Is Sembcorp Marine Ltd A Buy Now?

[A version of this article first appeared in the 12 October 2017 edition of Take Stock.]

On 6 October 2017, Sembcorp Marine Ltd (SGX: S51) announced the sale of nine jackup drilling rigs to Borr Drilling Limited (OB: BDRILL) for a total sum of US$1.3 billion (around S$1.77 billion).

Up, up, and away

The announcement was well-received by the market, as Sembcorp Marine’s share price climbed by 4.6% to S$1.82 on the next trading day.

According to am article from The Business Times published last Tuesday, analysts from several research houses think the deal will drive Sembcorp Marine’s stock price higher; brokerage firm CIMB even has a price target of as high as S$2.51. The same article from The Business Times also reported on DBS Group Research’s thoughts that the deal hints at a potential recovery for the oil rig market.

What to do now

So, is Sembcorp Marine a buy now, given the size of its deal with Borr Drilling, and the bullishness of analysts? I don’t know. But what I do know is that the deal for the nine jackup rigs has a number of troubling aspects. I would like to use today’s edition of Take Stock to point them out.

Trouble sign 1: Sembcorp Marine is making a loss

The first troubling sign I found concerns the nature of the deal. The total size of the deal is US$1.3 billion, plus a market-based fee that is calculated based on any potential uplift in value of the nine rigs involved.

Of the US$1.3 billion amount, Borr Drilling will be paying US$500 million upfront. The balance of US$800 million “will be paid at any time within five years from the respective delivery dates of the Rigs.” The nine jackup rigs will be delivered progressively over a 14-month period, from the fourth quarter of 2017 to the first quarter of 2019.

Borr Drilling will also pay “interest at market rates” from the date the rigs are delivered to the date that the US$800 million is fully paid up.

While US$1.3 billion seems like a big sum, Sembcorp Marine is actually taking a loss on the rigs. According to the announcement, “the transaction for the sale of the nine jackup rigs will collectively result in a loss of approximately S$15 million” if the aforementioned market-based fee and interest at market rates are excluded.

Trouble sign 2: Short history of operations from Borr Drilling

The second troubling sign concerns Borr Drilling. Borr Drilling is a very new company – it was established only on 8 August 2016. The company has no track record of running a profitable business in the current environment for the oil & gas industry; in the six months ended 30 June 2017, the company actually made an operating loss of US$17.7 million.

Given Borr Drilling’s short track record, the balance payment of US$800 million that Sembcorp Marine is supposed to receive for the nine jackup rigs looks risky to me. (Bear in mind that the US$800 million may only be fully paid up five years from the first quarter of 2019.)

Trouble sign 3: Management has spotty history

The third troubling sign concerns Borr Drilling’s management. Simon William Johnson and Rune Magnus Lundetræ are the company’s chief executive officer, and deputy CEO and chief financial officer, respectively.

Johnson joined Noble Corporation in 2010 and was a senior vice president there prior to being appointed as Borr Drilling’s CEO on 1 August 2017. Meanwhile, Lundetræ was at DNB Markets before he joined Borr Drilling on 19 December 2016; prior to DNB Markets, Lundetræ was chief financial officer of Seadrill Limited from 2012 to 2015.

Noble Corporation is a US-listed company that operates in the offshore drilling industry as an owner of ultra-deepwater and high-specification jackup rigs. As for Seadrill, it is a US-listed offshore drilling contractor. It’s clear that Johnson and Lundetræ have solid experience in the offshore drilling industry where Borr Drilling is operating in too.

But here’s the rub. According to data from S&P Global Market Intelligence, Noble Corporation’s revenue had fallen by 18% from US$2.73 billion in 2010 to US$2.24 billion in 2016, and its bottom-line had deteriorated from a profit of US$773 million to a loss of US$856 million over the same period. In 2014, Noble Corporation’s profit was just US$83.3 million. Seadrill, meanwhile, filed for bankruptcy last month, after suffering losses in 2015 and 2016, and in the second quarter of 2017, based on data from S&P Global Market Intelligence.

It’s clear that Noble Corporation and Seadrill have suffered mightily in recent years, likely because of the sharp fall in oil prices since late 2014.

Would Johnson and Lundetræ have the operational chops to make Borr Drilling a thriving company in the years ahead, one that can comfortably afford the US$800 million balance payment for the nine rigs it has bought from Sembcorp Marine, if oil prices stay stagnant or fall from current levels? It remains to be seen.

A Foolish final word

There’s an air of optimism surrounding Sembcorp Marine now at the moment given the deal it signed last week to sell nine jackup rigs.

But from what I see, there is a lot to be worried about. The deal is risky for Sembcorp Marine when we consider that (1) it may only receive the bulk of the deal’s value years in the future; (2) Borr Drilling has a very short operational track record; and (3) Borr Drilling’s top two executives have been in senior leadership positions with offshore drilling companies in recent times, and the companies have been hammered in the past two to three years.

At Stock Advisor Singapore, the Motley Fool Singapore’s premium stock recommendation newsletter that I serve on as an analyst, we study the business of our recommended companies carefully, and try to steer clear from companies whose revenues are at risk.

None of the above is meant to say that Sembcorp Marine will definitely be a poor investment going forward. But, investors need to be aware of the risks involved with the company.

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Disclosure: The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn't own shares in any company mentioned.