Market speculation of a merger between SIA Engineering (SIAEC) and ST Engineering Aerospace (STE Aerospace) has long surfaced from time to time. Such speculation, however, has over the years remained just that — speculation. Yet, recent events could suggest otherwise.

Since last year, several Temasek-controlled companies have undergone or proposed a restructuring exercise. In September 2020, Sembcorp Industries completed a demerger from its former subsidiary Sembcorp Marine (Sembmarine). The two companies are now no longer related to each other, save for their common first name.

Then, in February, Keppel Corp announced that it will restructure Keppel Offshore & Marine (Keppel O&M) into three entities. Amid the multi-year slump in the oil and offshore and marine industries, Keppel believes this new structure will place Keppel O&M in a position to benefit from the global energy transition. The company may consider disposing of Keppel O&M if there is a suitable buyer.

Last month, CapitaLand proposed to divide its businesses into two entities. The company will place its property development business under CapitaLand Development (CD), which will be fully owned by CapitaLand. The company, in turn, will be taken private by CLA Real Estate Holdings, an indirect wholly owned subsidiary of Temasek Holdings.

CapitaLand Investment Management (CLIM), on the other hand, will house CapitaLand’s fund management and lodging businesses. These are likely to comprise the company’s holdings in several REITs, business trusts and private funds, as well as its serviced residence and hotel assets. CLIM will be listed on the Singapore Exchange. CapitaLand shareholders will decide whether to approve the proposed restructuring exercise in an EGM to be held in 3Q2021.

Now, the spotlight could shift to SIAEC and STE Aerospace. SIAEC, which provides maintenance, repair and overhaul (MRO) services for planes, is effectively controlled by Temasek. The state investment firm owns a combined direct and deemed interest of 55.42% in national flag carrier Singapore Airlines (SIA), which in turn owns an 80% stake in the company.

Similarly, STE Aerospace is effectively controlled by Temasek. The company is a wholly owned subsidiary of aerospace, defence and engineering company ST Engineering (STE), which in turn, is majority-held by the state investment firm, with a combined direct and deemed interest of 51.54%.

CGS-CIMB Research believes the possibility of a restructuring exercise involving both companies could now “resurface”. This, the brokerage believes, could happen through the paring down or complete divestment of SIA’s stake in SIAEC, which implies that the company could be taken over by STE. “We reiterate that this is our ongoing wish but it could also be a binary event,” CGS-CIMB’s head of research Lim Siew Khee wrote in her April 8 report.

Following the report, shares of SIAEC and STE spiked on April 9. The former ended at $2.51, up 14.9% from the previous day’s close, while the latter ended at $3.99, up 2.3%. SIAEC has since retraced some of its gains, but it is still up 22.8% year-to-date. STE has been range-bound between $3.97 and $4.00. It is up 4.5% year-to-date.

‘Nationalistic’ reasons

There may be several reasons to why SIA could pare down or divest its entire stake in SIAEC. For one, CGS-CIMB believes the airline will not privatise SIAEC as the remainder stake in the company, of just 20%, would offer little earnings accretion.

Yet at the same time, the brokerage points out that the airline does not necessarily need to divest its stake in SIAEC to raise cash. It notes that SIA has sufficient liquidity options, such as the $6.2 billion mandatory convertible bonds it has yet to tap. The airline could also raise new secured financing and/or sell and leaseback against $10 billion of unencumbered aircraft assets, it adds. Moreover, SIA has reduced capital expenditure by postponing the delivery of new planes.

Still, the airline may pare down or completely divest its stake in SIAEC due to “nationalistic” reasons, according to CGS-CIMB. One reason is to improve liquidity in the market. “Previously, we thought it made little sense for this, given SIAEC’s strong dividend repatriation (average 76% payout). With the current downturn and reduced profits at SIAEC, SIA may not get much of dividend income from SIAEC,” says Lim.

Secondly, Singapore may want to strengthen its status as an aviation hub given the impact of Covid-19. According to Shukor Yusof, founder of aviation consulting firm Endau Analytics, the pandemic has brought about unprecedented changes within the industry that will necessitate a relook at how businesses are operated.

Indeed, consolidation is an ongoing, common theme, cutting across different segments of the aviation industry. Last November, Korean Air announced a US$1.9 billion ($2.5 billion) deal to take control of Asiana; just last month, AerCap announced a US$30 billion acquisition of the aircraft leasing unit of US conglomerate General Electric, GECAS. “It would make sense for some of the larger MRO (maintenance, repair and operations) players to assess their positions in the marketplace once the pandemic subsides,” he tells The Edge Singapore.

