25 July 2017
A merger between two of the Singapore’s largest offshore rig builders, Keppel Offshore & Marine and Sembcorp Marine, might be on the cards.
This is according to a report by DBS Bank – The Development Bank of Singapore, which believes it is time for Singaporean shipyards to reform, restructure, and reposition themselves to create global champions.
DBS says that the speculation on the M&A between the two rig construction giants has emerged, or re-emerged, due to the prevailing difficult situation in the offshore and marine sector, and the recent changes in the leadership of the two conglomerates.
According to the report, the two companies were in similar talks back in 2001, but were unable to reach an agreement.
Giving rise to the re-emergence of the merger speculation, was a recent appointment of a new CEO at Sembcorp who has launched a strategic review of the business.
“While it is premature to shed more light on the future direction of SCI, it might revive market speculation on potential rationalisation of the three home-grown industrial plays, namely SCI, Sembcorp Marine (SMM) and Keppel Corporation (Keppel),” DBS said.
The DBS sees the bottoming out of oil and gas, and shipping industries as setting a stage for the recovery for shipbuilding, with new contracts emerging after having hit a bottom low.
“YTD new orders have been disappointing, with Keppel and SMM securing merely S$308m and S$75m respectively, lagging behind our expectation of S$1.5-2bn. The finalization of potential FPSO and LNG projects has taken longer than expected, partly because of the oil volatility and difficulty in securing project financing. However, with our optimism on oil price recovery and the trend shifting towards cleaner energy, we believe these projects will eventually come through over the next 6-12 months for both SMM and Kep,“ DBS said.
On the optimism on oil price recovery, the DBS forecasts the price to average US$55 – 60/bbl in 2018, with the recovery in oil prices driven by accelerated inventory drawdowns “as we move into another year where demand will continue to outstrip supply.”
The bank’s long-term oil price forecast of US$60-65/bbl remains unchanged.
However, in its Keppel-SMM merger scenario report, DBS warns the recovery pace in the shipbuilding sector is likely to be moderate as shipyards continue to grapple with overcapacity.
“Keppel O&M and SMM are barely profitable at the current activity level (down 50-60% from peak) despite being one of the more cost efficient shipyards, and with all the cost reduction measures in place. Hence, it seems logical consolidation of the two Singapore rigbuilders will further increase competitive strength to lead on a global basis,“ the DBS said.
LNG is the place to be
The bank sees the shipyard’s move to diversify the product line and dive into the construction of LNG related facilities as a positive one, with Keppel set to deliver its first FLNG vessel this month, and Sembcorp working to clinch an order for its first-of-its-kind modularised LNG terminal.Looking forward, the LNG business is expected to drive the order books of both players, according to DBS.
“For comparison, the contract value for a jackup rig was approximately S$280m while that for drillships was c.S$700m prior to the recent oil crisis. Keppel’s FLNG vessel orders from Golar were priced at over S$900m each.
“FLNG orders currently account for over 50% of Keppel’s orderbook (S$3.5bn as of end-March 2017). For SMM, a modularised LNG-importing terminal is expected to be worth S$200-300m while an exporting unit could be almost S$1bn. This is a strategic move to reduce reliance on drilling solutions and tap on the robust demand growth for natural gas as cleaner energy. We believe LNG solutions will be a major order driver for Singapore rigbuilders moving into 2018.”
DBS is also mildly optimistic about the offshore rig market, as it sees rig utilization and day rates – which have dropped by 50 percent since June 2014 – as bottoming out.
“We believe a gradual recovery in oil prices and the rig market in 2017 will set the stage for rising newbuild demand thereafter,” DBS said.
However, high oil prices are not the only factor needed for the offshore rig market to rise again. Namely, this also dependent on retirement of old fleets, and the new competition from the Chinese yards.
What is more, DBS says, a slower order flow is expected, as the market takes time to absorb about 160 rigs scheduled for delivery in the next two years.
Creation of rig building giant on the cards?
In its Asian Insight X report, in which DBS opines that a possible merger between the two might be a good idea in the long run, the bank has worked out various scenarios, such as: Keppel swapping its infrastructure business for Sembcorp’s stake in Sembmarine, or Sembcorp spinning off the Sembarine subsidiary to Keppel in full or partially.
“We believe merging Keppel O&M and SMM will give rise to a stronger and more competitive rig building giant in the longer run. A global power house will be created by combining the competitive strength, world class facilities, and branding of both rig builders. In addition, there is room for further cost rationalization in this structural downturn,” DBS said.
Furthermore, DBS said that, while the macro outlook has improved, the rig building sector continues to face structural issues with yard overcapacity and rig oversupply.
“Both Singapore rigbuilders have been rationalizing their operations since early 2015 to cope with the lower activity level. A merger could make sense to further streamline their operations, achieve cost synergies and eliminate competition in the medium term,” the bank added.
Worth noting, this is all speculation, and it hard to tell how the situation will unfold.
For what it’s worth, in a recent conference call, Keppel’s CEO Loh Chin Hua downplayed the rumor of looking at a merger with main competitor, even saying he didn’t know who the competitor might be.
According to a conference call transcript shared by Seeking Alpha, the CEO was asked if he would entertain the idea of a larger consolidation within the Singapore shipyard sector “i.e. with your main competitor?” Read More