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CGS-CIMB upgrades SembMarine to 'add' following revised deal terms while Citi keeps its 'sell' call

Felicia Tan
Felicia Tan10/28/2022 04:30 PM GMT+08  • 8 min read
CGS-CIMB upgrades SembMarine to 'add' following revised deal terms while Citi keeps its 'sell' call
Analysts are mixed over the revised deal terms of the proposed merger between Sembcorp Marine (SembMarine) and Keppel Offshore & Marine (Keppel O&M).
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Analysts are mixed over the revised deal terms of the proposed merger between Sembcorp Marine (SembMarine) and Keppel Offshore & Marine (Keppel O&M).

CGS-CIMB upgrades SembMarine to ‘add’

CGS-CIMB Research analysts Lim Siew Khee and Izabella Tan have upgraded their recommendation on SembMarine to “add” from “hold” previously as they see the revised terms working in SembMarine’s favour slightly.

Their upgrade also comes upon the deal certainty to acquire Keppel O&M, bringing SembMarine one step closer to becoming the largest yard in the region. The enlarged entity will bring the combined order book of both SembMarine and Keppel O&M to around $18.57 billion.

“This is a key driver to lead SembMarine to profitability, potentially by FY2024 [ending Dec 31, 2024]. Based on the previous peak in 2013, the combined order book for both SembMarine and Keppel O&M was $26.5 billion, driven mainly by Sete Brasil drilling rigs contracts,” they write in their Oct 28 report.

“Peak combined net profit and revenue for both were $14 billion and $1.6 billion, respectively, in 2014. As such, we believe the run-rate of revenue and profit based on the proforma order book post-merger could gradually reach $5 billion - $6 billion and a conservative net margin of 3%-5%, yielding a profit of $160 million to $280 million per annum (p.a.),” they add.

See also: Citi maintains 'buy' rating on Genting Singapore off the back of MBS results beat

Under the revised terms released on Oct 27, the number of shares to be issued by SembMarine will be reduced by 3.1 billion to 36.85 billion (from 40.0 billion previously) with an enlarged share capital of 68.24 billion, down from 71.34 billion previously.

No court approval is required. Only the simple majority shareholders’ approval by SembMarine and Keppel Corporation is required. Temasek Holdings will retain its stake of 35.5%.

To Lim and Tan, the simplified transaction structure’s revised terms appear to have improved and reflect possible previous pushback from SembMarine’s minority interests.

See also: 'Brighter outlook' for Hong Leong Asia as China reopens, building materials segment to report doubled profits: CGS-CIMB

“SembMarine’s proforma net tangible assets (NTA) [per] share improves [by around] 5% from 6.5 cents to 6.8 cents based on the enlarged entity based on FY2021 NTA of $4.6 billion,” they write.

With the change in structure, the analysts see that the management control and strategy should remain with SembMarine.

“We were previously concerned about SembMarine grappling to restructure the combined entity (Bayberry) for growth as its end-2021 order book was only at $1.3 billion versus Keppel Corp’s $5 billion,” the analysts point out.

Now, they expect integration risks to be “minimal” as both SembMarine and Keppel O&M now service a common single largest customer, which is Petrobras, which contributes 76% to the combined order book.

“In fact, we expect cost optimisation for materials and equipment procurement, leading to margin expansion,” the analysts add.

In their report, the analysts have also increased their target price estimate to 19 cents from 11 cents previously.

“Execution is key and improvement in operations and profitability is a key re-rating catalyst for SembMarine,” they write.

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“SembMarine traded at an average of 2-4x P/BV in FY2013-2016 during the peak cycle. We now use 1.6x P/BV or the average trading band since the oil price crash in 2015. It also represents a 50% discount to the average peak cycle,” they add. “Our earnings per share [EPS] have not factored in the enlarged share base and merger numbers.”

Citi retains ‘sell’ call as integration risks remain

Contrary to CGS-CIMB’s upbeat outlook, Citi Research analyst Jame Osman is taking on a more negative view as he retains his “sell” call on SembMarine with an unchanged target price of 8 cents.

“While the deal term revisions do not come as a surprise, they come earlier than expected – but more importantly may not be sufficient to mitigate the risk that the resolution may not be approved by minority shareholders, in our view,” says Osman in his Oct 27 report.

