Offshore and Marine - RHB Invest 2016-01-21: A Monopsony Makes No Cents For Singapore

Offshore and Marine - RHB Invest 2016-01-21: A Monopsony Makes No Cents For Singapore Offshore & Marine KEPPEL CORPORATION LIMITED BN4.SI  SEMBCORP INDUSTRIES LTD U96.SI  SEMBCORP MARINE LTD S51.SI 

Offshore & Marine - A Monopsony Makes No Cents For Singapore 

  • With oil prices now at USD28/bbl, the market is again speculating whether Keppel and SembMarine would be merged by parent Temasek. This is an issue that goes back to a time even before 1999. 
  • We believe that long-run economics and internal factors argue strongly against the merger. 
  • Choosing a path contrary to the good bank/bad bank concept in the rig-building industry runs contrary to the long-term viability of an integral sector in Singapore’s economy. 

 No economic sense in Keppel-SembMarine merger, or to privatise SembMarine. 

  • Keppel and Sembcorp Marine (SembMarine) would probably secure more contracts globally as separate entities. For example, of Sete Brasil’s 29-rig order split amongst five builders, Singapore has won a total of 13. A merged entity might have won only 8- 10 orders, thus bringing in less economic benefits to Singapore. 
  • The pitfalls of a monopsony are well-documented, and the current duopoly yields a more competitive environment with a greater diversity of smaller supporting companies benefitting Singapore’s economy. 
  • Further, we think that Sembcorp Industries’ (Sembcorp) capital would be much better spent in the high-return-visibility business of building utilities in a power-hungry developing market, rather than privatising SembMarine. It may, however, not have a choice, given Temasek’s 49.7% ownership stake. 

 5M factor approach provides three reasons for non-merger. 

  • This analysis approach, used to avoid accidents in a multitude of industries, is handy to discuss a potential misstep of a Keppel-SembMarine merger. 
  • We find that the incompatibilities in the “man”, “machine” and “management” factors argue against a merger. The “mission” and “medium” stay the same, and a merger will not change the "medium" in which the companies operate. 

 A prudent Keppel management would wait for build quality issues to be clarified, and it does not need extra capacity. 

  • The recent build quality issues that have surfaced at SembMarine have severe long-term ramifications if not properly addressed, as Singapore competes globally solely on our quality and reliability. 
  • Further, SembMarine’s new yard in Brazil has gone well over-budget and for which new orders are not visible. Its new yard in Singapore would also be unnecessary capacity for Keppel, at a time when its own yard space is hungry for more work. 

 Apply the lessons of the global financial crisis (GFC). 

  • During the GFC, one of the strategies employed to save financial institutions was the “Good bank, bad bank” paradigm where non-performing loans were separated from an otherwise-healthy institution to ensure the survival and proper functioning of the latter. 
  • If Keppel and SembMarine were to merge, should any of the subsidiaries develop operational problems, the entire merged entity would be seen to be at risk. Such a merged entity would compound the individual risks, rather than separate such risks. 

 All said, we cannot predict...

  • ... what might, in the end, very well be a directive from the top. However, we have made our economic case clear, and hope that it prevails.

Lee Yue Jer CFA RHB Securities | http://www.rhbgroub.com/ 2016-01-21
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