A Vulture Looks at the Sembcorp/SembMarine Re-cap deal

Kyith of InvestmentMoat was probably the first prominent blogger to write about the implication of Sembcorp Industries (SCI) and Sembcorp Marine (SMM) deal. I would not repeat his (and many other bloggers' effort here). Kyith did a very good job in his prognosis on how the stock would go. He penned his post a day before trading resume, and the market did respond in line with his numbers.

In the minds of most investors, the jewel is SCI. Having got rid of its loss-making subsidiary, SMM, the earnings would be higher, and therefore deserve a higher stock price based on the same Price-Earnings (PE). Now, PE is subjective to the mercies of the market, but a range between 8-10 would still bring it way above than its pre-announcement of $1.5 a share.

Not only that, SCI's investors would receive 470-ish SMM stock for every 100 SCI stock held. It is clearly a fantastic time to be an SCI investor.

While everyone's attention is on SCI, the vulture (and contrarian) in me is looking at SMM instead. Let me explain why.

Firstly, let's establish that SMM's business is not wonderful. We are not talking about a capex-light-cash-rich company like Perfect Shape. SMM is far from a cheap price-to-book value stock like... ChangShouHua. We have no idea how valuable SMM's assets are, since the profits of SMM is somewhat, in a lagged manner, correlated to oil prices.

SMM's share price is going to be heavily depressed for a few reasons. When the prices are depressed to an unreasonable limit, it might make sense to buy a little. Here is why the prices will decline:

1) Nobody likes right issues to pay for debts. This is not a REIT acquiring a property, where it can be proven mathematically accretive.

2) It is a terrible business

3) Huge dilution

3) SCI's share holders are going to receive 470-ish shares from SCI's management. I believe they would dump the shares. It makes sense. Firstly, nobody likes uncertainty (maybe only value investors). Secondly, the odd number of shares make selling in the future, awkward.

Let's do some guesstimation on the numbers.

SMM shareholders would look at having to cough up $0.20 for every rights they wish to convert. They would receive 5 rights for every stock, which means the dilution is a considerable 1/6.

The existing number of shares is 2090.904569 million shares. Post-event, that would be 12545.427414 million shares.

Looking at the annual reports since 1998, SMM had very good years between 2009 and 2011, where they earned about 700, 860 and 751m in profits. 

Let's not depend on these rosy numbers and be conservative. when the oil prices are in the region of 45-50, SMM is capable of making around 90-120m annually at best. When oil prices were at 70+, it could earn 200m.

I going to make it easy for everyone and value SMM at about 12 PE. If SMM makes 100m a year, 1200m (12 x 100m) spread across 12545.427414m shares is 9.6 cents.

If SMM makes 200m a year, that would be 19.2 cents.

***

As I write (17-June-2020, 1010pm), SMM is selling at 52.5 cents a share. 

In other words, $1.525 would give you six shares of SMM post-rights conversion.

The price of 1 SMM stock, in the eyes of the market, is 25.4 cents a share.

***

Let's assume that it takes 5 years for sentiments to pick up, If you expect a 20% return annualized, then you will be hoping that SMM, post rights, is priced at 12 cents a share. That is if you are expecting a 200m profit/year. It feels optimistic today, but maybe not when times are good.

IMO, the market is not stupid all the time, but just for brief durations. I expect the opportunity to come from possibly SCI shareholders dumping the free shares, another oil crisis, or something else. 

I do not believe too much in forecasting a trigger, but to pay attention to value/price gap. As of now, SMM is not a buy in my list based on my amateurish assumptions/projections, merely on the price itself.