Shareholders of Keppel Corp have a lot to cheer about, following recent announcements by Keppel and Sembcorp Marine (SCM). They will reap benefits from higher net tangible assets (NTA), earnings per share and a dividend-in-specie, subject to approvals from shareholders. And surely, Keppel’s shareholders will approve the schemes, which are a win for the group. SCM shareholders, on the other hand, may grumble at being diluted (see Tables 1, 2 and 3).
Keppel and SCM announced that they have entered into a definitive agreement for the proposed combination of Keppel Offshore & Marine (KOM) and SCM to create a new entity, called Bayberry, that will be focused on offshore renewables, new energy and cleaner offshore & marine solutions.
The restructuring of KOM, and merger of KOM and SCM (to create Bayberry) are in roughly four parts and some five resolutions to be voted on in an EGM. One of SCM’s resolutions requires more than 75% of shareholders to vote for the scheme. The bar is lower at more than 50% of shareholders needed to vote for the rest of the resolutions.
In a series of developments, KOM will be restructured. SCM shareholders will exchange their shares in a 1-for-1 ratio in Bayberry. KOM will be placed in Bayberry. According Keppel’s Chapter 10 announcement, KOM and SCM will be held as wholly-owned subsidiaries of Bayberry, to be listed on the Singapore Exchange.
KOM to divest legacy assets to Asset Co
KOM’s legacy assets and associated receivables will be divested to Asset Co, and Keppel will receive equity and debt securities issued by Asset Co amounting in to around $4.05 billion. Keppel will also receive $500 million in a cash component from KOM.
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When KOM is placed in Asset Co, Keppel will receive $120 million in 10% PIK Toggle Perpetual Securities, and $3,929.8 million in fixed rate vendor notes in the Asset Co. Keppel will maintain a 10% stake in Asset Co. The other shareholders of Asset Co will be Kyanite — a unit of Temasek — with 15.1%, and 74.9% will be held by Baluran, a unit of ASM Connaught House Fund V, managed by Argyle Street Management.
To finance the $500 million cash component, KOM has entered into a commitment letter with DBS Bank for the provision of financing to KOM for up to $500 million, subject to the satisfaction of the terms and conditions contained in a commitment letter. Keppel says KOM reserves the right to explore alternative financing options to settle outstanding interest and make partial redemption of the relevant perpetual securities to Keppel.
Keppel shareholders get an upside — initially through higher NTA and earnings per share (see Tables 3 and 4), then in a dividend-in-specie from part of Keppel's stake in Bayberry. Keppel’s 46% stake in Bayberry will be distributed to Keppel shareholders via the dividend-in-specie.
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In May 2020, Keppel announced a Vision 2030. In order to realise Vision 2030, Keppel has said it would like to monetise KOM’s legacy assets — mainly unsold, incomplete offshore rigs — over time. Vision 2030 revolves around solutions for sustainable urbanisation, and an increased focus on renewables. The proposed transaction will accelerate Keppel’s pivot towards new energy and decarbonisation solutions, the company says.
Asset Co, with independent management and new shareholders, will be able to monetise these assets over the next 3–5 years if market conditions improve. External investors in the Asset Co transaction will provide capital that can be used for finishing uncompleted legacy rigs, which will no longer be funded by the company. Improving conditions in the offshore & marine sector, underpinned by improving oil price and increasing utilisation and day rates of offshore drilling rigs, provide an opportunity for Asset Co to monetise the legacy rigs. As the rigs are monetised, the company’s economic exposure in Asset Co will be reduced over time.
“Asset Co will be independently managed so we do not have control. Its source of funds will have to come from the charter agreements plus sale of rigs,” says Loh Chin Hua, group CEO of Keppel, in a briefing on April 27.
The vendor notes from Asset Co issued to Keppel will be gradually converted into cash, and these freed-up funds can be re-invested into future growth initiatives and also used to reward shareholders. Asset Co’s management team will focus on completing uncompleted rigs to improve their marketability and generate cash flow until suitable outright sales can be arranged. Finally, the management team will look at selling the rigs.
