Temasek's partial offer to unlock value in Keppel causes its share price, related counters to jump

The announcement sent shares of Keppel up 14.4% to close at $6.68 when the counter resumed trading on Oct 22. The stock ended higher at $6.73 on Oct 23. Shares of its rival, Temasek-linked Sembcorp Industries, went up 10% to close at $2.29 on Oct 21, as did those of its 60.87%-owned and listed subsidiary Sembcorp Marine (SembMarine), which rose 11.7% to close at $1.34. Sembcorp Industries, however, ended lower at $2.28 on Oct 23, while the latter continued its climb to close higher at $1.40.

Although Temasek does not intend to delist or privatise Keppel, the global investment company says the wider control enables it to undertake a “comprehensive strategic review” of the latter’s businesses. This may include joint ventures, strategic partnerships, acquisitions, disposals, mergers or other transactions. The aim is to create “sustainable value” for all shareholders, it said. To ensure the smooth facilitation of the strategic review, Temasek says it may propose new directors to be installed on Keppel’s board.

Analysts, on the whole, are optimistic about a potential restructuring exercise resulting from the strategic review. Many are betting that this is likely to include Sembcorp and SembMarine too. “There has long been talk of a potential restructuring of businesses under the Keppel Corp and Sembcorp Industries stable, such as the merging of the offshore and marine (O&M) yards,” according to an Oct 22 report by OCBC Investment Research.

UOB Kay Hian analyst Adrian Loh agrees. “With Temasek clearly wanting to realise more value in its Singapore-based investments, the obvious stock that has been badly hit by the downdraft in the O&M sector is SembMarine; hence, a restructuring of the business — via amalgamation with Keppel Offshore & Marine (Keppel O&M) — could take place in the medium to longer term once the Keppel offer is completed,” he writes in an Oct 22 note.

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Notably, the conditions for restructuring appear conducive. UBS analyst Cheryl Lee points out that earnings trends in the O&M industry have been weak, and cost synergies between Keppel’s and Sembcorp’s O&M businesses can be reaped. In addition, both companies are trading at low valuations.

O&M restructuring

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For now, the partial offer requires both domestic and foreign regulatory approvals. These include anti-trust clearances in the European Union, China and Brazil, as well as foreign investment clearance in Australia. Here, the partial offer requires regulatory clearance from the Monetary Authority of Singapore as well as Info-communications Media Development Authority as Temasek will have an indirect interest in M1. The entire process could take several months.

Assuming the regulatory hurdles are cleared, and the partial offer is fully subscribed, what could the restructuring exercise look like? Lim Siew Khee, head of research at CGS-CIMB, hypothesises that a new O&M entity could be formed to house the businesses of Keppel O&M and SembMarine. This may be implemented through the issuance of a dividend in specie of Keppel’s O&M business into the new O&M entity at a valuation of $3.6 billion, or 1.3 times book value. As at Sept 30, Keppel’s O&M business had a book value of $2.8 billion.

On the other hand, Sembcorp may have to privatise SembMarine at a premium of 10% to 20%, according to Lim. This is to account for the conversion of the $2 billion subordinated loans from Sembcorp to SembMarine, and the $1.5 billion bond issue by Sembcorp to Temasek, into equities.

Following that, Sembcorp may choose to inject SembMarine into the new O&M entity via a share swap exercise, says Lim. This may leave Sembcorp with a stake of below 50% in the new O&M entity. The new O&M entity will ultimately be owned by Sembcorp, Keppel’s existing shareholders (including Temasek), minority shareholders of SembMarine and a small free float, she says. UOB Kay Hian’s Loh reckons other energy-related businesses, such as Penguin International, Dyna-Mac Holdings and KrisEnergy, could be injected into the new O&M entity too.

According to Lim, the freeing up of Keppel’s and Sembcorp’s balance sheets could give rise to more options of synergy creation. In particular, Sembcorp could take on Keppel’s infrastructure business, by swapping out its urban development business to Keppel, thereby allowing the latter to unlock the value of its Vietnamese industrial parks.

Keppel could also buy or recycle its property-related assets to achieve its midterm return-on-equity target of 15%, while benefiting from the redevelopment of the Greater Southern Waterfront. “We do not rule out the divestment of M1 to StarHub to help the ailing telco segment and create a cleaner structure for Temasek-linked companies,” she writes in an Oct 22 report.

Analyst recommendations

So what does all this mean for minority shareholders? Lim of CGS-CIMB says the “excitement” over the offer price could push Keppel’s share price closer to the offer price in the near term. This could also be capped by the +/-5% profit-taking arbitrage, implying a top-end range of $7, she adds. However, Lim warns that the downside of the long and tedious process for pre-conditions could lead to a lethargic share price, causing the stock to be rangebound at $6.61 to $7.

Still, Lim maintains her “add” rating for the stock with a price target of $8.36. UOB Kay Hian’s Loh also maintains his “buy” call with a price target of $7.61, while Lee of UBS has a “buy” rating with a price target of $7.80. Lee also has a “buy” rating for Sembcorp with a price target of $2.84 and a “neutral” rating for SembMarine with a price target of $1.25.