Ezion Holdings (EZI SP) - UOB Kay Hian 2018-04-17: Delayed Resurrection

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EZION HOLDINGS LIMITED 5ME.SI

Ezion Holdings (EZI SP) - Delayed Resurrection

• Ezion’s successful restructuring puts it on the path to recovery, and could result in a multiples re-rating. However, valuations are highly dependent on conversions by shareholders and security holders. 
• Current book value is closer to 15.1 S cents assuming 50% conversion by Series B security holders. Share price of S$0.197 is at a premium to that of peers who have significantly lower debts. 
• Upgrade to HOLD and raise target price to S$0.18, pegged to 1.0x 2019F P/B. Entry price: S$0.151.

Post-restructuring, book value starts at 12.4 S cents without conversions. 

• The likelihood of conversions by warrant holders and security holders is uncertain as they are currently out of the money, with the exercise price at a premium to book value. 
• Without conversions, Ezion Holdings’ (Ezion) fully-diluted book value of 21 S cents is unlikely to be realised, and current book value post-restructuring is closer to 12.4 S cents.

No more than 1.0x 1-year forward P/B valuation. 

• Peers that have emerged from bankruptcy are trading at close to 1.0x P/B. Local peer Marco Polo Marine, which has no debt left, is trading at 1.1-1.2x NTA. While Ezion should turn profitable, this is weighed against its excessive net gearing of 785% relative to peer average of 124%. The current 26% premium to book is unwarranted, and a fair valuation should not exceed 1.0x 1-year forward P/B, in our view.

Restructuring buys six years of time. 

• Post-restructuring, Ezion has six years’ time to generate sufficient cash flow to partly repay banks and security holders. Reduced interest expense and minimal debt repayment should facilitate this. We estimate that current debt of US$1.5b can be reduced by 35% at the end of six years without conversions.

Balance sheet improving, but equity shareholders take a backseat. 

• With the impairments, Ezion’s service rig fleet is now profitable at the gross level. With this and the reduced interest expense, a return to profitability is expected. Balance sheet is expected to improve, but until Ezion’s debts are settled, little to no cash flow will be attributable to shareholders.

Upgrade to HOLD, target price raised to S$0.18, pegged to 1.0x 2019F P/B, a premium to peer average of 0.8x 2019F P/B. 

• Current valuations imply 1.2x 2018F P/B, which seems high considering that Ezion’s balance sheet remains highly geared. The company may be on the path to recovery, but investors should position cautiously given the restructuring. Share price is expected to trade downwards towards Ezion’s adjusted BVPS of 15.1 S cents in the near term. 
• Upgrade to HOLD.
• Ezion resumed trading on 17 Apr 18, at 9am.

RESTRUCTURING BUYS TIME TO REPAY DEBTHOLDERS 

Restructuring buys six years of time. 

• With shareholders’ approval from the EGM, Ezion has successfully refinanced over US$1.0b in bank debt and US$434m of debt securities (Series 003-008).

4Q17 net gearing of 785%, to fall to c.100% on full conversion. 

• Gross/net gearing as of 4Q17 was 810%/785%, stripping out perpetuals from equity and re-classifying it as debt. Assuming full conversion from the warrants, convertibles and options, Ezion’s equity will rise to US$1b, while net debt is expected to decline to about US$1b. This roughly translates to net gearing of 100%.

Annual interest expense reduced to U$23m-25m post-restructuring. 

• Interest rates on Ezion’s debt have been reduced significantly: interest on the bonds/perpetuals (Series 003-008) have been reduced to a fixed 0.25% p.a., while interest on the bank debt has been reduced to an undisclosed variable amount. 
• Ezion expects annual interest savings of US$30m for its bank loans and US$28m for its bonds. Assuming bank interest slightly above the banks’ cost of funds, future interest expense is estimated at US$23m-25m p.a., a reduction of 33-39%.

Back-of-the-envelope calculation suggests Ezion to generate US$550m in six years.

• The restructuring buys Ezion six years worth of time to build up cash flow to repay its debt.
• A back-of-the-envelope calculation suggests that Ezion can generate ~US$90m of operational cash flow p.a. after administrative expense of US$16m-17m and interest payment of US$23m-25m. Over six years, this amounts to c.US$550m, suggesting that Ezion can pare down its total debt (of ~US$1.5b) by 35% assuming no conversions.

