Keppel Corp (KEP SP) - UOB Kay Hian 2017-03-22: Keppel’s Deal With Borr A Masterwork, Assuming A Forfeit By Transocean

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KEPPEL CORPORATION LIMITED BN4.SI

Keppel Corp (KEP SP) - Keppel’s Deal With Borr A Masterwork, Assuming A Forfeit By Transocean

• Borr announced a transaction of US$1.35b for Transocean’s jackup rigs, with Keppel simultaneously announcing that its newbuilds were transacted at a slight haircut of US$216m (original: US$219m). Assuming Transocean forfeited its deposit, valuations make more sense and display Keppel’s skill at negotiating despite its difficult position. The revised delivery sees a 0-1% earnings increase over 2017-18.
• Keppel remains a trading play. 
• Revise target price to S$6.98, maintain HOLD. Entry price: S$6.25.

WHAT’S NEW

Borr Drilling buys Transocean fleet for US$1.35b. 

• Borr Drilling (Borr) announced on the evening of 20 March that it was acquiring Transocean’s fleet for US$1.35b, more than the previously reported US$1.2b. 
• The transaction sees an implied US$1.08b (US$216m per rig) ascribed to the newbuilds at Keppel’s yard, and an implied US$270m for the remaining 10 rigs in its active fleet. Borr will make a downpayment of US$275m, and assume the remainder of the payment instalments owed to Keppel.

New delivery dates: Three in 2017-18, two in 2020. 

• The delivery dates of the five rigs, presently deferred to 2020, have been revised. Keppel will now deliver the first three rigs, presently ~75% complete, over 2017-18. Depending on Borr’s timeline, delivery schedule is either 1+2 / 2+1 in 2017/2018. The remaining two are presently less than 20% complete, and will be delivered in 2020.

Transaction to be completed before end-May 17. 

• This is subject to all three parties executing definitive agreements and satisfying formal closing conditions. Borr will pay the aforementioned deposit at completion.

STOCK IMPACT

Cash flow improvement a general positive. 

• Borr’s deposit comes on top of the US$219m deposit already collected from Transocean. 
• Altogether, cash value representing 45% of the US$1.1b contract will be collected, with another US$242m (estimated) to be collected on delivery of the first three rigs. This translates to a cash inflow of roughly US$172m-344m (S$241m-482m) for Keppel within 2017 alone, a general positive for its current tight balance sheet situation.

Order risk removed for 3 rigs only. 

• In our view, the deal represents an effective sale of three rigs. As the remaining two have very little work done, it is possible that the cost thus far are below the deposit already paid on the rigs.
• Possible demonstration of Keppel’s skill as a business negotiator. At face value, the valuation of US$216m per newbuild does not make sense. Assuming Transocean forfeited its deposit to get the deal across the table, the resultant values make more sense in two ways: 
  1. Borr gets 21% off the outstanding balance of the newbuilds, plus an intangible time premium on speed to market for three newbuilds, and 
  2. Transocean’s fleet of active jackups gets ascribed a market value of US$489m, with values for each rig looking more realistic. 
  If the assumptions are true, they would represent a masterful demonstration of Keppel’s skill as a business negotiator on deals.

EARNINGS REVISION/RISK

Earnings increase of 0-1% from new delivery schedule. 

• The change in delivery sees 2017 and 2018 earnings revised upwards to S$863m (+1.4%) and S$793m (+0.1%) respectively as we bring forward earnings estimates associated with the first three rigs.
• Our 2019 earnings falls to S$820m (-1.2%) as a result.

Contract win assumptions maintained at S$1.5b for 2017 and S$2.0b for 2018-19.

• We are keeping our contract win assumptions unchanged. Contract wins will primarily be driven by production related orders in the near-mid term. 
• Our assumptions are guided by Keppel’s historical non-rig orders, which averaged US$1.7b (S$2.4b) per year over 2011- 14, and US$0.8m (S$1.1b) per year over 2015-16.

VALUATION/RECOMMENDATION

Trading play still, contract wins likely to catalyse share price. 

• At this level, Keppel’s share price is largely at fair value. The fundamental outlook for its offshore & marine (O&M) business remains poor, and we hesitate to raise valuations. 
• At the same time, we recognise that contract wins will likely spur share price upwards given the optimism as oil price rises. Should that happen, the O&M unit will likely see a short-term re-rating that trends with SMM’s forward P/B. Refer to the table on the right.

Maintain HOLD, with target price lifted to S$6.98. 

• We raise our SOTP price to S$6.98, as we switch over to P/B valuation for the Property unit. Property is now pegged to 0.8x current P/B, in line with the 2013-16 average of peer CapitaLand. 
• The O&M unit remains pegged at 1.2x 2017F P/B, while Keppel Capital is valued at 19x 2017F PE. Assuming that Keppel continues to skilfully negotiate its way out of its predicament, it may appear the worst of orderbook impairment risks are behind us. Weak O&M earnings buttressed by stable Property earnings translates to lacklustre growth, but nonetheless commendable in the current environment. 
• Maintain HOLD.

Foo Zhi Wei UOB Kay Hian | Andrew Chow CFA UOB Kay Hian | http://research.uobkayhian.com/ 2017-03-22

UOB Kay Hian SGX Stock Analyst Report HOLD Maintain HOLD 6.98 Up 6.450