SCM swaps its shares for Bayberry shares
The first part of SCM deal is its scheme where SCM shares will be placed in Bayberry in the ratio of 1-for-1 — meaning each SCM share is exchanged for one Bayberry share. SCM shareholders will own 44% of Bayberry, and KOM will own the remaining 56%.
How did this ratio come about? According to the pro forma financial information, it appears that the NTA of SCM in Bayberry is $3.8 billion, and the NTA of KOM in Bayberry is $0.9 billion. If so, why does SCM hold 44% and Keppel 56%? Indeed, this is what puzzled analysts at both the Keppel and SCM briefings.
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The value of Bayberry is based on SCM’s share price of $0.122, the volume weighted average price (VWAP) for 10 days up to and including Apr 26. SCM has 31.4 billion shares outstanding. The SCM share exchange values SCM’s share in Bayberry at $0.122 times 31.4 billion shares or $3.83 billion on a pro forma basis. Keppel’s pro forma share of Bayberry is the product of $0.122 and 39.9 billion shares, which is the number of Bayberry shares to be issued to Keppel for KOM on completion of the proposed transactions.
On a pro forma basis, this values Keppel’s stake in Bayberry at $4.87 billion. But why was Keppel awarded 56% in Bayberry? KOM’s orderbook in Bayberry is $5.1 billion compared to SCM’s $1.3 billion. But it is unclear why the discounted cash flow (DCF) valuations attribute higher values for KOM compared to SCM.
According to CEO Loh, the KOM consideration was reached after taking into account, among others, the relative ratios of KOM and SCM based on a discounted cash flow valuation. The enterprise value ratio and the equity value exchange ratio were determined following extensive negotiations and due diligence, and also taking reference to an assessment prepared by DBS appointed as joint financial advisor to KOM and SCM.
“When we announced the MOU in June, we had said both companies will use DCF to work out the exchange ratio. Both companies retained DBS as an independent adviser to work out enterprise value and exchange ratio. It’s more about the earnings capability of both entities. If the exchange ratio is 50:50, when you get to the equity bridge you have to deduct various liabilities, and you end up with 56:44,” Loh says.
“The basic approach for the determination is driven by the DCF approach, looking at the future potential of each company. Given the nature of the business and the long cycle, the evaluation of future potential is driven by longer-term potential. DCF is driven by key parameters that arrive at valuations for each company. In terms of enterprise value, it’s similar for both companies to arrive at equity value based on the relative difference when the capital structure is taken into consideration,” explains Wong Weng Sun, group CEO of SCM.
Advantage Keppel
Some 90% of Keppel’s stake in Bayberry (equivalent to 46% of Bayberry) will be distributed to Keppel shareholders. Keppel will retain a 10% stake in Bayberry.
This 10% retained stake will be placed in a segregated account to fund claims, if any, relating to certain identified contingent liabilities for a period of up to 48 months from the completion of the proposed combination. This segregated account will be managed by an independent third party who will have authority to monetise the 10% based on pre-defined parameters. Bayberry has agreed to indemnify Keppel for certain identified contingent liabilities for up to 24 months from the completion of the proposed combination.
On a pro forma basis, Keppel’s EPS in FY2021 would have increased from 56.2 cents to approximately 72.5 cents, excluding the net disposal gain from the proposed transactions. Including the net disposal gain from the proposed transactions, EPS would have increased to approximately 281.3 cents. If the proposed transactions and proposed distribution-in-specie completed, Keppel’s NTA would be $5.54. Gearing would have decreased from 0.68x to approximately 0.63x.
SCM, on the other hand, sees its NTA diluted from $0.12 to $0.07. However, its pro forma net loss of 6.49 cents is reduced to a net loss of 2.2 cents in Bayberry.
Based on the accretion and dilution announced on April 27, Keppel’s shareholders are the larger beneficiaries of the proposed transaction. Moreover, Keppel gets to monetise $4.05 billion through Asset Co, KOM pays Keppel $500 million, and its stake in Bayberry is valued at $4.87 billion, giving a total of $9.42 billion.