The deal is also now expected to close by as soon as January 2023 with the respective extraordinary general meetings (EGMs) to be held in December this year or January 2023, he points out.

Referring to a previous report, where the analyst flagged that obtaining majority approval from SembMarine’s minority shareholders was the key risk, Osman adds that he had expected that if Keppel O&M had continued to secure significant new orders and widen the order book between both parties, this meant a higher likelihood of the merger resolution being passed.

In this report, however, he notes that SembMarine has managed to lift its order book significantly to $6.7 billion, coming close to Keppel O&M’s order book of $11.8 billion since securing two floating production storage and offloading (FPSO) contracts from Petrobras worth $7.8 billion. In the same period, SembMarine had also announced other positive developments including the earlier receipt of receivables from customer Borr Drilling.

“Assuming the pro-forma book value of Keppel O&M remains unchanged at $900 million, the exchange ratio revision has little impact on SembMarine’s potential book value dilution (NTA of the enlarged SembMarine entity remains at [around] 7 cents [per] share versus FY2021’s 12 cents [per] share),” says Osman.

“As such, it remains unclear to us whether the two percentage point upward revision in exchange ratio for SembMarine shareholders will be deemed sufficiently positive for minority shareholders,” he adds.

To this end, the analyst says he still prefers Keppel over SembMarine even if the latter could potentially benefit over the longer term from the proposed acquisition with Keppel O&M through an enlarged order book and broadened engineering capabilities.

To him, “the larger scale of the enlarged entity may pose a double-edged sword as it also means a larger cost base to navigate near-term inflationary and other operational headwinds ahead”. This is in addition to facing integration risks post-merger and in specie distribution of shares in the enlarged SembMarine entity to Keppel’s shareholders could pose an overhang on SembMarine’s share price.

SembMarine ‘well placed’ to return to profitability in FY2023: UOB Kay Hian

UOB Kay Hian analyst Adrian Loh has kept his “buy” rating on SembMarine with an unchanged target price of 15.6 cents.

To him, the combination of Keppel O&M and SembMarine will benefit both companies in the short and long term.

“For Keppel Corporation, the divestment of Keppel O&M will allow it to focus more on asset-light and,or recurring-fee businesses while SembMarine will become a larger and arguably more competitive entity with a strong renewables focus,” Loh writes in his Oct 28 report.

Furthermore, the analyst believes that SembMarine is “well placed” to return to profitability in the FY2023 with the new merger terms in place and on the back of nearly $6.9 billion of new orders in FY2022.

“In just short six months since this transaction was first announced in April, [SembMarine] has dramatically improved in quality. In April, the combined entity reported a net order book of $6.4 billion as at end-FY2021 and this has risen nearly 3x to [over] $18 billion,” he points out.

“Both Keppel Corp and SembMarine have announced a number of large and exciting new order wins in FY2022. The merged entity will have over 30 projects under execution in three broad silos: offshore renewables, new energy (e.g. floating carbon capture storage and ammonia carriers) and cleaner offshore marine solutions,” he adds. “What has not changed is the creation of a new global player in the above three silos which will capture the strong order momentum in offshore wind farms and new energy sources like hydrogen.”

Loh continues: “In our view, the offshore construction cycle for both conventional oil and gas and renewables has room for growth in the next few years, especially given the lack of spending by the global oil and gas industry which constrains energy supply.”

However, he points out that the risk to his view is for restrained capital expenditure (capex) spending despite oil and gas prices being at elevated levels, with energy companies returning cash to shareholders via dividends or share buy-backs.

OCBC keeps 'hold' on SembMarine

The team at OCBC Investment Research (OCBC) has retained its "hold" call with a fair value estimate of 12 cents.

"A significant milestone will be the proposed combination of Keppel O&M and SembMarine which will result in a premier global player in the energy sector," the team writes.

"Orders aside, the market is likely to focus on the upcoming proposed combination of Keppel O&M and SembMarine," it adds.

To the team, an increase in oil and gas prices as well as better-than-expected new order flows at "decent margins" are potential share price catalysts. On the flip side, a fall in oil and gas prices, an impairment of assets and provisions as well as minimal new order flows are downside risks.

As at 4.27pm, shares in SembMarine are trading 0.4 cents higher or 3.28% up at 12.6 cents.

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