Limited to equity issuances to fund business expansion. 

• We expect most of the operational cash flow generated by Ezion to be earmarked for debt repayment, leaving little for business expansion. Banks will be leery of lending further and thus Ezion is heavily dependent on new equity to grow its business. 
• At present, its options are constrained to either new equity from the warrants (2018-Shareholders) or fresh equity issuances to new shareholders. The latter seems the more likely financing route as shareholders are out of the money on their warrants and less likely to exercise them.

Future business growth contingent on strategic alliances and JVs. 

• With new capital likely to be limited, the bulk of growth going forward is expected to come mostly from alliances and JVs with strategic partners. This assumes an asset-light model where Ezion leverages its operational expertise and marketing network to deploy its partners’ assets, earning the spread between the marketed rate and breakeven operating dayrate. 
• Margins are expected to be high though profit contribution per vessel will be small. We estimate operating profit of US$1m-2m per asset operated, adding US$10m-20m p.a. in earnings assuming 10 vessels in operation by 2020.

Existing operational assets turn profitable post-impairment. 

• The impairment reduces the largest expense item holding back profitability: depreciation. According to the breakdown between asset classes and we note that both liftboats and service rigs were significantly profitable before depreciation. 
• Post-impairment, annual depreciation for Ezion’s assets will decline from US$142m to c.US$80m, and we estimate that both service rigs and liftboats can generate gross margins in excess of 15% going forward.

Liftboat operating environment improving. 

• According to Ezion, the dayrates on the recently-signed contracts averaged US$35,000-40,000/day for charters within Southeast Asia and West Africa. For Southeast Asia, the higher dayrates may be capped by rising competition from the likes of Baker Tech and Eversendai, who have developed liftboat fleets. 
• Utilisation, recorded at 72% in 2017, could improve to as much as 80-85% in 2018- 20 as the remaining three liftboats in its fleet are deployed.

Service rig market remains challenging. 

• The market for service rigs remains challenging given the abundance of under-utilised jack-up drilling rigs that could be deployed for the same purpose. Average dayrate was reported at US$54,500/day in 2017 due to higher legacy contracts. With their expiry, average dayrates will trend lower owing to bareboat charter rates in India ( < US$10,000/day) and North Sea dayrates averaging US$30,000/day. We expect dayrates for service rigs to remain flat. Utilisation was reported at 19% for 2017, and we think this will trend up to 60-70% at best.

Return to accounting profitability with minimal cash flow for equity holders. 

• Post restructuring and execution of its asset-light strategy, Ezion is expected to return to profitability. Assuming complete deployment of its liftboats by 2020 and 70% utilisation from eight service rigs, we expect 2018-20 earnings to reach US$10m, US$43m and US$66m respectively. 
• However, this represents accounting profits with little to no attributable cash flow to equity holders as cash flow is set aside for debt repayment. This is in contrast to the pre-2014 period where FCFE per share was comparable to or in excess of core EPS

Balance sheet improving, but not out of the woods yet. 

• With its capital structure rejigged, Ezion is unlikely to face the liquidity strain it was previously enduring. However, it is not entirely out of the woods yet, merely buying time to address the outstanding debt. 
• It is unlikely that cash flow will be sufficient to reduce its debt by more than 50% unless holders of the Series B and Amended Series 008 convert their shares. 

Pavilion Capital’s investment is mostly positive. 

• The Temasek-affiliated entity is potentially investing as much as S$50m in Ezion, providing endorsement of its support for the company. This will ease business negotiations with potential strategic partners and boost confidence in Ezion’s share price. However, Pavilion Capital’s (Pavilion) past dealing in Marco Polo Marine (MPM) might present a share price overhang. Pavilion had acquired 170m MPM shares at 3.5 S cents and sold 70m of it at 5.9 S cents when trading in MPM shares resumed. 

LOW PROBABILITY OF BOOK VALUE UPSIDE FROM CONVERSIONS 

Pre-conversions, book value per share is closer to 12.4 S cents. 

