SapuraKencana moves to next level

Jagdev Singh Sidhu, The Star

ON Monday night after announcing a US$2.9bil deal that will make SapuraKencana Petroleum Bhd the world’s largest tender rig operator, president and group chief executive officer Datuk Seri Shahril Shamsuddin got a phone call from the United States. It was from a fund manager of an institution who just heard about the deal with Seadrill Ltd.

“Someone called in last night asking for a placement of a block of shares. And these are big overseas funds, guys whom we saw in the US recently. Our company was fresh in their minds and we were at a certain ebitda level (before the proposed deal) and with this deal, we have crossed the threshold in terms of size and liquidity of shares,” he tells StarBizWeek.

The non-binding MoU with Seadrill, once completed, will see SapuraKencana take a 51% share of the global tender rig business, in the process making the company more appealing to investors who want exposure to large companies. With 21 tender rigs, and with its next closest competitor globally having four, the deal lifts SapuraKencana to another platform.

Analysts too have become bullish on SapuraKencana, with many raising their earnings projections and target prices.

“We are positive on this deal, operationally and financially speaking. This exercise instantly transforms SapuraKencana into the largest tender-assisted rig operator in the world, by fleet size. This is an earnings accretive deal,” says Maybank Investment Bank in a note after the deal was announced.

Amresearch raised its forecast of SapuraKencana’s earnings per share for its 2014 and 2015 financial years by 24%-30%. It says earnings from the injection of 10 tender-assisted rigs (TAGs) plus a 49%-stake each in five TAGs was partly offset by a 7% increase in share capital.

How the deal came about

Prior to the merger between SapuraCrest Petroleum and Kencana Petroleum Bhd, the former had a working relation with Seadrill after Semdvig, a company it had a joint venture with, was taken over by Seadrill.

The new-found relationship with Seadrill took off and Seadrill’s chairman John Fredriksen started to work closer with SapuraKencana. He introduced the Malaysian company to Brazil where it won a US$1.4bil contract from Petrobas to build and operate three pipe-laying support vessels (PLSVs).

Shahril says discussions then proceeded over combining the rigs SapuraKencana had with that of Seadrill.

“We said why don’t we combine and strengthen our position and instead of just the five rigs, why don’t we look at the whole tender rig business. About a month ago, we looked at it again very seriously and in the last two weeks we intensely had negotiations. The deal was closed Friday night (Nov 2).”

“It’s a way for them to refocus and reposition their business and at the same time help SapuraKencana transform itself into a very solid high margin business. The tender rig business brings pretty strong margins and overall what will happen is our margins will be a bit more robust.”

The tender rigs bought by SapuraKencana have contracts up to 2019 and an orderbook of US$1.6bil. Furthermore, the tender rig business is a higher margin business and at 40%, is larger than what SapuraKencana is currently enjoying. Consolidating the operations also settles the issue of the company having 2 licences from Petroliam Nasional Bhd.

One concern analysts have voiced is that the acquisition of the tender rigs will change the make-up of the group from an oil and gas service provider to that of a tender rig operator where the price earnings multiple investors are willing to pay is lower.

Shahril disputes that assumption, saying the acquisition re-inforces the vision of the company to become a fully integrated oil and gas service company.

“In our business there are four verticals. There is offshore construction services, fabrication, drilling and energy. Energy is the one that takes on all the RSC (risk-service contract) opportunities. And with RSCs, there are so many services that go into supporting that business and drilling is one of them. There are a lot of symbiotic relationships between the verticals to support each other.”

“The more rigs you have, the more chances there will be to mature. Overheads are spread over and we get scale. And in this business, it is very difficult to compete globally without scale. So the choice was very obvious. It is facilitated by the fact the relationship was good, the assets are young, it has a good backlog and it’s margin enhancing and value accretive,” he says.

What it means for SapuraKencana

Apart from being more profitable, the scale of the business will allow SapuraKencana to be more competitive in its bids. But it’s the balance sheet size that was created from the merger between SapuraCrest and Kencana that allowed the Seadrill deal to happen.

“You have to be of a certain size before something like this gets presented to you. The merger allowed us to get onto a lot of people’s radar to see where the big deals come in,” says executive vice chairman Datuk Mokhzani Mahathir.

“But Seadrill is unique because of the relationship SapuraCrest has had, both on the personal and working level that has been established over many years. That’s why this deal was made possible.”

“In terms of value, it meets all of the requirements the board has asked us to look at, such as in terms of value, synergy, growth, control and management… everything. So we are quite comfortable with it.”

Completion the deal will see SapuraKencana have an order book of RM18.5bil and its cashflow should improve as a result of the contracts the rigs have secured. It’s ability to cross-sell its services will improve and Shahril says multiple rigs, newbuilds and the company’s track record will help in access to new markets and opportunities.

Shahril says the improved financials will help but the group has already planned and allocated on the capital requirements for the four segments it

“We have almost fully invested for the next 5 years in offshore construction services with the 5 new vessels coming up. That’s going to grow,” he says.

The transaction with Seadrill settles the expansion in the rigs segment and the company has already calculated just how much it needs to take advantage of the marginal oilfield business. Capex for the modernisation of its fabrication business has also been settled.

Both Shahril and Mokhzani feel securing more marginal oilfields will depend on how the company bids and the larger tender rigs business will only help in its proposition to Petronas for more RSC jobs.

“The more integrated services you have, the better chance you will have in order to quickly deploy the development of these marginal oilfields,” says Shahril.

Although the group’s gearing will rise, Shahril says that’s momentarily and will rapidly climb down after 2 years. “Any acquisition will have borrowings and the borrowings will be depleted over time as we payback. We are comfortable with the gearing and its in line with the growth companies in this sector anyway. ”

Shahril says allocating more cash for dividends as cashflow improves will be balanced by the needs of the business versus reward for shareholders.

“Once the debt levels goes down in 2 years, then we will start increasing our dividend payments,” he says, adding that the value of the company to shareholders will be either captured in dividends or in the value of the shares.

If there is one risk from the transaction with Seadrill, it is the execution of the business.

“Execution risk is always there. When you do business in the oil and gas, execution risk is everything. But we have the asset and the people to deploy and execute projects and in that sense, the risk is minimal for us anyway,” says Mokhzani.

“I don’t think Seadrill would have sold this to anyone else because they know we can take care of this business for them. I think that is also why John Fredriksen has agreed to join the board because he is not going to let go of this business, this asset to anybody and he is comfortable with the people he is dealing with now.”

Fredriksen on board

The acquisition of the tender rigs from Seadrill will see Fredriksen join the board of SapuraKencana, a move that both Shahril and Mokhzani feel will add value to the company given his experience, contacts and knowledge of the oil and gas industry.

But is there also a risk in Fredriksen and Seadrill increasing its stake in SapuraKencana from 6% to 13% from this deal given his previous record of trimming down Seadrill’s shareholding in SapuraCrest?

“I don’t see that, not with him coming on the board,” says Shahril.

“The last time he sold he had invested in the company when it was worth 49 sen and then the value of the shares grew tremendously. He had a US$450mil exposure in a company he had no control over. By him coming onto the board, he can have influence as opposed to before it was just an investment. So he liquidated half,” says Shahril, who says Fredriksen liquidated the shares in the past and re-invested it with SapuraKencana in Brazil.

Shahril also doesn’t think Fredriksen on board will lead to a clash of personalities and influence.

“Good solutions come out of constructive conflicts. Differences in ideas is not a bad thing. He identified with our direction and now he is endorsing it by coming on board. He will not have taken that step if he did not see the value in this company,” he says.