Tuesday, June 09, 2020

When the COVID Wave Strikes, those Swimming in Sembawang needs Rights Issues

Warren Buffett famously said, "when the tide is out, then we know who is swimming naked". Well in Singapore today, it's rights issue buffet for companies that start with S. COVID-19 has brought down our Singapore Inc companies like dominos. We saw Hin Leong, which didn't even had a chance to do rights issue and went belly up. Then our beloved national carrier Singapore Airlines raised S$15 billion in March which was more than twice its market cap. 

Who's swimming naked?

Now, we have the Sembawang Corporation Group in trouble. More specifically, Sembcorp Marine (SMM) is in trouble. Its parent, Sembcorp Industries (SCI) and grandparent Temasek are going to save it. Not without caveat though, SCI will disown the child by giving away SMM shares to its own shareholders. But the way it is done, minority shareholders of SMM will need to cough up a lot more money to stay in the game. Yes, minority shareholders in Singapore got screwed, again!

Here's the key highlights of the proposed transaction taken from SCI's website:

1. S$2.1 billion renounceable Rights Issue 

• Sembcorp Marine to undertake a S$2.1 billion renounceable Rights Issue 

• 5 for 1 at S$0.20 per share at 31.0% discount to TERP based on 76.5% discount to last close of S$0.85 on 3 June 2020 

• Sembcorp Industries to subscribe for its pro rata entitlement of S$1.27 billion and take up an additional S$0.23 billion if necessary to a total commitment of up to S$1.5 billion 

• Sembcorp Industries will set off its outstanding S$1.5 billion subordinated loan extended to Sembcorp Marine in June 2019 to subscribe for the rights issue; the loan will convert into equity on Sembcorp Marine’s balance sheet 

• Temasek has agreed to sub-underwrite the remaining S$0.6 billion of the rights issue with no sub-underwriting fees 

2. Proposed Distribution of Sembcorp Marine shares to Sembcorp Industries shareholders 

• After the completion of the rights issue, Sembcorp Industries proposes to undertake a distribution of its stake in the recapitalised Sembcorp Marine to Sembcorp Industries shareholders on a pro rata basis as dividends 

• Sembcorp Industries shareholders will receive between 427 and 491 Sembcorp Marine shares for every 100 Sembcorp Industries shares owned, with no cash outlay 

• The transaction will result in the demerger of Sembcorp Marine from Sembcorp Industries

The chart below shows clearly how SCI will no longer own SMM after everything is said and done. Temasek will still own both entities but SCI's shares in SMM will be transferred to SCI's own shareholders. As such, SCI's public shareholders will own 30.9 to 35.4% of SMM. This effectively demerge SCI and SMM. Some say paving the way for merger between Sembcorp Marine and Keppel O&M. But, we shall see, it is never so simple.

SCI to gives its SMM shares to its shareholders

To sum things up, SCI shareholders got the long end of the stick, while SMM shareholders got screwed. SMM share price collapsed 30-40% today dropping to 50 cents at one point before recovering while SCI share price rose 30-40% to above S$2. The market verified that this is a transfer of wealth from SMM minority shareholders to SCI minority shareholders. SMM shareholders will not see their capital if they do not subscribe to the rights issue. Well, also not that high a probability if they do! SCI shareholders will get SMM shares at the end of day and get to sell them for a bit more profit. 

Similar to SIA's situation, SMM raised an amount more than its market cap. S$2.1 billion vs its market cap at S$1.6 billion-ish before the announcement. So the share price will have to more than double just to get back to where it was. During the best of times, its market cap went to S$11 billion! Barring any miracle, we can say that it will never get near that market cap. For the last five years, its market cap hovered between S$2.8 to S$3.6 billion.

Looking past the last two decades, there are almost as many years as it was free cashflow (FCF) positive as it was negative. It's so volatile we cannot even compute a FCF number. For what it is worth, the average annual FCF is minus S$700m over the last 20 years. It did make an average of c.S$250m from 2000 to 2009 but a huge negative from 2010 to 2019. In short, it's hard to justify any market cap using FCF. Well, it is a similar situation with SQ but airlines, rightly or wrongly, command a higher EBITDA multiple and fortunately for airlines, EBITDA is not FCF. 

Capex heavy businesses

Again as with airlines, the oil and gas industry is highly capital intensive, which means it is always in need of capital to drill, to grow and to compete. Look at the stuff Sembmarine needs to build (above), it sucks, time, capital, manpower. It needs land, large building and factories, permits etc. It's just not good business. To make things worse, companies like Sembmarine has to take on leverage to manufacture these rigs and ships which weakens its balance sheet. So when the tide goes out, or when shit happens, everyone is screwed. 

Once upon a time, I liked that Keppel and Sembmarine ruled the world with high market share in rigs. They got scale, they even monopolized the design of the rigs. They were riding high on high oil and gas prices. COVID-19 showed us high oil price was a mirage, something that just goes up and down. It can also go negative. Well, I guess there's a lesson to relearn here: avoid capex heavy businesses. 

So while Sembcorp Industries shareholders are laughing now, well, SCI is in the same capex heavy shit business. Building power plants and utilities is not like selling ice creams. SCI shareholders might want to think about selling out before the next wave goes in (or goes out) depending on which metaphor you like. Meanwhile, stay safe!

Huat Ah!

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