Sembcorp Marine – what if 1/3 of shareholders dump their shares

Keppel Corporation (KCL) is distributing a 49% stake in Sembcorp Marine (SMM) to its shareholders, maintaining a 5% stake.

This means that a very large portion of shares will now be in the hands of minority shareholders.

As part of the distribution, institutions and investment funds who currently hold shares in KCL will also receive a proportionate number of shares in SMM, being 19,085 shares in Sembmarine for every 1000 shares held in KCL.

Looking at KCL’s list of substantial shareholders from its 2021 annual report, there is only one substantial shareholder with more than 5% stake in KCL – Temasek Holdings with a 21% stake in KCL.

This means that Temasek will receive a 10.2% stake in SMM. Adding on to its existing stake of approximately 25%, Temasek will hold approximately 35% which is just above a third of shares in SMM.

KCL’s minority shareholders will receive the rest of the distribution and own nearly 39% of SMM. Existing SMM minority shareholders will only have 21% of shares combined.

Entity	Approximate shareholding in SMM
Keppel Corp	5%
Temasek	35%
SMM minority shareholders	21%
KCL minority shareholders	39%

Looking at the table above summarising the shareholdings by entity, it seems KCL + Temasek combined will still be the largest shareholder with approximately 40%.

KCL minority shareholders will form the second largest group with 39% while existing SMM minority shareholders will form the smallest group.

SMM & KOM merger transaction details

The initial merger between SMM & KOM was for an equity ratio of 44:56 for SMM:KOM and was subsequently improved by 2% to 46:54, reducing the acquisition consideration from SMM’s perspective by 7.8% from $4.87 billion to $4.5 billion.

KCL also reduced the stake that it would retain from 10% to 5% and distributed the remaining 49% to its shareholders.

While there were positive macroeconomic developments in the offshore & marine sector as well as the renewable energy sector, there was an overhang over the rising interest rate environment and increasing geopolitical uncertainty.

In recent months, there were significant order wins and financial performance improved for both entities and the finalisation of the merger would benefit both entities.

Keppel shareholders probably do not care for KOM.

Keppel Corporation is a conglomerate with the following 4 main business units:

1. Energy & Environment – Keppel Offshore & Marine, Keppel Infrastructure, Keppel renewable energy
2. Urban Development – Keppel Land, Keppel Urban Solutions, Sino-Singapore Tianjin Eco-City
3. Connectivity – Keppel Data Centres, Keppel Logistics, M1
4. Asset Management – Keppel capital, REITs, Trusts & private funds.

Looking at KCL’s FY22 net profit by segment, KCL classified $88 million of net profit as discontinued operations. This discontinued operations amount to about 9.5% of profit and refers to the Keppel O&M (KOM) division which was awaiting the merger with SMM. (read Alvin’s valuation of KCL here)

As the KOM division accounts for a small proportion of the overall KCL group, this means that many KCL’s shareholders are not investing in KCL for the KOM division but for the other parts of the conglomerate.

This is especially since KCL rebranded, restructured and implemented its Vision 2030 plans with a goal to provide solutions for sustainable urbanisation, focusing on four key areas comprising energy & environment, urban development, connectivity and asset management.

This begs the question on what will happen to SMM if all these KCL minority shareholders dump their shares in SMM.

There will be disaster if all KCL minority shareholders sell their shares in SMM on 1 March 2023

KCL has already traded ex-distribution and the SMM shares are expected to be distributed to shareholders on 1 March 2023.

Without a doubt, should all 39% of minority shareholders try to sell their shares in the open market on 1 March, this will be a huge disaster.

Should everyone hold on to their SMM shares?

Investors who dislike the O&M sector due to reasons such as cyclicality or ESG challenges and Keppel’s Brazil corruption saga would likely try to sell their shares as soon as possible.

On the other hand there will be a group of investors who would be keen on riding out the potential O&M upcycle.

KOM had secured $8.1 billion in new orders in 2022. The new orders brought KOM’s net orderbook to $11 billion, its highest level since 2007.

In November 2022, SMM disclosed in its 3Q22 business updates that its net order book was at $7.1 billion with renewables, wind energy and other clean and green solutions accounting for 34% of this net order book.

SMM also continues to see improvement in orders visibility, underpinned by high oil and gas prices, renewed concerns of energy security in the wake of geopolitical tensions, and acceleration of the energy transition towards renewables.

Combined, this is an order book of $18 billion, of which more than $12 billion in orders were secured in the last year.

The combined entity would have significant scale and a global footprint in key markets with a focus on 3 subsegments, namely offshore renewables, new energy and Cleaner O&M solutions.

Valuation of Sembcorp marine

Although the sizeable order book sounds good, investors will do well to note that the combined entity will have about 68.2 billion shares outstanding, being 31.4 billion shares in SMM and 36.8 billion shares issued to KOM shareholders.

Based on a share price of $0.13, this equals to a market capitalisation of nearly $9 billion!

In its heydays, SMM used to achieve a net profit margin between 7% and 12%, for example in year 2009, its net profit margin was 12.2% while in year 2014, it was 9.6% and in 2015 it was 7.5%. This was off the back of revenues of $5-6 billion annually.

If we assumed that the $18 billion order book would be delivered equally over the next 3 years, this would mean SMM would record revenues of $6 billion a year. Should the company also be able to deliver a net profit margin of at least 9.5%, this would translate to profits of $570 million and represents an estimated P/E ratio of approximately 16 times.

While this does not sound expensive, this also does not scream cheap.

These are lofty expectations given SMM was loss making for the last four half years in 2021 and 2022 off the back of nearly $2 billion revenue in both years mainly due to residual COVID-19 challenges such as project delays contributing one-off increases in costs.

Closing statements

We know that if all the minority KCL shareholders dump their shares, this would be a disaster for existing SMM shareholders as these minority shareholders could take the view that they either do not want to be invested in the O&M sector or decide to take profit in a stock that seems to be fairly valued.

It is envisioned that the combined entity would gain synergies from its combined competencies and capabilities which may lead to SMM securing more order wins and delivering projects at more robust margins, the market will likely then react favourably to such results.

Of course, many minority KCL shareholders may take a wait and see approach and should SMM be able to deliver stronger results, these KCL shareholders could very well be the next loyal SMM shareholder.