IT IS hard not to feel pity for shareholders of Sembcorp Marine (Sembmarine).

 

Just before its recapitalisation plan was announced in early June, shares in the beleaguered offshore and marine (O& M) company traded at S$0.85.

 

In fact, the stock had climbed some 25 per cent in the preceding three trading days, possibly in anticipation of a deal involving an offer for the whole company.

 

Instead, the company unveiled a 5-for-1 rights issue of new shares at a deeply discounted price of S$0.20 that was to be followed by a distribution in-specie of its shares held by Sembcorp Industries (SCI).

 

Sembmarine, or SMM, lost about half its market within a couple of weeks of that announcement, and it has fallen a lot lower since then.

 

On Wednesday, SMM closed at S$0.169 which is a steep 45 per cent discount to its book value.

 

To be sure, the outlook for SMM' s business is tepid. Besides operations at its yards being disrupted by Covid-19 restrictions, weak global economic growth is likely to weigh on new orders in the quarters ahead.

 

SMM reported a 41 per cent year-on-year decline in revenue for H1 2020 to S$906 million, and a net loss of S$192 million versus a net loss of S$7 million for H1 2019. The Bank of Singapore (BOS) is forecasting a net loss of S$208 million for 2020, and a net loss of S$127 million for 2021.

 

" We continue to see multiple headwinds on low order book clarity and capex requirements. Taking into account the potential for impairments ahead, we lower our fair value estimate to S$0.20 (based on 0.65 times book value)," BOS said in a report last week.

 

Yet, for many demoralised shareholders of SMM, a more immediate problem is that SCI has effectively handed out billions of " free" shares through the distribution in-specie, which are now flooding the market. Holders of each SCI share received 4.911 shares in the recapitalised SMM.

 

In truth, the SMM shares that SCI distributed to its shareholders were not " free" . While recipients of these SMM shares from SCI did not have to come up with any cash, they shouldn' t lose sight of the fact that the value of these SMM shares was peeled out of the original SCI.

 

Just before the announcement of the recapitalisation and de-merger of SMM, shares in SCI traded at S$1.53. On Wednesday, shares in SCI closed at S$1.34. But holders of each SCI share would also have 4.911 SMM shares worth S$0.169 each. The total value each SCI share and associated SMM shares would be S$2.17.

 

Still, a significant proportion of the SMM shares that SCI distributed are now probably in the hands of investors who may not particularly want to keep them, especially since they could continue falling in value.

 

How many shares are we talking about? SCI distributed a total of 8.77 billion SMM shares to its shareholders, of which 7.5 billion were rights shares. As Temasek Holdings owns about 49.3 per cent SCI, it would have received some 4.33 billion SMM shares.

 

One could argue that the remaining 4.45 billion SMM shares that were distributed to minority shareholders of SCI are now in " loose" hands.

 

To put that in perspective, those 4.45 billion shares are equivalent to a 35.4 per cent of the total outstanding shares of the recapitalised SMM.

 

Temasek in control

 

Yet, in the longer term, it is the intentions of Temasek rather than the " loose" shareholders of SMM that will drive the O& M company' s share price.

 

Besides the 4.33 billion SMM shares Temasek would have received from SCI, it also took up 1.03 billion SMM shares at S$0.20 each under a sub-underwriting deal. The total of 5.35 billion shares it has obtained would be equivalent to a 42.6 per cent stake in the recapitalised SMM.

 

What could Temasek do to lift the value of SMM? One popular urban legend is that Temasek ultimately plans to engineer a merger of SMM and Keppel Corp' s O& M arm.

 

It should be pointed out that the companies themselves have never broached this subject publicly, and such a merger would be complicated and fraught with risks.

 

More to the point, a merger would not solve the basic problem that SMM and Keppel O& M face, which is weak in demand.

 

Nevertheless, there are a number of factors that could revive speculation about a merger, and influence the share prices of Keppel and SMM.

 

Firstly, shares in Keppel have fallen significantly since Temasek said last month that it would not proceed with its partial offer. In October last year, Temasek proposed to acquire some 554.9 million shares in Keppel at S$7.35 each, to raise its stake in the company from 20.45 per cent to 51 per cent.

 

After watching the re-rating that SCI has experienced following the de-merger of SMM, many shareholders of Keppel would probably very much like to see Keppel O& M similarly separated from the group. Without the O& M unit in its fold, Keppel might well trade at a better valuation.

 

On Wednesday, Keppel closed at S$4.25, which is a 25.4 per cent discount to its NAV as at June 30 of S$5.70 per share.

 

Interestingly, Keppel O& M had net assets of just S$1.77 billion as at June 30, down from S$2.83 billion as at Dec 31, which could make it easier for the Keppel group to offload it in a sale or merger deal.

 

This came about after Keppel took impairment charges in H1 2020 of S$930 million, mostly related to Keppel O& M. As a result, Keppel reported a net loss of S$537 million for H1 2020, compared to a net profit of S$356 million for H1 2019.

 

It was this steep loss that allowed Temasek to back out of its partial offer for Keppel, by invoking a " material adverse change" pre-condition.

 

Of course, even if a merger deal with Keppel O& M is in the offing, it isn' t possible to know exactly what it would mean for shareholders of SMM without knowing the precise structure and terms of the transaction.

 

Same boat

 

The larger point for SMM' s minority shareholders is that they are really in the same boat as Temasek, whether they obtained their shares largely from the 5-for-1 rights issue or entirely from the distribution in-specie by SCI.

 

About one-fifth of Temasek' s SMM shares came from the sub-underwriting deal, which would have cost it S$0.20 per share. The other four-fifths of its SMM shares were de-merged from its SCI shares, the value of which it will certainly want to preserve.

 

So, the current spate of selling notwithstanding, it seems logical to assume that whatever strategic moves Temasek makes with SMM will be in the interests of most minority investors too.

 

In the end, if Temasek succeeds in steering SMM through these difficult patch, whether its efforts entail a merger with Keppel O& M or not, the only shareholders to be pitied might be the ones who did not participate in the deeply discounted rights issue for fear that they would have been throwing good money after bad.