Saturday, 2 May 2020

Will Keppel Offshore & Marine and Sembcorp Marine Merge?

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In my last article, I received a comment to share insight about the possible merger of Keppel Corp (KC) and Sembcorp Marine (SCM) to ensure survival in the light of the current low oil price environment. In response, I wrote this article. To avoid confusion, Keppel Corp is the parent company of Keppel Offshore and Marine (KOM), so the merger on the cards is between KOM and SCM.


WHY A MERGER IS POSSIBLE

Declining earnings
Since the oil crisis began in late 2014, both KOM and SCM had been reporting profit slumps. During the heyday, KOM’s earnings attributed to >50% of group’s profits. Today it is a completely different story. While KOM’s revenue is still 25-30% of the Keppel group’s topline, earnings fell drastically. For FY2019, Keppel group earnings is $707m while KOM net profit is S$10m, attributing to a mere 1.5% of what the group earns.

SCM fares worse financially. SCM reported revenue decline in 2019 to S$2.9B from 4.9B a year earlier. Losses widened to S$137m compared to S$74m in 2018. While a big part of the losses is due to impairments, the cost of sales exceeds revenue. This shows that SCM’s projects are loss making, a clear indication that contracts were taken at very low or no margins. Cash is also quickly depleting from S$840m end 2018 to S$390m end 2019. SCM’s balance sheet has a current ratio of 0.9 and a net debt of S$4.1B, of which 1.5B is borrowed from its parent company Sembcorp Industries (SCI).

Temasek share acquisition of Keppel Corp
Last Oct, Temasek offered to buy control of KC in a S$4.1B deal to increase stake from 20.5% to 51%. The offered price is S$7.35. The deal will likely to be concluded this year subject to domestic and foreign regulator’s approval. In the deal, Temasek publicly stated that it does not intend to delist KC, and it will undertake strategic review of its business with the objective of creating a sustainable value of all shareholders. The strategic review does not discount possibility of a merger. See below quote.

QUOTE : “ The Offeror remains open to all possibilities arising from the Strategic Review. The Strategic Review may result in (i) the Company refocusing on and strengthening certain businesses, and/or (ii) potential corporate actions including, but not limited to, joint ventures, strategic partnerships, acquisitions, disposals, mergers, or other transactions involving the Company, in each case as determined by the board of directors of the Company in the best interests of the Company and Shareholders.”   UNQUOTE

Temasek is also 50% owner of SCI which in turn owns 61% of SCM. With the acquisition of additional Keppel shares, one does not rule out possibility that Temasek will then sell off KOM to merge into SCM.

Benefits of merger
Both KOM and SCM offer rig and shipbuilding, ship conversion and ship repair services. While KOM and SCM employ different strategies and business focus, there is significant overlap of expertise. Human capital and yard facilities can easily be crossed-use to achieve higher efficiency and capacity utilization. Merger can increase global market share and reduce competition to achieve better contract pricing. After-all, KOM and SCM are the world’s first and second biggest builders of oil rigs respectively. Supply chain pricing power will also improve due to economies of scale. In view of Singapore tightening of foreign employees, a single entity will also solve issues of labor crunch.

Specifically, a merged entity also allows for a more diversified track records of capabilities and experiences. For example, Keppel is specialist for Floating Production Unit (FPU) conversion, but has neither newbuilt track record, nor EPCI Turnkey FPUs experience. On the contrary SCM has received several turnkey EPCI FPU contracts in recent years such as Shell Vito & Whale, Equinor Johan Castberg, Total-Modec Alisa that elevates them to compete with the likes of big shipbuilders in Korea for complex O&G projects. Keppel has recently included delivery of Dredging ships in their portfolio, which SCM has no experience. On the other hand, SCM has more focus in Navy, Ferry, Ro-pax, Cruise-liner repairs, while Keppel has lesser focus in ship repair.


WHY A MERGER IS NOT POSSIBLE

Anti-competition objection
In March 2019, Hyundai Heavy Industries (HHI) signed an estimated U$1.7B agreement with the state-run Korea Development Bank to buy its smaller rival Daewoo Shipbuilding & Marine Engineering (DSME). Following the deal, HHI and DSME will have a combined backlog in very large crude carriers (VLCCs) and LNG carriers accounting for more than 60 percent of the world total.

Due to the monopolistic status, the deal will need to get approval from fair trade authorities in European Union (EU), Japan, China, Singapore and Kazakhstan since these countries have shipping companies which are HHI and DSME’s biggest customers. One year has passed, the merger plan is still under review by the authorities in five countries. So far, only Kazakhstan has approved it.

