Keppel is the winner from the merger with Sembcorp Marine. Here’s why

TL;DR

• After years of speculation about a merger, Sembcorp Marine will combine with Keppel’s Offshore and Marine business to build a global player in offshore renewables and new energy.
• Keppel appears to be the clear winner from the transaction, as it will book a sizeable gain from injecting its offshore & marine business into the combined entity.
• There is less to cheer for Sembcorp Marine as the company will be contributing the bulk of assets to the combined entity but shareholders will be receiving fewer shares in return.
• If you are looking for other companies that will benefit from the shift towards renewables, Sembcorp Industries is also worth a look!

What happened?

The big news in the Singapore market recently, is the announced merger between Keppel Offshore and Marine and Sembcorp Marine.

This is not a surprise, as both companies entered into exclusive negotiations since June last year to combine the two entities.

For those not familiar with both companies, Keppel and Sembcorp Marine were once the global leaders in the offshore and marine industry.

The oil that fuels our electricity and allow our cars to run? They are produced from drilling rigs that Keppel and Sembcorp Marine produces.

Here’s a fun fact: Keppel made it to the Guinness book of record for delivery a record 21 rigs in 2013!

Yes, this sounds very old economy. But definitely very important for our global oil supply chain!

What do we know about the merger?

An agreement has been signed to form a combined entity. To keep things simple, let’s call this Bayberry.

If you are a Sembcorp Marine shareholder, you will exchange your shares in Sembcorp Marine for shares in Bayberry, which will continue to trade on the SGX.

If you are a Keppel Corp shareholder, things will get a bit more complicated.

• Keppel will inject its Offshore & Marine business to Bayberry and get a 56% stake in Bayberry in return.
• Sembcorp Marine shareholders will then hold the remaining 44% stake in Bayberry.
• What will Keppel do with 56% stake of Bayberry? It will distribute 46% to its shareholders through a dividend in specie. This means that all Keppel shareholders will be entitled to some shares in Bayberry.

How will Bayberry look like after this is all done?

• Temasek will hold a 33.5% direct stake in Bayberry and will be the largest shareholder.
• Keppel will continue to retain a 10% stake in Bayberry.

The remaining shares will be held by other shareholders of Sembcorp Marine and Keppel.

Why merge?

Ok, so that was complicated. Like us, you are probably wondering why go through all of this trouble.

To start with, we need to realise that both companies have been facing a tough time.

Demand for oil drilling rigs has fallen sharply as oil prices have trended lower in the past few years. Yes, the Ukraine crisis has led to a spike recently, but this needs to be more sustained for customers to come back.  

The global shift towards renewables has made things even more difficult for the two companies.

This has led to sharp losses for both companies, as they do not have enough work to cover the cost of running their operations.

Read more about the problems faced by Keppel and Sembcorp Marine here

How will the merger help?

Firstly, it will allow Keppel and Sembcorp Marine to combine their capabilities.

Each company has about S$2.0bn of revenue in 2021. By combining, the revenue of Bayberry would get to about S$3.9bn.

Here, bigger may be better as some similar costs can be removed, allowing them to improve on their profitability.

More importantly, it creates an opportunity to build a global player in offshore renewables and new energy.

And this is where things get exciting.

In offshore renewables, the global expenditure is expected to reach S$260bn between 2021 and 2030.

In new energy, there are many interesting developments in hydrogen, ammonia and carbon capture technology.

These are the areas where Bayberry would want to be positioned for long term growth, and they have already seen some initial success.

Sembcorp Marine won its first offshore wind farm project in 2014, and won 3 additional wind farm projects since.

Keppel O&M signed a MOU with Sumitomo in Dec 2021 to explore implementation of ammonia bunkering in Singapore.

Both companies already have a combined orderbook of $6.4bn in the areas of offshore renewables, new energy and cleaner offshore and marine solutions, and the merger could allow them to do much more by combining their capabilities.

Is this good for you as an investor?