It makes sense to create a “powerhouse” through the merger of SIAEC and STE Aerospace, says CGS-CIMB. Combining both companies would grant the enlarged entity a monopoly of line maintenance services at Changi Airport, the brokerage explains.

It is also advantageous from STE’s point of view. The merger would provide the company with airframe MRO capabilities for both wide and narrow-body aircraft and “complete solutions” for Rolls-Royce, Pratt & Whitney and CFM engines.

Since last year, SIAEC has taken advantage of the aviation crisis to prepare for an eventual recovery in air travel. The company is betting that the utilisation of narrow-body planes will take off first, before their wide-body counterparts do. To that end, it has taken full control of SIA Engineering Philippines Corp (SIAEP), which provides line and airframe maintenance, repair, de-lease checks, cabin retrofits and overhaul services for narrow-body planes.

SIAEC has also realigned its other joint venture companies. The company has acquired the remaining 35% stake in Heavy Maintenance Singapore Services. The latter provides airframe maintenance, cabin upgrade and modification services for Airbus aircraft and is now a wholly owned subsidiary of SIAEC.

The company has divested its 51% stake in Aviation Partnership (Philippines) Corp (APPC) to Cebu Air for US$5.6 million in cash. APPC provides line maintenance services in Manila, Cebu, Davao and Clark, as well as other secondary airports in the Philippines. The company no longer has any equity interest in APPC now.

SIAEC is in the process of dissolving its Thai line maintenance joint venture with NokScoot Airlines — Line Maintenance Partnership (Thailand). NokScoot Airlines, Thailand’s long-haul low-cost carrier, had entered liquidation as the pandemic worsened conditions for the struggling airline.

Under CEO Vincent Chong, STE is in an acquisitive mood. The company has made clear its balance sheet can be stretched to fund M&A so as to capture new growth. Just last month, STE tried to make an 11th-hour bid to lure Cubic Corp, a US-listed transportation and defence company, from its original suitors — Veritas Capital and Evergreen Coast Capital. However, the board of Cubic decided to accept the latter’s joint offer of US$75 a share. This was despite STE’s revised offer of US$78 a share, which values the target at US$2.4 billion. If the deal had gone through, it would have marked STE’s largestever M&A deal.

Under Chong, STE has already made at least two big acquisitions: paying US$506 million for nacelle maker MRAS, and paying 250 million euros ($400 million) for satellite company Newtec. Having integrated these two earlier acquisitions, it is not unthinkable that STE has the appetite for more, and SIAEC might just be of sufficient interest.

“We are always on the lookout but we want to make sure that whatever investment we make, including M&As, they have to be in alignment with our growth strategy in the areas that we are focusing on,” Chong told The Edge Singapore in an interview last December. “We have always been on the lookout so when the opportunities present themselves, we will be in a position to capture them.”

Analysts positive

For now, analysts are optimistic on both SIAEC and STE. CGS-CIMB has upgraded its rating for SIAEC to “add” from “hold” previously. The brokerage has also raised its target price for the stock to $2.85 from $1.78 previously.

CGS-CIMB reckons the risk-reward for SIAEC is improving given the limited downside risks, as more flights through Changi Airport gradually resume with more bilateral travel bubbles established. It also notes that SIAEC is already a beneficiary of strong cargo trends as it performs line maintenance for cargo aircraft. Moreover, the company is backed by net cash of about $500 million, ripe for earnings-accretive M&As to increase market share.

CGS-CIMB has forecast SIAEC’s line maintenance revenue to return to more than 50% of pre-Covid-19 levels in the coming financial years. The brokerage has also raised its FY2022-FY2023 core earnings per share forecasts by 13%-18%. “We believe SIAEC’s key line maintenance operations in Singapore, the US, Japan and Hong Kong are likely to be the first to benefit from the resumption of more flights,” says Lim.

Meanwhile, RHB Research has maintained its “buy” recommendation for STE with a higher target price of $4.50, from $4.25 previously. The brokerage’s optimism is underpinned by the company’s strong order book of more than two years of revenue visibility and ability to sustain dividend payments.

RHB believes that STE’s well-diversified business will find interest from defensive investors in a risk-off scenario. At the same time, growth-seeking investors may not be left out as a stronger economic recovery could further boost its earnings, the brokerage says. This, it explains, will come from higher order wins and earlier-than-expected recovery in its aviation MRO business.

“Even though the proposed Cubic acquisition did not materialise, we remain optimistic on STE’s earnings recovery in 2021, aided by normalisation of order delivery across key business segments,” RHB analyst Shekhar Jaiswal wrote in an April 12 report.