Last week, Keppel Corporation halted its trading ahead of the announcement of the potential combination of Keppel Offshore and Marine with Sembcorp Marine. If the proposed transaction is successfully completed, a new entity will be formed and listed on the Singapore Exchange.

With the scale to bid for larger contracts from the increased size and capabilities of the joint entity, read on for excerpts from a Macquarie Research (MQ) note published on 25 June 2021 to learn more about MQ’s outlook for Keppel’s O&M business…{break}

Keppel finds a solution for its O&M business

Keppel Corporation (KEP) announced this evening it was entering into two non-binding Memorandum of Understandings (MOU). Press release Here.

Yard combination: The first is with Sembcorp Marine (SMM) with a view to combine Keppel Offshore & Marine (KOM) and SMM. KEP will transfer the associated assets and liabilities of KOM’s yard assets for shares in the Combined Entity and up to S$500 million in cash.

KEP intends to distribute the shares as dividend in specie to its shareholders, and maybe the S$500 million cash if they have no use for it. The yard will be valued on a discounted cash flow basis, and its value remains in discussion. Post-combination, KEP and the Combined Entity envision entering into a strategic partnership via a 50:50 Joint Venture.

Sale of KOM’s rigs to Kyanite. The second is with Kyanite Investment Holdings (Kyanite), a wholly owned subsidiary of Temasek, with a view to sell KOM’s legacy rigs completed and uncompleted rigs and associated receivables to a separate Asset Co.

KEP will retain not more than a 20% stake in Asset Co, while Kyanite will seek external investors to hold the balance of at least 80%. KEP stated the value of the legacy completed / uncompleted rigs to be worth S$2.9 billion, so the estimated recovery is S$2.3 billion at 80%. KEP will receive the consideration for these assets sold in the form of credit notes.

Read-through for the deal is positive, assuming it completes

The read-through is positive for KEP. Initial terms are very much in KEP’s favour, and appear to be structured in a way that allows maximum recovery of the capital locked up in KOM.

MQ thinks a successful deal will result in a valuation uplift if KEP is able to recover the bulk of the value locked up in its Offshore & Marine (O&M) business. KEP thinks there should not be further impairments. MQ currently values O&M at negative S$740 million (1x Financial year 2023 Price/Book ratio), so a successful deal could translate into a $0.041/share uplift to its current Sum of Parts Valuation of S$5.44.

MQ will not obsess with the post combination structure of the entities. In MQ’s view, the strategic partnership with the Combined Entity exists to preserve legal obligations on on-going projects. For the stake in Asset Co, it appears to be part of the negotiations, and MQ thinks KEP would have preferred none if they could.

KEP remarked that the deal will be earnings accretive, without guiding a quantum. Net gearing is not expected to vary significantly from current 0.88x post completion, despite deconsolidation of KOM’s debt. This is due to a change in shareholder equity which results in the neutral movement.

The final thing to note is that discussions are still on-going, with very little firm details. The process will likely take several months, with completion likely to occur only in 2022, if it happens.

Action and recommendation

MQ thinks market might view the deal positively. Its recommendation remains Neutral.

12-month price target: S$5.44 based on a Sum of Parts methodology.