• It is best to examine Ezion’s book value before the impact of warrants, options and conversions. Taking those into account presents a complex discussion on probabilities. 
• As of 4Q17, about 46% of Ezion’s book value comprised perpetual securities and preference shares. As equity shareholders have no claim to those securities, they are excluded, lowering our book value per share (BVPS) to 10.4 S cents. The potential equity investment from Pavilion, the interest, consent, term loan facility (TLF) and professional fee shares which were issued at a premium then lift this by 2.0 S cents. Note that Pavilion’s investment is not final, subject to conditions precedent being met by 19 Apr 18. Aggregating these figures, the base case for Ezion’s BVPS starts from 12.4 S cents. 

BVPS becomes ~21 S cents only if 100% conversions happen. 

• The Series B security holders, Amended Series 008 security holders and warrant holders (2018-Shareholders) generate the bulk of equity value at 5.1/1.1/1.9 S cents respectively. 
• Value creation is largely driven by security holders and shareholders, who have to fully convert in order for book value to reach ~21 S cents. 

Conversion/exercise price may remain at premium to book throughout exercise period. 

• Share price will likely trade close to Ezion’s book value going forward. 
• For its current BVPS of 12.4 S cents to reach the exercise price of 27.63 S cents without conversions, Ezion will have to make at least US$56m p.a. for the next five years. That scenario might be a bullish scenario assuming high fleet utilisation. Furthermore, the conversion price for the Series B and Amended Series 008 is set to the higher of six-month VWAP or conversion floor price of S$0.2763, potentially setting it at a premium to book value throughout the conversion/exercise period. 

Assuming rational investors, the probability of Series B conversion is low. 

• Warrant holders and security holders are likely to remain out of the money in the short to medium term. Maximum capital recovery should be their primary directive and if Ezion is on the path to recovery, rational investors will expect their Series B to be paid in full at the end of six years. This train of thought presents a low likelihood of conversion, so the fully-diluted book value of 21 S cents may not be realised in the short term. 

Assuming 50% early conversions, near-term book value is 15.1 S cents. 

• However, there may be security holders whose imperative is capital recovery at any price and will exercise their early conversion option. Assuming 50% early conversion from Series B security holders, Ezion’s book value will rise to 15.1 S cents. 

HOLD RATING AT BEST, STILL TOO EARLY TO GET INTO THE GAME 

Expect share price to trend down to 15 S cents post-trade resumption. 

• At this juncture, 4Q17 book value stands at 12.4 S cents. Assuming 50% conversions from Series B security holders, valuations should find a floor at the adjusted BVPS of 15.1 S cents. Post potential short-covering, we expect the market to trade down to this value as was the case with Marco Polo Marine (MPM SP/NOT RATED/S$0.035). 
• Post-trade resumption, Marco Polo Marine’s share price has drifted downwards to its post-restructuring net tangible asset value (NTA) per share of 3.0 S cents from its pre-suspension price of 5.9 S cents. 

Valuations should not exceed 1.0x 1-year forward P/B post-restructuring. 

• Valuations of peers that have emerged from deep restructuring or Chapter 11 proceedings trade at 1.0-1.1x forward P/B. Tidewater and Gulfmark Offshore recently emerged from Chapter 11 bankruptcy, and are trading at 1.0x 1-year forward P/B. Marco Polo Marine, while having no forward estimate for its P/B, is trading at 1.1-1.2x its NTA. 
• The global average shows OSV companies trading at 1-year forward P/B of 0.8x, with an average net gearing of 130%. While Ezion is expected to make profits going forward as compared to its loss-making peers, it carries a debt burden that far exceeds peer average. Realistically, Ezion should command at most 1.0x forward P/B. 

Upgrade to HOLD, with revised target price of S$0.18. 

• We peg our valuations to 1.0x 2019F P/B, arriving at a target price of S$0.18. 
• Ezion may be turning around profit-wise, and we recognise the improvement in Ezion’s balance sheet that may drive a multiples rerating. 
• However, as equity holders have no attributable cash flow for the next six years, and current valuation is high at 1.26x 2018F P/B, we see no hurry to chase the share price. We expect Ezion's share price to trend down towards its adjusted book value of 15.1 S cents in the near term and we will only turn buyers at that level. 
• Upgrade to HOLD.

Foo Zhiwei UOB Kay Hian | http://research.uobkayhian.com/ 2018-04-17

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