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Sembcorp-SembMarine debt deal raises some questions

Sembcorp Industries' (SCI) S$2 billion on-lending to its subsidiary Sembcorp Marine (SMM) is essentially a lifeline thrown to the struggling shipbuilder, which only in recent quarters returned to the black.


SEMBCORP Industries' (SCI) S$2 billion on-lending to its subsidiary Sembcorp Marine (SMM) is essentially a lifeline thrown to the struggling shipbuilder, which only in recent quarters returned to the black. The exercise makes a lot of sense for SMM, but perhaps less clearly so from the view of SCI minorities.

On Monday, SCI retreated four Singapore cents or 1.6 per cent to S$2.41 on a volume of 4.8 million shares traded, while SMM lost four cents or 2.6 per cent to finish at S$1.51, with 10.5 million shares changing hands.

In a Friday announcement, both parties had said that SCI is extending a S$2 billion subordinated loan facility to SMM to strengthen its financial position amid the downturn in the global offshore and marine (O&M) industry.

This will comprise an issuance of S$1.5 billion five-year bonds, which will be taken up in large part by Singapore state investor Temasek Holdings, BT understands, as well as S$500 million to be funded from SCI's existing resources.

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According to Bloomberg data, Temasek has about 49.46 per cent stake in SCI, and 1.47 per cent stake in SMM.

SMM will use the subordinated loan to retire about S$1.5 billion of borrowings, and the balance S$500 million for working capital and general corporate purposes.

Since the O&M downturn began, SMM has become a drag on the conglomerate's top and bottom line. In the first quarter of this year, it posted a paltry net profit of S$1.7 million, down 68 per cent due to lower revenue from its rigs, floaters, and offshore platform projects. That said, this was also its second straight profitable quarter after some quarters of losses.

SMM said that despite more enquiries and tenders for offshore production units, innovative engineering solutions and gas-related projects, competition has remained stiff and production activity is expected to remain low. It secured new orders worth just S$175 million in the first quarter of 2019, a far cry from the billions in contract value that it used to clinch in better years.

As at end-March 2019, SMM had about S$875 million in interest-bearing borrowings that will come due in 12 months. The company has told analysts that it would enjoy about S$18 million in interest savings from the lower-cost loan. Worked backwards, this means that SMM's initial weighted average cost of capital is in the range of 4.5 to 5 per cent.

There is probably no other option for SMM in its current financial state to refinance its borrowings at a better rate than the 3.55 per cent coupon rate that SCI is offering,

While SMM shareholders will view this positively, SCI minority shareholders, on the other hand, may find it harder to answer the question of how the deal is good for them.

While the news certainly didn't cause any major downgrades on SCI (only some reduced target prices), the exercise has a visible impact on its financial metrics, chiefly, its increased liabilities. In an email note, CGS-CIMB Research analyst Lim Siew Khee said that based on her calculations, SCI's net gearing will rise from 1.27x to 1.56x.

There will be less impact accounting-wise, as "the loan that is borrowed by SMM is also consolidated in SCI, so technically the balance sheet impact is not that great, except for the additional S$500 million debt that SMM is taking on for working capital", she said.

Next is the risk that at the end of five years, SMM may not be able to repay the loan if its operating performance does not improve significantly. Analysts say if that happens, the debt can be reprofiled further, but essentially it means that SCI is bearing some risk in taking on the middleman role, using its brand name to help out a subsidiary, which arguably also benefits itself when the subsidiary starts to performs well again.

In addition, the debt deal also averts a worse scenario where SMM decides to do a rights issue, and SCI is forced to raise funds to maintain its 61 per cent control.

In his report on Monday, Daiwa Capital Markets analyst Royston Tan said the exercise is "slightly disadvantaging" for SCI stakeholders, considering that the company will be taking on the financial liability on behalf of SMM without being compensated through an interest premium".

The transaction will result in SCI's gross debt-to-capitalisation ratio increasing from the current 56 per cent to 58 per cent.

Mr Tan wrote: "While the S$2 billion in subordinated loans issued to SMM might not be the best use of SCI's capital, given our view that these funds can be channelled into utilities or energy projects to generate higher investment returns versus used to strengthen the balance sheet of SMM, we believe this transaction will not impede SCI's ability to source project financing for future utilities projects."

DBS analyst Ho Pei Hwa also said that much of the latest exercise is meant to help "buy SMM some breathing space as sector recovery takes time". She added that SCI's management is continuing to evaluate options to increase liquidity, and she believes a recapitalisation exercise is possible at some point.

Ms Lim suggested one way in which the debt deal could work in SCI's favour: "SCI's businesses are starting to converge in the energy space, such as offshore wind farms. Possibly, SCI sees value in SMM's business, and thinks it will pay off in the long term to SCI shareholders ."

Most believe that the O&M sector rebound will be years in the making. Mr Tan believes the industry will struggle for the next two to three years before orders start streaming in again for local yards, due to the current oversupply of drilling assets that could take a long time for the market to absorb.

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