.
It is better late than never.
The enlarged entity will likely be able to streamline their operations and cost cut to lower operating expenses to be able to compete for projects against heavyweight yards in Korea and China.
More details will be needed to assess if Keppel is indeed a good buy at a level over S$5.50, particularly on the number of shares received by Keppel pertaining to the enlarged entity.
Do Like Me on Facebook if you enjoy reading the various investment and personal finance articles at New Academy of Finance. I do post interesting articles on FB from time to time which might not be covered here in this website.
Join our Instagram channel for more tidbits on all things finance!
SEE OUR OTHER WRITE-UPS
- 1Q 2020 TOP HEDGE FUND LETTERS TO SHAREHOLDERS
- 8 OUTPERFORMING STOCKS TO BUY NOW (PART 2)
- 8 OUTPERFORMING STOCKS TO BUY NOW (PART 1)
- 4 RECESSION-RESISTANT STOCKS WITH A FORTRESS BALANCE SHEET
- 4 STOCKS WITH MORE THAN 80% RECURRING REVENUE OWNED BY GURUS
- A LIST OF “BEST” DIVIDEND GROWTH STOCKS
Disclosure: The accuracy of the material found in this article cannot be guaranteed. Past performance is not an assurance of future results. This article is not to be construed as a recommendation to Buy or Sell any shares or derivative products and is solely for reference only.
