Analysts and The Edge Singapore have pointed out that the Keppel Offshore & Marine (KOM) and Sembcorp Marine (SCM) combination benefits Keppel Corp more than SCM. On June 10, an SCM shareholder Philip Loh, has started a “votenoformerger” page. Two points - highlighted by The Edge Singapore following the April 27 announcement - the exchange ratio in the combined entity and a controversial $500 million payment are points of contention for Loh.
According to SCM's FY2021 annual report, as of March 8, one Philip Loh Chin Hwee holds 50.5 million shares, equivalent to 0.16% of the company.
Let’s go back a bit. On June 6, based on an SGX release, SCM's management answered questions related to the sale of SCM into a combined entity with Keppel Corp which was referred to as Bayberry in Keppel’s Chapter 10 announcement. On Apr 27, Keppel and SCM jointly announced they would set up Bayberry. All of SCM’s shares will be placed in Bayberry in exchange for a Bayberry share. That is, SCM shareholders will all get shares in Bayberry on a 1-to-1 basis. Bayberry will be listed on the SGX.
Now Keppel will divest Keppel Offshore & Marine (KOM) into Bayberry too and Bayberry will issue new shares to Keppel such that Keppel will own 56% of Bayberry. That means SCM’s shareholders will own 44% of Bayberry.
The Edge Singapore questioned the wisdom of the ratios during the media briefing and in an editorial. It appears that shareholders have also asked this question. The answer was this: “The Proposed Combination is based on a 50:50 Enterprise Value Ratio between Sembcorp Marine and Keppel O&M.”
Why enterprise value and not net asset value or NAV? Enterprise value, as we all know, is the market capitalisation plus debt, minus cash. Is market cap a better valuation than NAV? Arguable.
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Still, the SGX announcement says: “The restructured Keppel O&M will have minimal external debt at the point of the combination as Keppel has equitised all its shareholder loans and perpetual securities. Accordingly, the book value or NAV of the restructured Keppel O&M is not the most representative metric due to the multiple corporate actions as part of their restructuring.”
Valuation metrics
The starting point of the valuations of asset-based companies is their NAV. Market value is based on market perception of NAV, earnings growth or lack thereof and market sentiment at a point in time.
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“The Enterprise Value Ratio and the Equity Value Exchange Ratio were determined after taking into account an assessment conducted by DBS Bank, which acted as the Joint Financial Advisor to Sembcorp Marine and Keppel O&M with respect to the relative ratios of Sembcorp Marine and Keppel O&M. The relative ratios were based on a DCF methodology conducted by DBS Bank,” SCM’s management says.
Indeed, discounted cash flow or DCF is used to obtain NAV. But the valuation and ratio for SCM and KOM are being determined by Enterprise Value not NAV. Interestingly, Enterprise Value is likely to fluctuate daily but NAV may move perhaps twice a year, often just once a year.
At any rate, regarding the NAV, SCM’s management says “With regard to the differences in book value between Sembcorp Marine and Keppel O&M, Sembcorp Marine has a higher book value as its yards are relative newbuilds, whereas Keppel O&M’s yards are nearly fully depreciated, which lowers their carrying values.” The point on depreciation is true. I am tempted to go off on a tangent on the valuation of leasehold industrial properties which are not depreciated till 20 years or less of land lease is left, but I will desist.
At any rate, both SCM and Keppel, according to various announcements “agreed to adopt Enterprise Value.” The ratio was proposed by DBS Bank.
Over and above the ratio, KOM will pay $500 million to Keppel before the merger, financed by DBS. This indicates that KOM will come into the combined entity without $500 million than it otherwise would have. While SCM isn’t paying for the $500 million, Bayberry’s valuation will be affected because KOM is entering the combined entity without that amount.
“The $400+ million cash in KOM’s pro forma balance sheet is from a $500 million loan provided from parent company Keppel. At the point of merger, this $500 million subsidiary loan will be repaid to Keppel by an assumed bank loan that is to be taken by the combined entity. Therefore, the pro forma KOM is effectively going into the merger with zero or negative cash balance,” Loh asserts.
Loh points out that if the merger goes through, SCM’s NTA per share will drop from 13 cents to around 7 cents. This would be the third consecutive year that a corporate exercise at Sembmarine has resulted in a dilution of its NTA per share, after their highly discounted rights issues in both 2020 and 2021, he indicates.
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"Disadvantageous to SCM"
“The fact that the terms of the proposed merger is highly disadvantageous for the SCM minority shareholders has been validated by recent articles published in The Edge Singapore. In the article released on April 28, writer Jovi Ho referred to Keppel as ‘the accretive winner in O&M, SembMarine merger’. A second article was then released, which referenced analyst ‘sell’ calls on SCM and ‘buy’ calls on Keppel. Given that these calls were made almost immediately after the merger terms were announced, it is safe to say that the terms of the proposed merger is viewed by analysts to be unfavourable for SCM shareholders,” Loh says.
When asked for comment, SCM says in a statement via a spokeswoman, "We have been in conversations with shareholders who have reached out to us with their views and questions about the Proposed Combination and will continue to keep our dialogues open. Philip Loh has accepted an invitation to join the upcoming SIAS-SCM Dialogue Session scheduled for June 20. We encourage our shareholders to also join as we look forward to listening to their views and having constructive discussions with them."
For its part, SCM believes that the merger will add value to SCM's businesses despite the seemingly unfair ratios in the combined entity. "Sembcorp Marine believes that the Proposed Combination is the best pathway to unlock long-term value for all stakeholders. It will create a Combined Entity with greater scale and broader geographical footprint, allowing it to capitalise on the global energy transition. The Combined Entity will be better positioned, both operationally and financially, to weather ongoing and future industry challenges and also to capture opportunities in the US$260 billion offshore renewables market, as well as the US$290 billion O&M sector," SCM says in its statement.
For the combined entity to succeed, SCM shareholders get to vote on a scheme of arrangement (SOA) and the proposed combination. More than 50% of shareholders present and voting with more than 75% of shares in value are needed for the SOA resolution to be passed.
How does the arithmetic look? Temasek, which holds 17 billion shares or around 54%, won’t vote. SCM has 31 billion shares outstanding so the free float is 14 billion (give or take). The top 19 shareholders (without Temasek) own 7 billion shares likely to be held by some funds, some high net worth individuals and some retail investors. Loh is one of these 19 shareholders. He needs shareholders with 1.75 billion shares to vote against the SOA, to be on the safe side assuming these 19 shareholders vote.
We now await the independent financial adviser’s and the proxy advisor’s recommendations. Stay tuned.
