Sembcorp Marine (SMM SP) - UOB Kay Hian 2017-04-06: Transocean Looking to Acquire West Rigel from SMM

Sembcorp Marine (SMM SP) - UOB Kay Hian 2017-04-06: Transocean Looking to Acquire West Rigel from SMM SEMBCORP MARINE LTD S51.SI

Sembcorp Marine (SMM SP) - Transocean Looking to Acquire West Rigel from SMM

  • Transocean is rumoured to be acquiring the US$568m West Rigel, currently held in a standstill agreement by Sembcorp Marine (SMM)/North Atlantic Drilling (NADL)
  • An acquisition, if any, will be timely and a huge positive given the bankruptcy risk of NADL. 
  • Financial impact is subject to negotiation between the parties, with SMM possibly divesting the rig at no losses only if NADL agrees to a haircut. A re-rating is likely should a positive outcome occur. 
  • Maintain HOLD and target price of S$1.61. Entry price: S$1.45.



WHAT’S NEW


Transocean to buy West Rigel? 

  • According to an established offshore rig publication, Transocean is rumoured to be acquiring the West Rigel. 
  • To recap, the West Rigel is a US$568m harsh environment semi-submersible ordered by North Atlantic Drilling (NADL) in 2012. It is currently held by Sembcorp Marine (SMM) and NADL in a 77:23 joint venture as part of a standstill agreement in end-15.

Seadrill announces likely Chapter 11. 

  • Seadrill announced on 4 April that it was preparing to implement a restructuring plan which will likely involve schemes of arrangement or Chapter 11 proceedings. It has since been granted an additional 3-month extension until end-Jul 17 to implement a restructuring plan.

NADL likely be impacted if Seadrill files Chapter 11. 

  • As a 70.4%-owned subsidiary of Seadrill, NADL is part of any restructuring plan its parent has. In its 4Q16 earnings call, NADL said it was preparing contingency plans, including “potential scheme of arrangements or Chapter 11 proceedings” should a consensual restructuring of Seadrill not be achieved.


STOCK IMPACT


A transaction will likely be positive for SMM. 

  • Materialisation of the deal will be a huge boon to SMM as it removes a risky, sizeable order from its balance sheet. Of the seven rigs at risk totalling US$1.8b on SMM’s balance sheet, the West Rigel represents 31% of that amount. 
  • Furthermore, it removes any future complications that may arise should JV partner NADL get impacted by Seadrill entering Chapter 11.

Improvement to cash flow matters more than earnings impact. 

  • A transaction will free up capital locked up in the project, allowing SMM to deleverage its balance sheet. This alone is the more crucial point in the current environment as weak earnings are likely to be a facet of the business for the next few years.

Financial outcome subject to negotiation proceedings. 

  • With no indicative deal size, it is difficult to ascertain the financial impact of a transaction to SMM. As Keppel’s recent transaction with Borr Drilling suggests, it is possible for the yard to negotiate a favourable outcome for itself. 
  • However, unlike the case of Transocean (in the Borr Drilling deal), NADL has no obligation on the outstanding amount due on the West Rigel, so it will likely strive for maximum recovery of its investment. Therefore, much depends on SMM’s negotiation skills to ensure a positive outcome.

Possible for SMM to walk away unscathed. 

  • Pricing wise, we expect the transaction to occur with a 20-45% discount to the contract cost, based on recent transactions.
  • References to average historical prices are not applicable in this environment as deals are on a case by case basis. The uncovered cash cost for SMM is estimated at US$284- 452m after adjusting for possible variation orders and the fact that West Rigel is held on NADL’s books (as of 4Q16) for US$210.4m. 
  • Depending on the discount used and whether NADL takes a haircut, it is possible for the outcome to result in either a small profit or losses for SMM. 


EARNINGS REVISION 

  • No earnings revision. We leave our earnings estimates unchanged until the deal materialises.


VALUATION/RECOMMENDATION


Likely upward re-rating on a positive outcome. 

  • A positive outcome from a deal will solidify the perception on two fronts: 
    1. that the rig market has bottomed, with a viable secondary market for transactions, and 
    2. the impairment risk for unsold rig units is indeed abating. 
  • This could see a re-rating to 1.5x 2017F P/B valuation, which would imply a valuation of S$1.87 on our part. 
  • Failure would mean that the threat of impairment remains very real, and we would continue to hold on to our current 1.3x 2017F P/B valuation peg.

Maintain HOLD and target price of S$1.61, pegged to 1.3x P/B benchmark. 

  • Despite the improving oil price outlook, capital budgets for offshore production contracts remain subdued and challenging to bid for. Even if SMM wins contracts, they will likely fall short of the annual S$4b-5b in contract wins the new yard was designed for. 
  • With a weak earnings outlook, SMM is fundamentally a HOLD, and remains a trading play to oil price at best.

RISKS 

  • Asset impairments.
  • Lower-than-expected contract wins.




Foo Zhi Wei UOB Kay Hian | Andrew Chow CFA UOB Kay Hian | http://research.uobkayhian.com/ 2017-04-06
UOB Kay Hian SGX Stock Analyst Report HOLD Maintain HOLD 1.610 Same 1.610



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