Saturday July 16, 2011

Merger of equals

By JEEVA ARULAMPALAM
jeeva@thestar.com.my

A QUIETLY put together deal, the proposed merger of local oil and gas service providers SapuraCrest Petroleum Bhd and Kencana Petroleum Bhd announced earlier this week has taken many by surprise.

Dubbed a “merger of equals”, sources say the deal was done by way of a merger as opposed to one acquiring another so as to send out the right signal to the market.

“In the case of an acquisition, one will be known as the acquirer and the other an acquiree. This message trickles down to the staff and will impact the overall morale. But this deal signals the merger of true equals,” sources close to the deal tell StarBizWeek.

Analysts and industry players say the timing for the merger is right given the Government's emphasis on the growth of the oil and gas sector as a national key economic area.

With a friendship exceeding three decades, Sapura Group president and chief executive officer Datuk Shahril Shamsuddin and Kencana's chief executive officer Datuk Mokhzani Mahathir are viewed as the most likely candidates to head the merger, driven by a consolidation in oil and gas (O&G) service providers. But still the biggest challenge is making the merger work.

The offer

Once SapuraCrest and Kencana merge, the new entity will become the country's largest O&G service provider by asset size at RM6bil and second by market capitalisation at RM10.88bil.

“This not only gives the financial muscle for the new entity to undertake larger and more complex projects in future, but the merged entity will have economies of scale,” says a source close to the deal.

The proposed merger, valued at RM11.85bil, will see special-purpose vehicle Integral Key Sdn Bhd (IKSB) buy up the assets, liabilities and business undertakings of both companies, to be paid in cash and new shares in IKSB.

Mayban Ventures Sdn Bhd owns the SPV and the latter will be jointly advised on the corporate deal by Maybank Investment Bank Bhd and CIMB Investment Bank Bhd.

Although the name of the new merged entity has yet to be disclosed, sources indicate that it will likely be known as Sapura Kencana Petroleum Bhd.

CIMB Group deputy chief executive officer Datuk Charon Mokhzani told a media briefing on Monday that the SapuraCrest-Kencana merger using an SPV was akin to that of Synergy Drive Sdn Bhd's buyout offer in 2006. That Synergy Drive deal saw several plantation companies held by major shareholder Permodalan Nasional Bhd merge to create the world's largest publicly-traded oil palm company, now known as Sime Darby Bhd.

The overall offer price for SapuraCrest is RM5.87bil, which works out to RM4.60 per share. The company will receive 15% of the offer price in cash, or some RM875mil, while the balance will be in new IKSB shares.

Merger announced: Legal advisor Sreesanthan Eliatamby (left), Maybank Investment Bank Bhd CEO Tengku Datuk Zafrul Aziz and CIMB Investment Bank Bhd executive director Datuk Charon Wardini Mokhzani (right) at the announcement of the deal of merger between Kencana and SapuraCrest recently.

Meanwhile, the offer price for Kencana was some RM5.98bil, or RM3 per share. Its cash payment amounts to 16.2% of the offer price, or RM969mil, and the balance will be satisfied with new IKSB shares.

“The new shares and cash portion at a ratio of 85:15 respectively is being used to sweeten the deal for all shareholders,” Maybank Investment Bank Bhd chief executive offer Tengku Datuk Zafrul Tengku Abdul Aziz says.

However, sources say the cash portion is to ensure that all shareholders view the merger as a good deal and will help incentivise other major shareholders in voting the deal through. Shareholders' approval amounting to 75% on both sides will be needed for the deal to proceed.

With both Shahril and Mokhzani on board for the merger, a key shareholder of Sapura is Norway-based Seadrill Ltd with a 23.6% stake while Kencana has Kumpulan Persaraan Wang with a 6.8% stake in it. Both Sapura and Kencana have a common shareholder the Employees Provident Fund (EPF) with a 10.1% stake and 7.8% stake respectively in the companies.