Earlier in 2018, Japan had already lodged a complaint with the World trade Organization (WTO), claiming that Korean government has provide unfair financial support to Korean shipbuilders. South Korean and Japan held talks on the merger on 30 March 2020 but failed to iron out their differences.

Singapore regulators also said the deal between HHI and DSME threatens to remove competition in the supply of LNG carriers, container ships and oil tankers to Singapore customers. In turn, it will also create high barriers to entry for new players specifically with regards to LNG carriers.

It was reported last month that EU antitrust regulators have suspended their probe into the merger of the two South Korean firms until further notice, waiting for more information to be provided by the companies. Early last year, EU also rejected the transport rail services merger between two giants Siemens and Alstom citing concerns of competition fairness which may lead to higher prices for the passengers.

In view of the extreme difficulty to get approval from fair trade authorities, a possible merger between KOM and SCM, the world’s two largest rig builders will definitely face the same scrutiny and resistance from anti-trust watchdogs.

Rising unemployment
Mergers is said to bring performance efficiency over the long term, but this always come at the expense of workers who will be made redundant and obsolete.

After the HHI acquisition of DSME is announced, DMSE workers took to the street with the support of union to block the deal, and prevented HHI from making on-site inspection at the DSME shipyard at Geoje. Unionists in South Korea also brought the case to the EU to reject the merger. Andreas Mundt, president of Germany’s Federal Cartel Office, told Korean reporters in March 2019 that a merger was “not a solution” to overcoming the crisis faced by the companies from a market perspective.

In the light of current Corona pandemic with unemployment rising, to have a merger deal now between KOM and SCM could potentially leads to more layoffs. Imagine employees have been working in the maritime industry all your life with skill-set only applies to this sector, and when they are retrenched, what are the odds of them able to transit to other sectors? A merger with profitability at the back of mind, may results in an abrupt rise of unemployment with insufficient time to reallocate the workers who are made obsolete. Temasek being a sovereign fund, I reckon they will also consider this factor seriously.

Inefficiencies from merger
Due to reduce competition within Singapore. Although there are still shipyards in Singapore such as ST Marine and Kuok’s group Paxocean, there is really little other competition within the country. If there is any state-owned projects within Singapore government to be awarded, there will be no or reduced competition. Non-competition over a longer term may cause decline in human efficiency.

Furthermore, KOM and SCM are in general competitive only in niche and high-end projects nowadays. A workforce that is too comfortable will become lackluster in innovations and efficiency over time. In no time, competition from China and Vietnam will catch up and eliminate any competitive edge that the Singapore company has.


CONCLUSION

In my opinion, there is an equal chance of merger and staying as two independent companies.

On paper merger brings efficiency and makes sense in current low demand environment. But restructuring two sizeable companies into one to make it more efficient is easier said than done in reality. It is not just the tangible financial and mechanical process that accountants and administrators think of.

There are many intangible considerations such as psychological well-being of employees, cultures and loyalty to the company, good people leaving, and deterioration of team spirit when workers are made obsolete etc. As an insider in the industry, both companies have very diverse culture, and very different strategy and direction. It will be an uphill task to make the merger successful in the shortest time.  

If you really want me to make a stand, I do not think the merger makes sense in today’s environment. Announcing a merger does not mean instant solution. It may take months or years for antitrust regulatory to approve. Meanwhile, it will just further deteriorate the already low morale of the workforce in both companies.

In addition, both KOM and SCM are already diversifying into the gas and renewables sector with less reliant on O&G. KOM’s orders for 2019 is >S$2B with gas and renewables accounting for more than 60%. SCM achieved $1.49 billion in new orders, of which $530 million related to greener solutions, including gas and renewable energy projects.


17 comments:

  1. Thank you...a good read especially from one who has domain expertise in the OG

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    1. Dear sgdiv, thanks for dropping by and your compliments. Check out your website and see that u are an old timer in the blogosphere and wrote some wonderful articles. When the sudden stop lately in writing?

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  2. good read. thank you for your hardworking.

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    1. Hi C plus, thanks for dropping by. Did spend some time researching the data and news on the HHI-DSME, but the rest mostly by opinion from experience.

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  3. nice read for a sunday morning..

    i think SCM did well to est their mega yard. was there this year, and kinda reminds me of the smaller K-pop version (korean super duper mega yards of HHI, SHI , DSME. =) i recall being to these kpop yards many years back. and boy, was i mind blown. my legs always ached everyday, due to the sheer amount of walking from one end to the other, then up and down the rigs. literally, like a road march with PPE!. hah

    anw, back to the topic. i actually think the merger will go ahread. why? in any typical corp structure. there will always be those in the office (paper pushers) and those on the ground (tool pushers). one crunches numbers, the other does crunches. temasek is the former. and numbers will always look good for a merger.
    how many times have we seen paper pushers in office head butting with tool pushers on the ground, just becoz something looks good
    on theory, but not practical/feasible to be implemented.

    the only thing that is in their way, is the anti-competition trust.

