The Jan 28 announcement of Keppel Corp’s exit from the rig-building business should have elicited a positive response from the market. After all, ditching the loss-making business of its subsidiary Keppel Offshore & Marine (Keppel O&M) is a crucial step to reviving the company’s flagging fortunes since the 2014 crash in crude oil prices. But the market appears to think otherwise.

Shares of Keppel have since rolled back some of the gains made after the company announced a strategic review of Keppel O&M last year. The stock is down 11.5% to close at $5.07 on Feb 3 from the six-month high of $5.73 on Jan 21. This translates to 0.9 times its book value.

The market’s negative reaction can be partly attributed to Keppel’s weak FY2020 results ended Dec 31 — which was released in concurrent with the exit announcement. The company swung into its first annual loss since the Asian financial crisis shook the region in 1998. It bled $506 million compared to earnings of $707 million in FY2019. The loss was mainly attributed to impairments of $952 million recorded under Keppel O&M — the bulk of which was recognised in 2Q2020.

Excluding impairments in both years, the company said it would have registered earnings of $446 million for FY2020, compared to earnings of $828 million for FY2019. Keppel O&M was the only loss-making unit in FY2020.

Keppel’s revenue also tumbled 13% y-o-y to $6.57 billion in FY2020. The lower top line was mainly due to reduced contributions from its energy & environment, urban development and asset management segments. This, however, was offset by higher revenue from the connectivity segment.

The second reason for the market’s negative reaction — and perhaps more troubling — is the possibility of a long-drawn exit from the rig-building business. While Keppel says it will continue to explore inorganic options, the company plans to transform Keppel O&M organically to be “more competitive, relevant and aligned” to its new strategy of sustainable urbanisation.

CGS-CIMB Research warns that such restructuring efforts will take time to bear fruit. This is because the oil market is “challenging”, and thus, may make an immediate exit not feasible. “Medium-term catalyst: full exit from rig business,” CGS-CIMB’s head of research Lim Siew Khee writes in a note dated Jan 28.

Phillip Securities is of a similar view. “We think the market will be disappointed by the absence of a clear and immediate exit plan from the O&M business while retaining their higher value-added renewable energy division,” Phillip Securities’ senior research analyst Terence Chua writes in a Feb 1 report.

Challenging transformation

As part of the transformation process, Keppel O&M will be restructured into three entities: Operating Co (Op Co), Rig Co and Development Co (Dev Co). The latter two are deemed as “transient” entities. Keppel believes this structure will place Keppel O&M in a position to benefit from the global energy transition.

Under Dev Co, any uncompleted rigs that have “firm” contracts with Keppel O&M’s customers will be completed by the entity. The completed rigs will either be delivered to customers, or be transferred to Rig Co that will put them to work or be sold. Rig Co may also “explore bringing in third-party investors” for the completed rigs. A team will be appointed to support Rig Co’s chartering and marketing activities. When Rig Co is cash-flow generating, it can also be monetised or spun off.

Keppel O&M so far has $2.9 billion worth of rigs on its hands. These include several uncompleted rigs for Sete Brasil, Awilco Drilling, Borr Drilling and an undisclosed customer, and several completed rigs for Fecon International Corp, Clearwater Capital Partners and TS Offshore. Keppel O&M also has a drillship named CAN DO — presumably thus christened when times were better.

However, Rig Co will have its work cut out for it. Market observers warn that the demand for rigs is still sluggish. Oddmund Føre, vice president & product manager of rigs & vessels at Rystad Energy, warns that there is no market for newbuilds currently, given a “heavy” oversupply of rigs. Moreover, investments have dried up since the Covid-19 pandemic struck last year, he notes.

According to Føre, both new development plans and exploration prospects have either been cancelled, or delayed. Even underutilised, or dormant wells in mature fields — where investment commitments are not exorbitant — have seen cancellations and delays, he adds. “We expect both floater and jack-up [rig] demand to decline into 2021 before a new recovery starts for both rig segments into 2022,” Føre tells The Edge Singapore.

Andrew Harwood, research director at Wood Mackenzie, agrees. He points out that the floating rig fleet has been halved since 2014, while utilisation rates are likely to hit just 70% of current capacity in 2021. “We expect offshore utilisation rates to remain low this year, as the drop off in drilling activity outpaces the stacking and in many cases the scrapping of capacity,” he tells The Edge Singapore.