While the board is currently mulling over the deal and will decide on whether to approve the deal and bring it to vote by shareholders, sources say Seadrill is keen for the merger to happen as it will have a stake in an integrated O&G service provider that will derive earnings from both the domestic and international markets.

Market talk is rife that the SapuraCrest-Kencana merger was truly the brainchild of Shahril and Mokhzani, with both chiefs having secretly toiled away on getting this merger off the ground for several months. However, they are said to be forced to stay behind the scenes due to the highly sensitive nature of this deal involving several key shareholders.

Both chiefs were not present at the media briefing on Monday and have declined to comment on the deal, pending their respective boards' decision. The investment bankers have taken a lead on this deal and are seen as the forefront speakers of the deal.

Market observers say that Maybank's involvement is through its ties with Mokhzani, with the bank's more recent engagement with Kencana being its private placement, while CIMB was brought in through its dealing with Shahril's SapuraCrest.

While that may be, sources say the investment vehicles of Shahril and Mokhzani (Sapura Technology Bhd and Khasera Baru Sdn Bhd respectively) have an agreement in which their shareholding structure would not differ more than three to four per cent in the new merged entity. Based on the proposed merger, the shareholding difference between Sapura Technology and Khasera Baru is 3.8% (refer to shareholding structure chart).

Of the new IKSB shares being issued, SapuraCrest will get some 2.499 billion new shares in IKSB at an issue price of RM2 while Kencana will receive 2.505 billion new shares.

The deal is expected to be concluded within a six- to eight-month timeframe, with both companies to be de-listed upon completion of the exercise.

The new entity will subsequently be listed, taking on the listing status of either SapuraCrest or Kencana.

While the offer is valid until August 15, sources says the boards of directors of both companies may revert as quickly as next week with an answer.

Concerns on the deal?

A main concern among the analyst fraternity is who will lead the new merged entity -Shahril or Mokhzani.

“The key concern now is not the deal's merits but who will take the lead as there are staff on both sides and they would want their respective chiefs to head the new merged entity. You can't have two CEOs for day-to-day running and deciding on strategy,” says a market observer.

While the proposed deal calls for a merger integration committee to be set up upon the offer acceptance by the boards, both Shahril and Mokhzani will co-chair the committee on its pre-merger governance and help accelerate integration after the merger.

Although there are indications that both Shahril and Mokhzani will likely steer the new entity together as joint-CEOs, it is a foregone conclusion that one will eventually take a back seat but still maintain a role in the company's overall operations.

Mergers being aborted as the parties involved are unable to agree on management control of the new merged entity is a valid concern, as seen with property companies IJM Land Bhd and Malaysian Resources Corp Bhd aborting their proposal to merge last December.

However, integration of both O&G companies may prove slightly easier as both are technical-oriented companies, say market observers.

While analysts say the offer price for both companies are acceptable, the respective boards will now be tasked to ensure that shareholders have received an attractive offer.

Thus, Kencana has appointed AmInvestment Bank Bhd as its adviser and Credit Suisse as its financial adviser for the offer while SapuraCrest has appointed RHB Investment Bank Bhd as its main adviser and is in the midst of considering either Goldman Sachs or Morgan Stanley.

“Directors of both companies need to have their own advisers so that they can advice the boards accordingly on the valuation of the deal and if the pricing is attractive,” says a local research oil and gas analyst.

Tengku Zafrul says that the valuation was derived from market consensus of analysts' reports based on next year's forecasted numbers and at price earnings ratio of 18 times calendar year 2012.

Based on Bloomberg data, SapuraCrest is currently trading at a PE of 22.64 times while Kencana is trading at 25.21 times.

Sources close to the deal say since the deal can take-up to eight months, it is difficult to rule out the possibility of a revaluation of the deal should either companies win large contracts or make provisions in the coming months.