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    1. Hi bro, oh ya... its already sunday wo realising. Agree about SCM did well on megayard and heard it efficient. I was there several times too in office n also went onboard. Went to HHI and SHI in Korea too in recent yrs n lots of walking. In fact I was in SHI when the earth quake shook. But good thing is, u will not perspire as much compared to SG/Batam yards.

      Agree with paper pushers having more say. For me it is 50-50. But I do not think it will b this year, bcos the Covid situation does not really warrant an announcement of merger, bcos there will be restricted communications with anti-competition regulation.

      Also, business-wise, while KOM has already sold some fixed yard asset (I heard or understood - DYODD), SCM need to sell off more yards, which they are only at the beginning. The core problems now with both yards is not inefficiency from human resource point of view. Bcos they already trim down a lot during the oil crisis. The problem is external no demand from O&G and there are too many shipyards and excess capacity.

      Hence it is imminent within KOM and SCM to finish their internal problems structuring such as reducing no. of yards, before a merger makes more sense. So maybe next year, 1-2 years later. A merger now does not solve the core problem (which is lack of demand) they are facing.

      Diversification within them n downsizing yard capacity provides better solutions, I think. Just my own opinion

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  4. Smm has no more sig yards to downsize anymore. They are left w their mega Tues yard and brazil yard, both with no utilisation. Would it be better to bite the bullet now and merge and downsize or drag on to help the employment rate in sg?

    Yes a merger now does not solve the lack of demand but it helps to reduce excess cost so that when demand resumes, they are in a much stronger position to compete against korean and china yards....

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    1. i did not know that SCM has sold all their small shipyards and left with megayard n brazil yard.

      Where did u hear or read that info?

      Admiralty, Pandan, Tuas Crescent, Tanjong Kling, PT Karimum, PT SMOE yards all sold?

      By ttsh way in dealing with SCM, they told that SMM was already the very outdated abbreviations and were told to use SCM.

      Perhaps investors want merger, bcos it’s all $ and cents we care and all about ourselves. But do u know that in the last 2 yrs SCM were actually running short of capacity in terms of human resources when they took on just 1-2 or 3 projects.

      Their immediate soln is not merger, maybe for outsider n on paper, but merging NOW (i emphasize NOW) will not creat miracle improvement like what “on paper” investors think.



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  5. For everyone’s info: Korean yards are always more expensive than SCM. But not sure if SCM under-quote. Korean yard eg SHI got project such as FLNG which is at the highest end worth more than $5bil in Coral South FLNG.

    SCM winning all the projects from Korea last 2-3 yrs. Eg Johan Castberg FPSO worth $490m. Shell Vito believed worth more than $1B. Shell Vito and also Technip Karish FPSO.

    Current Megayard is quite full with modules for Johan Castberg arriving for integration. Likewise Karish hull coming from China to megayard for integration. Shell vito is progressing.
    Shell Whale, they just signed the contract.

    Petrobras is also working on FPSO with SCM in Brazil.

    All these are big projects worth total billions.

    Hmmm... No utilization?

    Problem is as I mentioned above their margin is too low and often low skill set of new hire are not proficient as Marine sector lost a lot of talents and are no longer as efficient as in the past.

    If SCM and KOM merges now, more talents will lost, and in a very niche sector, it’s not as if, u can just hire people when u get new projects.

    Outsider or paper tiger like what FC mentioned are killing the industry. It is the loss of all the talents that is causing excessive high project costs unlike in the past when they are more efficient.

    Of course pricing is shitty as oil companies also squeezed due to lack of demand.

    Many good people in SCM left and many quit the industry, some went back to their home countries, bcos they felt unfair that after the oil crisis they were squeeze of their pay and bonus. Then 2 yrs ago, SCM received many projects and has a shortage of resources. Many fresh grads or people who are not familiar were employed. The old people who stay on have to teach the newbies which sometimes have higher salary than them and higher position than them.

    The old and experienced people cannot take this unfairness and left!

    There are many issues internally and not just as what outsider see, so SIMPLE AH...

