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Premature to bet on a merger of Singapore's leading yard groups

A BROKER report reviving the merger talk between Singapore's two large yard groups has triggered spikes in trading volumes mainly for Keppel Corporation and the listed marine arm of Sembcorp Industries.

DBS Vickers suggested in a research note on Thursday last week that the possibility of a merger and acquisition between the marine arms of Keppel Corp and Sembcorp Industries has resurfaced, prompted by the prevailing challenges in the offshore and marine sector. The brokerage argued for the merger of Keppel Offshore & Marine (Keppel O&M) and Sembcorp Marine to create "a global power house".

Stock prices in Keppel Corp and Sembcorp Marine (SembMarine) jumped the next day and trading activity in the two counters have averaged above their three-month trading volumes most part of this week.

But as punters seek to profit on any upside in a sector hit by waves of bad news since the collapse of oil prices in 2014, those investing for the longer haul should take time to evaluate what may work for or against a merger first floated 15 years ago.

To begin with, Kim Heng Offshore & Marine Holdings' executive chairman, Thomas Tan, has argued that Singapore as a small nation, cannot support one too many large yard groups.

This argument is not new, but what Mr Tan is trying to allude to is that, with the downturn, the rivalry between the two groups may serve to benefit the customers at the expense of their financial health.

Yet, in the early noughties when the merger talk first surfaced, others have also counter-argued that even in this little red dot, competition can drive competitiveness and by offering more than one option, the sector can continue to attract customers to Singapore's shores.

This line of thought may have waned in this downturn considering fewer jobs are on the table, so reduced competition can leave more breathing space for improved margins.

So a merger seems to make good sense though it still takes two hands to clap and several factors can complicate what may seem like a straightforward equation.

Credit Suisse analyst Gerald Seow pointed to one telling sign suggesting at least one of the two yard groups may not be keen on exploring a merger with the other.

Keppel Corp group chief executive Loh Chin Hua mentioned, at the recent results briefing, that the group was interested in building capabilities, not capacity.

Coming from this perspective, Mr Seow argued that one driver identified for the basis of the merger - that is, matching up in scale with larger rival yard groups in China and South Korea - may not feature high up on Keppel Corp's priorities for its O&M business.

The Credit Suisse analyst also highlighted that a merger with Keppel O&M is just one among strategic options for Sembcorp Industries to restructure its listed O&M business unit.

To Mr Seow, privatisation of Sembcorp Marine makes more economic sense for its parent group compared to the merger proposition.

However, if the two conglomerates have indeed started exploring the possibility of a merger, it will ultimately boil down to both sides agreeing to a valuation of their O&M business units. This was one issue hindering a merger deal 15 years ago, those familiar with the talks back then said.

To bridge a deal will call on the parties involved to reach a common ground and what can be key hurdles are either side still holding varying aspirations for their O&M businesses.

The numbers, as they stand, are telling of more differences than similarities between the corporate developments of the two yard groups.

IHS Markit's APAC lead for Yards and Fabrication, Ang Dingli, pointed out that Keppel O&M has 30 per cent of the jack-up rigbuilding market compared to a 17 per cent share held by SembMarine since 2003.

Keppel O&M also has a larger 35 per cent share of the FPSO (floating production, storage and offloading vessel) conversion market, more than twice the 17 per cent share held by SembMarine.

At the other end of the spectrum, SembMarine has topped the chart for years now as the choice yard for repairs of liquefied natural gas (LNG) carriers.

SembMarine's offshore platform business unit, SMOP, also has a longer track record in topsides module fabrication for offshore production structures, Mr Ang said.

Thus far, it would appear a merger of the two yard groups does sound akin to a marriage between two individuals of disparate background even as they do share a strong rig-building background and, more recently, a common push towards breaking into the high-value floating liquefied natural gas (FLNG) segment.

While it makes sense for Singapore to have one combined larger yard group, investors need to take a moment to reconsider betting on Keppel O&M and SembMarine consummating the marriage for the greater national interest anytime soon.

Fifteen years ago, talk of a merger evaporated after months of hogging the spotlight. Does it make sense now to start speculating all over again on the likelihood of a merger deal when the market doesn't have a clue even on whether the parties are keen for talks on a prenuptial agreement?