Let’s go through the analysis to decide if the transaction is good for shareholders of Sembcorp Marine and Keppel.

For Sembcorp Marine shareholders, there doesn’t seem to be much to cheer about the transaction.

This is especially after going through much pain over the past few years, as investors had to bear with a sharply declining share price and put in capital into two rights issues.

From a financial perspective, Sembcorp Marine appears to be the one putting more assets into Bayberry, as it is contributing more than 80% of the net tangible assets into Bayberry. However, Sembcorp Marine shareholders are only getting 44% of the shares of Bayberry.

This might be explained by Sembcorp Marine being in a worse position, with a net loss of more than $1 billion last year, compared to Keppel which was close to break even.

The only obvious benefit is that disregarding what happened in the past, this might be the only way for the company to turn itself around.

For Keppel Corp shareholders, the benefits are more evident.

As it will be injecting its assets into Bayberry at an attractive valuation, it will book a gain of S$4bn from the transaction.

Shareholders of Keppel will be able to realise this gain through the dividend-in-specie that they will receive in Bayberry shares.

More importantly, the transaction will allow Keppel to accelerate on its Vision 2030 transformation.

The company had announced plans to sharpen its focus on renewables and environmental solutions in order to become a powerhouse of solutions for sustainable urbanisation.

How does this transaction help? Keppel will be selling its old rig assets to an asset company, with 90% of this company to be owned by external investors. This will allow the company to further move away from the parts of its business which are not doing well and have been a drag to its performance.

Lastly, Keppel’s balance sheet will improve from the transaction. It will receive S$500 million in cash as part of the Keppel O&M restructuring. Together with a removal of debt from the offshore and marine division, Keppel’s net gearing will fall from 0.68x to 0.63x.

What happens next?

There are still a lot of details which need to be worked out. For example, who will run Bayberry? Who will be on the board of Bayberry? And what will be new entity called?

Keppel? Sembcorp? SembKep?

There are also certain conditions that need to be satisfied, and these will take some time over the next two quarters.

Once these are completed, an Extraordinary General Meeting (EGM) would be held sometime in 4Q22 for shareholders of Keppel and Sembcorp Marine to vote on the transaction.

While there are benefits of the transaction from creating a global player in renewables, Sembcorp Marine shareholders might feel they are not getting as good a deal as compared to Keppel shareholders.

The transaction is also subject to regulatory approvals. Here, Keppel’s CEO has said that he does not believe that there will be any anti-trust issues based on the products and services of both Keppel O&M and SMM.

Lastly, there must not be any material adverse change relating to both Keppel and Sembcorp Marine’s businesses. For those who remember Temasek’s partial offer for Keppel in 2019, the deal subsequently fell apart after Keppel’s business was badly affected by the COVID-19 pandemic in 2020.

While we are definitely not expecting any pandemic and lockdown, there can be unexpected events that can affect whether the transaction is eventually completed.

What will Beansprout do?

Insight #1: Keppel seems to be the winner

From the analysis above, Keppel seems to be the clear winner from the transaction as it will realise significant value from combining its offshore and marine business with Sembcorp Marine.

This will also help to accelerate on its Vision 2030 transition.

Sembcorp Marine shareholders will have to be a lot more patient and look more long-term to think about what the combined entity might be able to do to create a leading player in the offshore renewables market.

Insight #2: Interested in renewable plays in Singapore? Look out for Sembcorp Industries too

Looking for a stock to own that plays into the shift towards renewable energy? Then Sembcorp Industries might be another stock in Singapore to keep a lookout for.

Sembcorp Industries has been actively building its portfolio of renewable energy assets in a move to support the global energy transition.

This would comprise wind, solar, and energy storage in key markets such as Singapore, Vietnam, China, India and the UK.

It currently has a gross renewable capacity of more than 5.7GW, and has a target to increase this to 10GW by 2025.

As one of the few companies with exposure to the green energy transition, Sembcorp Industries has done well so far this year. It was the top performer in the STI in the first quarter of 2022, with a total return of 34%.