Another concern highlighted by analysts includes the new merged entity having RM1.84bil added to its books as borrowings as a result of the cash payment made to shareholders of both companies. The new merged entity will borrow this sum from its investment bankers to pay shareholders, which results in the present net cash position of both companies reversing to a net debt of RM1.62bil post merger.

Analysts did say that the overall borrowings of the merged entity will be manageable with its net debt to earnings before interest, taxes, depreciation and amortisation ratio of two times and a net gearing ratio of 0.2 times as O&G service providers tend to have high gearing due to the capital intensive nature of the sector.

Aside from this, the market is also abuzz that some sub-contractors may feel threatened that their livelihood is at risk with the proposed merger.

“Now that both SapuraCrest and Kencana will become an integrated O&G service provider, some sub-contractors may feel threatened that they will not be needed under the merger,” says a source, adding that the merged entity will likely undertake a streamlining if its sub-contractors.

Come together, right now

The merger is aimed at creating a full-fledged O&G service provider with strong delivery capabilities across the value chain. The financial strength will also help support growth opportunities and act as a platform to strengthen presence globally.

Sources close to the company said that the gameplan was for the merged entity to derive some 50% of revenue in time to come from overseas jobs from some 15% currently.

Both players do operate in international waters presently, with SapuraCrest operating in Brunei and Indonesia while Kencana is in India and Australia.

“We believe that the proposed merger is timely in light of the investment cycle in the O&G sector, especially upstream activities,” Tengku Zafrul says.

“Larger projects with increasing complexity are being anticipated, and integrated O&G service providers will be in a stronger position to provide superior delivery capabilities. Large jobs require scale, breadth of specialist skills, and financial strength to be successfully delivered.”

Meanwhile, the merged entity will fulfil six Entry Point Projects pertaining to the Malaysia O&G sector, primarily rejuvenating existing fields through enhanced oil recovery, developing small fields through innovative solutions, intensifying exploration activities, attracting multi-national corporations to bring a sizeable share of their global operations to Malaysia, consolidating domestic fabricators, and developing engineering, procurement and installation capabilities.

OSK Research says in a report on the merger that both companies were keen as it would create a bigger entity as a more complete 1-stop solution provider for the O&G industry.

“Being bigger would enable the combined company to compete with its international O&G peers, especially in venturing beyond Malaysia, while being a 1-stop solution provider would tie in with Petronas' style of awarding contracts to a single contractor, which can better manage project costs, timelines and deliver quality,” it said.

The research house adds that there are merger synergies for both companies - Kencana's strength lies in fabrication while SapuraCrest is good in installation of pipelines and facilities as well as provision of drilling services.

“Both companies have a strong asset base to support their businesses, with Kencana having a 172-acre fabrication yard in Lumut while SapuraCrest has some 5 workboats (including Sapura3000), as we understand it, and a few other offshore support vessels as well as five tender rigs,” OSK Researh says.

Size is important in the O&G industry since it is a highly capital intensive business and a bigger entity will have a higher success rate when bidding for new contracts and increasing the chances of being picked as the main contractor, which commands better margins for work done compared to doing the same work as a sub-contractor.

However, sources say that the merger is expected to create revenue synergies as opposed to cost synergies.

“Because the companies complement each other so there is not much overlap, we don't expect much cost savings. But some streamlining can be expected in the front liners and middle office on both sides,” he adds.

While layoffs can be expected typically in mergers, sources say that both companies are in need of engineers and will likely see the redeployment of management personnel to various units. The merged entity will see a staff strength of some 7,000 individuals.

On the surface, the proposed SapuraCrest-Kencana merger seems to have more merits than negatives. But the key challenges will truly arise when the integration of both companies begin to merge, but in the meantime, the market will be watching this new merger saga with keen eyes.

SAPCRES : [Stock Watch] [News]
KENCANA : [Stock Watch] [News]

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Business

Saturday July 16, 2011

Merger of equals

By JEEVA ARULAMPALAM jeeva@thestar.com.my

By JEEVA ARULAMPALAM
jeeva@thestar.com.my