Temasek's Keppel move may have SembMarine in its sights

TEMASEK Holdings' S$4.1 billion move to gain a controlling stake in Keppel Corp (KepCorp) is fuelling years-long intermittent market speculation of a merger of Singapore's two major shipyards - Keppel Offshore and Marine (Keppel O&M) and Sembcorp Marine (SembMarine) - or even the privatisation of the latter.

Temasek already owns a 20.45 per cent stake in diversified marine conglomerate KepCorp, in which the Vanguard Group and BlackRock Fund Advisors also has interests. The state investment company also has a 49.5 per cent stake (as of Dec 31, 2018) in Sembcorp Industries, the parent of Sembcorp Marine.

Temasek will work with KepCorp's board in undertaking a strategic review of its operations. The review will not only assess how best to help the O&M sector - Keppel's former biggest earnings contributor - stay competitive, but also work on other urgent reforms needed to required to bring the mojo back to KepCorp. Needless to say, a 51 per cent majority stake will help Temasek push through any reform.

Temasek has in the past supported companies during tough times. These included Neptune Orient Lines (NOL) and STATS ChipPAC. It eventually sold its entire 67 per cent stake in NOL to France's CMA CGM, and exited STATS ChipPAC in 2014 when the investments no longer made sense.

At stake now is Singapore's offshore and marine sector, which is facing many headwinds. Maritime, inclusive of the O&M sector, contributes roughly 7 per cent of Singapore's gross domestic product. While the depths of the post-2014 downturn seem to be behind the industry, oil prices are still volatile. Upstream capital expenditures have not yet recovered as companies remain cautious, and are not investing for new growth.

Over the years, SembMarine has continued to focus on the offshore business, with aggressive bids for contracts in a shrinking market. KepCorp, on the other hand, has taken a more diversified approach with tentacles in property and infrastructure as well. Its balance sheet is significantly stronger and is seen in a better position to weather the storm. Investors share this sentiment. On Monday, SembMarine's market value stood at S$2.8 billion, while KepCorp has a market capitalisation of S$10.6 billion.

Globally, there is still significant overcapacity in the shipbuilding industry and competition is only expected to increase as Chinese and South Korean shipyards continue to consolidate. Joel Ng, an analyst at KGI Securities, fears this is creating heavyweights with a significantly larger footprint. The recent consolidation of China State Shipbuilding Corp and China Shipbuilding Industry Corp will create a combined entity with assets of around US$120 billion, while South Korea's Hyundai Heavy Industries will have assets of about US$33 billion after its planned acquisition of Daewoo Shipbuilding & Marine Engineering.

All this makes for a stronger case to consolidate Singapore's two major yards. An attempt was made in 2001 but failed on merger terms, with subsequent attempts facing resistance from different parties.

Now that KepCorp's offshore and marine unit and Sembcorp Marine have reached long-awaited settlements with Sete Brasil on oil rig-building contracts worth billions of dollars, a significant overhang on their balance sheets have been removed.

The financial arguments for merging the two yards too seem to have strengthened during this challenging time. Usual arguments in favour of the union include potential cost savings from centralising overlapping functions like legal and compliance, information technology, accounting and administration. The merged entity would enjoy greater bargaining power in procuring raw materials, equipment and services. A consolidation will also free up space occupied by idle or less productive yards for other forms of development.

Additionally, the increasing trend among global fund managers to incorporate environmental, social and governance (ESG) factors into their investment decisions is another source of pressure. While ESG funds are still just a sliver of the US$6 trillion money market sector, fund shops are betting that the upward trend will continue. That could leave Singapore's O&M sector vulnerable.

Hence, it is not surprising that Temasek, as a major shareholder of both KepCorp and Sembcorp, would rather take the bull by the horns, call for a strategic review of businesses in shaping the future, than to adopt a wait and see stance.

The timing can't be better. Both SembMarine and Keppel are trading off their historical highs as they continue to lick wounds from the collapse in oil prices and contract cancellations: KepCorp shares closed on Friday at S$5.84 while SembMarine ended at S$1.20. Trading in KepCorp was suspended on Monday while SembMarine rose 14 cents to S$1.34.

As Singapore's investment company, there should be no sacred cow in Temasek's portfolio, except those which can drive high returns. So don't be surprised if the strategic review goes beyond KepCorp's O&M business. The review could even potentially see KepCorp's other energy-related interest in Penguin, DynaMac and Kris Energy put into a separate energy-focused company.

After all, KepCorp is a huge diversified conglomerate, with interests in asset management, urban solutions and telecommunications businesses as well. But clearly, the O&M sector will be a priority.