Keppel O&M’s best bet may be its pivot towards renewable energy and cleaner fossil fuels under Op Co, an asset-light and people-light unit. Op Co will focus on seizing opportunities in the energy transition, such as floating infrastructure and infrastructure-like projects related to renewables, gas solutions, new energy solutions and production assets. Op Co will also collaborate with other Keppel business units to provide other urbanisation solutions, such as offshore and nearshore infrastructure, and floating data centre parks.

Although it will no longer build rigs, Op Co will not completely ditch the rig business. Instead, it will move up the value chain by focusing on rig design and engineering solutions. All fabrication work will be subcontracted to third parties.

To that end, Keppel O&M’s existing yard operations may be streamlined, though not entirely. The fabrication of “non-oil rigs” may still require production space, says Keppel CEO Loh Chin Hua at the company’s FY2020 results briefing on Jan 28.

Keppel O&M’s existing offshore rig technology will be repurposed for other uses. For example, the jacking system has been used for wind turbine installation vessels, according to Chris Ong, CEO of Keppel O&M. “So, the capabilities are adjacent, and we are confident that we are able to make use of these strengths in the offshore [renewable] energy space,” he says at the same briefing.

So, with the restructuring of Keppel O&M into Dev Co, Rig Co and Op Co, does this mean that Keppel is not actively looking for a buyer for its O&M business?

The way Loh puts it, the company is hedging its bets. If Keppel is unable to find a suitable buyer for Keppel O&M, the company would have minimised its exposure to the O&M industry by pivoting to the renewable energy space. Yet if a suitable buyer is found, Loh believes it may enhance Keppel O&M’s appeal. “That would actually not harm us. In fact, it may strengthen [Keppel O&M’s] position,” he says.

More divestments

In the meantime, Keppel’s other businesses will continue to implement its new strategy under Vision 2030. Keppel has envisaged itself to become an integrated company that would provide solutions for “sustainable urbanisation”. In other words, the company would transform into a property developer that will draw on synergistic benefits from its other businesses.

As part of the efforts to achieve that, Keppel intends to monetise about $17.5 billion worth of assets over time. Of this, $3 billion to $5 billion will be unlocked over the next three years. The proceeds will be redeployed to seize new opportunities and improve return on equity (ROE).

According to Phillip Securities, Keppel has already divested $1.2 billion worth of assets and realised an estimated gain of $120 million. “We expect Keppel to speed up the divestment of non-core assets tracking the $3 billion to $5 billion target in three years,” says Chua. “We see the successful divestment of Rig Co as a potential catalyst for the company.”

For now, Keppel’s next divestment could likely be its logistics business under Keppel Telecommunications & Transportation (Keppel T&T). Although the logistics business has benefited from the increased demand for e-commerce and urban logistics over the past year, Loh says a third party would be better positioned to scale up the business.

As such, Keppel is ready to dispose of the logistic business in Southeast Asia and Australia. The company has started engaging potential buyers and appointed Rothschild & Co to be its financial adviser.

“We have received good interest from the market, with many potential buyers signing NDAs. The first bids are expected in February 2021, following which we will shortlist the buyers for deeper engagement. We are keeping options open, and may decide to divest our logistics business completely or continue holding a minority stake,” says Loh.

Analysts are mixed on their recommendations for Keppel. UOB Kay Hian’s Adrian Loh has maintained his “buy” call for the stock albeit with a lower target price of $6.10 from $6.30 previously. He points out that Keppel’s share price has recovered to trade at one standard deviation below its five-year average price to book multiple of one.

“Should regional economies continue to recover well from the Covid-19 pandemic in 2021, we believe that this gap can further close in the coming quarters,” writes Loh in his Jan 29 report.

DBS Group Research, however, has downgraded the stock to a “hold” rating from “buy”, albeit with a higher target price of $5.85 from $5.50 previously. “Operationally, Keppel should be on a recovery path as economic activities pick up with vaccination rollouts. [However], we keep an eye on restructuring execution and await more positive indicators to revisit the stock,” DBS analyst Ho Pei Hwa writes in a Jan 29 note.