Sembcorp Marine - Closer to becoming the largest regional yard

More favourable than previous terms

We think the revised terms work in slight favour of SMM. The number of shares to be issued by SMM will be reduced by 3.1bn to 36,848m (previously 39,950m) with enlarged share of 68.237m (previously 71.34m). No court approval is required for the transaction but simple majority shareholders approval by SMM and KEP. Temasek will retain its stakeof 35.5%. The simplified transaction structure's revised terms appear to have improved and reflect possible previous pushback from SMM's minority interests. SMM's proforma NTA/share improves c.5% from S$0.065 to S$0.068 based on the enlarged entity based on FY21 NTA of S$4.6bn.

S$18bn order book in the bag quickens SMM's path to profitability

Combined YTD order wins for newbuilds for both SMM and Keppel Offshore & Marine (KOM) amount to S$14.25bn (S$8.1bn for KOM and S$6.15bn for SMM), bringing combined order book to c.S$18.57bn. This is a key driver to lead SMM to profitability, potentially by FY24F. Based on previous peak in 2013, the combined order book for both SMM and KOM was S$26.5bn, driven mainly by Sete Brasil drilling rigs contracts. Peak combined net profit and revenue for both were S$14bn and S$1.6bn, respectively, in 2014.

As such, we believe the run-rate of revenue and profit based on the proforma orderbook post-merger could gradually reach S$5bn-6bn and conservative net margin of 3-5%,yielding profit of S$160m to S$280m p.a.

Integration may not be difficult

We were previously concerned about SMM grappling to restructure the combined entity (Bayberry) for growth as its end-2021 order book was only at c.S$1.3bn vs. KEP's S$5bn.

With the change in structure, we think the management control/strategy should remain with SMM. Integration risks could be minimal as both SMM and KOM now service a common single largest customer – Petrobras (c.76% of combined order book). In fact, we expect cost optimisation for materials and equipment procurement, leading to margin expansion.

Upgrade to Add from Hold with higher TP of S$0.19

Execution is key and improvement in operations and profitability is a key re-rating catalyst for SMM. SMM traded at an average of 2-4x P/BV in 2013-2016 during the peak cycle. We now use 1.6x P/BV or the average trading band since the oil price crash in 2015. It also represents a 50% discount to the average peak cycle. Our EPS have not factored in the enlarged share base and merger numbers.

No more Bayberry but SMM directly acquires KEP O&M

KEP and SMM announced that they are revising the terms of the merger, in hopes of expediting completion by Dec 22 or Jan 23, otherwise it would have stalled for two more months. Under the revised terms, SMM will directly acquire 100% of Keppel Offshore & Marine (KOM) and retain its listing status on SGX instead of forming a combined entity (Bayberry). The equity stake between SMM/KOM is now 46%/54% vs. the originally proposed 44%/56%. The S$500m cash payment by KOM to KEP remains but the change in equity ratio reduces consideration for KOM to S$4.50bn (previously S$4.87bn). The dividend-in-specie to KEP's shareholders reduces to 49% (46% previously). SMM's share to be retained by KEP for contingent liability purpose also reduces to 5% (previously 10%). KEP shareholders will receive 19.1 shares of SMM (S$2.33) vs. 18.5 shares previously (S$2.26).

Peak cycle driven by Sete Brasil; Petrobras less risky

During the peak cycle in 2012-2014, both SMM's and KEP's order momentum were driven by sizeable drilling rigs orders by Sete Brasil (a company that was set up to charter rigs to Petrobras at the time which accounted for c.64%/44% of SMM/KEP order book. However, oil price crash and operation "car wash" resulted in a series of cancellations of orders. Recent Petrobras FPSO projects are already earmarked for field deployment. We understand that payment terms are also on a milestone basis and cashflow neutral during the execution life cycle. Historically, the P-serious FPSO contracts have been well executed by KEP and SMM, although they were on a smaller scale.