Keppel Corporation - Tranformation into an asset light recurring income business model

• Keppel Corporation has entered into definitive agreements with Sembmarine (SMM SP, Non-rated) for the proposed combination of its Keppel O&M (KOM) unit and Sembcorp Marine.
• We view the two developments positively, and see them as a major step in its move to transform the Group from one with a lumpy earnings model to one with a recurring income stream.
• $500mn in cash to be re-invested into new growth areas, including potential share of gains with shareholders. Uncompleted rigs at Asset Co, will no longer be funded by Keppel and carry future potential upside.
• We continue to watch closely regulatory approvals required for the deal, integration plan of the combined entity, outcome of the remaining 10% combined entity shares and Keppel’s plan for the $500mn in cash.
• Maintain BUY with unchanged SOTP TP of S$7.07. While the recent developments have been positive, we have opted to keep our TP unchanged until the relevant regulatory and shareholders approval have been obtained. We valued the Group based on the four new segments unveiled during Vision 2030 to better reflect the Group’s reporting segments going forward. Our TP translates to about 1.0x FY22e book value, in-line with its 5-year average. Catalysts expected from approvals obtained for the transaction.

The news

Keppel Corporation has entered into definitive agreements with Sembmarine for the proposed combination of its KOM unit and Sembmarine. The proposed combination is based on a 50-50 enterprise value ratio between KOM and Sembmarine. After the deal is completed, Keppel and Sembcorp Marine will own 56% and 44% of the combined entity respectively. Keppel will distribute in-specie 46% of the combined entity shares to its shareholders and retain a 10% stake.

In a separate transaction, Keppel will also sell KOM’s legacy rigs and associated receivables to Asset Co and hold a 10% stake. The Group will receive vendor notes and perpetual securities, which have a value of about $3.9bn and $120mn respectively.

Keppel will realise about $9.4bn in value comprising $4.9bn which represents a 56% stake in the combined entity; an extraction of $500mn in cash as part of KOM’s pre-combination restructuring; as well as vendor notes, perpetual securities and a 10% stake in Asset Co worth a total of $4.1bn.

The two proposed transactions, inter-conditional and being executed concurrently, will be subject to relevant regulatory and shareholder approvals. Keppel expects the deals to be completed by end-2022.

Positives

+ Another step toward Group’s transformation to an asset-light recurring income model. The proposed combination of KOM and Sembcorp Marine and the resolution of KOM’s legacy rigs will see Keppel be more streamlined and focused. Importantly, this will continue the Group’s transformation toward an asset-light business model with a bigger proportion from recurring income (FY21: 28.5%).

The implied valuation of KOM at $4.87bn, which is represented as the value attributable to its 56% interest in the combined entity represents a significant upside to our valuation of KOM at  ~$1.5bn (or its NTA of $0.9bn). The upside represented here accounts for KOM’s $5.1bn orderbook, future order wins and margins computed by its independent financial advisor.

Post-completion, Keppel’s Energy & Environment segment would comprise mainly renewables, clean energy, decarbonisation and environmental solutions. The Group will then be much more streamlined, focused and aligned to its Vision 2030 plans.

+ Improved financial metrics. The proposed transactions, if successful, are expected to be earnings accretive to Keppel for FY21 on a pro forma basis. For illustration, had the proposed transaction been completed on 1 January 2021, the earnings per share for FY21 would have been $0.725 instead of $0.562, excluding the net disposal gain from the proposed transactions.

Had the proposed transaction and proposed distribution been completed on 31 Dec 2021, the net gearing would have decreased from 0.68x to 0.63x. Had the proposed transactions and proposed distribution been completed on 31 Dec 2021, the net tangible assets per share would have increased to $5.54 from $5.53.

+ $500mn in cash to be re-invested into new growth areas, including potential share of gains with shareholders. Keppel will seek to re-invest the $500mn in cash extracted as part of KOM’s pre-combination restructuring into new growth areas. We believe the Group could re-invest the proceeds into new growth areas such as data centres and clean energy assets.

We also believe that management could distribute some of the share of gains to its shareholders.

+ Uncompleted rigs at Asset Co, which will no longer be funded by Keppel carry future potential upside. Under the second agreement signed, Keppel has entered into a definitve agreement with Baluran Limited (Baluran), an indirect wholly-owned subsidiary of ASM Connaught House Fund V, and Kyanite Investment Holdings, an indirect wholly-owned subsidiary of Temasek, for the sale of Keppel O&M’s legacy completed and uncompleted rigs and the receivables associated with certain legacy rigs to a separate Asset Co.

Asset Co, which will be independently managed, will maintain, complete and monetise the rigs over time for repayment of the vendor notes and perpetual securities. The external investors of Asset Co will provide capital for completing uncompleted rigs, which would no longer be funded by Keppel. With the improving market conditions, there is confidence on the monetisation of these legacy assets over time. The vendor notes issued to Keppel come with a 5% redemption premium, which allow for the conglomerate to capture future potential upside on these legacy assets.

Outlook

The signing of the definitive agreements is a positive first step, but there are a couple of developments we continue to watch closely – regulatory approvals required for the deal, integration plan of the combined entity, outcome of the remaining 10% combined entity shares and Keppel’s plan for the $500mn in cash.

On the regulatory approvals required for the deal, we note that both Keppel and Sembmarine operate in many jurisdictions, and anti-trust and regulatory approvals will require some time to run through. The second item we are watching is the integration plan of the combined entity. We are watching for the detailing of the upside synergies expected to be created through the proposed combination, as well as opportunities for the combined entity in the energy transition as well as the recovery in the O&M business. Thirdly, there is the outcome of the remaining 10% of the combined entity shares which will be deposited into a segregated account for certain identified contingent liabilities.

The account will be terminated no later than 48 months from the completion of the the proposed combination, or as soon as these contingent liabilities have been dismissed or fully resolved. The balance amount in the account will then be returned to Keppel after making payments to the combined entity, if any. Last but not least, we are watching for how the Group will re-invest the proceeds for the $500mn in cash.

We will provide updates of these developments as they come along.