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    1. haha.. i guess that "no utilization" comment was a subtle reference to your reader above... i think he might meant more of "under utlization", rather than, "no utlization". the latter is a very strong word.. almost saying that there is zero activity, which i find it hard to believe too.

      i heard the korean yards produce their own steel? whereas, sg yards, import them from the likes of china/india/etc, which could be cheaper? from my conversation with operators, it appears that the korean-made usually carries a slight premium over the sg-made.

      previously, i stayed on one of french coy (dont want to mention name) support vessel, and capt invited me to the bridge for coffee. i casually mentioned looked like its been through some tough times.. and he gave a bemused look "its only 1 year old. but made in china, so what do you expect?" i think he was just being nice, thinking i was from china. he said, the coy made the decision to get from china, as delivery was fast and price was cheap. no other quotes came close. but the downside was the quality.

      back in the heydays there is a certain niche market ie. korean yards are known for their drillships and sg yards for the jack ups.i recall reading somewhere that >90% of Jackups are from sg-yards.

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    2. Hi FC, I hate arguing in blog comments , but I prefer to tell the truth based on data and logic. Anyway, I am engineer by training! And frankly, I am not boasting, but I do know the industry at different levels over the years from young executives to several CEO levels, and involved in handson-dirty job onboard in early days, to project, to commercial to financial part of the business and travel widely to close many complex deals.

      I agree on the utilization which you assume it means low in utilisation, but it is also not fair you assume on behalf on another reader, when the fact is, it was written as “no utilization”.

      Actually if you look at Megayard, they are actually quite high in utilisation. If you are not in shipbuilding, there are many technical and production related things many people does not know. Consider Megayard has several mega projects in range of >500 or >1B projects Equinor Johan Castberg, Shell Vito, Shell Whale, Technip Karish, how can it be considered under-utilise?

      Hereema Slepnir is one project SCM delivered last year. Reported in the news: At its peak, the construction of Sleipnir involved up to 3,700 workers in a single shift. It is not lies.
      https://www.sembmarine.com/2019/05/24/sembcorp-marine-completes-worlds-biggest-and-strongest-semi-submersible-crane-vessel-for-heerema

      So do you think reckon that it is wrong to say that SCM is under-utilized? Just 1 project in Hereema needs 3700 workers in 1 shift!

      Perhaps going forward in 2021 and 2023 low utilization and definitely not the last few years.

      And also, I am not wrong to say about selling other yards when there are so many yards in SCM : Admiralty, Pandan, Tuas Crescent, Tanjong Kling, PT Karimum, PT SMOE yard, aside from Mega and Brazil. Hence the problem is we cannot make a very firm statement when we do not know the truth or have not done sufficient research.

      I just want to be fair to the readers that they are receiving the truth on data. And of course, there will be part on opinions, which I will state it is my opinion.

      Hope you understand. This is also what I just taught my kids that we must be fair and be responsible in the words we speak and the words we write.

      :-) Ok, stay safe bro!



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    3. About the French captain, he is probably right on the inferior quality of China compared to Euro or Korean or SG built quality. But then again, it is very unfair to make that comments. Captain normally only prefer the ships they operate to be the best technically or to suit what they use to operate.

      But in business, we have to look at all aspects. Yes, inferior by how many % but, the pricing is so much cheaper, and overall, it is still a value deal and as long as the ships can do its work. To tell u the truth, I knew tons of Westerners who are also biased against Asia also. I knew many Euro or US products, they are not as good either but super expensive. In the past maybe...but nowadays, perhaps do not always think Europe is more superior. We have to look at overall Value versus price.

      I knew the Korean yard management levels. It was definitely more expensive than SCM not because of higher quality, but because they are very rigid still, and labour in Korea is much more expensive as they use Koreans, but we use B'desh and Indians, and Chinese!

      This is a fact, I heard from many Koreans on real projects they lost. And I went there often in the last few years. Not anymore... as I am also involve in land Construction biz, and other segments aside from Offshore.

      The drillships saga is gone in Korea. They under-quote and almost go bust if not for state salvage I believe. You can go google.

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  6. concidently , came across this..

    "Segmentally, revenue from the O&M division increased by $237 million to $569 million due mainly to higher revenue recognition from ongoing projects. Major jobs delivered by Keppel in 1QFY2020 include a jackup rig, a dual-fuel bunker tanker and a Floating Production Storage and Offloading vessel (FPSO) modification and upgrading project."

    https://www.theedgesingapore.com/capital/investing-ideas/keppel-corp-gets-buys-all-around-multi-business-strategy-remains-promising?utm_source=WeekdayEDM&utm_medium=email&utm_campaign=FREE

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    1. Yes, problems for KOM and SCM is not over-utilisation in the last few years. Trust me! and you can see for yourself above figures. It is low Sell Price because Clients just squeezed the price down and they lost too much talents and have project over-runs or poor estimation of costs upfront taking contracts at low margin they thought. But when project finished, they lost money.

      But of course going forward, they will have less O&G orders. But that said, KOM n SCM did get lots of Wind projects, and Solar Projects! And they also use their yards to fabricate other stuffs for their parent company I believe. DYODD.

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