Sapura Energy (SAPE) proposed a 5-for-3 rights issue of new shares that will raise up to RM3bn, together with the issuance of Islamic redeemable convertible preference shares (RCPS-i) at 2-for-5 existing shares, raising up to RM983m. SAPE will also be issuing free warrants based on a 1-for-10 rights share subscribed. All in, the RM4bn proceeds will be entirely used to repay the bank borrowings. Given the massive dilution, we downgrade the stock to a SELL with a lower RM0.32 target price.

Raise RM3bn From Rights, RM1bn From RCPS

SAPE has proposed to issue 10bn of new rights shares (representing 1.67x of current share base) at an issue price of RM0.30, which will result in RM3bn cash raised. It will also issue additional RCPS-i at an issue price of RM0.41, representing 40% of its current share base totalling RM983m. The RCPS-i will be convertible based on a 1-to-1 ratio in 5 years, with a 5% annual dividend rate. Together the total cash raised amounts to RM4bn, with the deal expected to be completed by 4QCY18.

Including Some Free Warrants

As part of the deal, SAPE will also be issuing free warrants on the basis of 1- for-10 rights issue subscribed, with a 7-year expiry. The indicative exercise price of the warrant at RM0.49 implies a 32% premium over SAPE’s theoretical ex-price of RM0.37.

Sole Purpose of Rights and RCPS-i to Pare Down Debt…

The entire amount of the proposed RM4bn raise, excluding RM21m related expenses, will be utilised to pare down RM3.96bn debt, falling due on Feb- 2019. This represents 24% of SAPE’s total borrowings, which will result in an annual RM190m interest cost savings once fully repaid. Effectively, gross gearing level will be reduced from 1.74x (as of end FY18) to 0.86x, on the assumption that all rights issue, RCPS-i and warrants are fully converted.

…by Raising 1.6x of Current Market Capitalization

While we are positive on SAPE’s intention to pare down part of its huge debt; based on the maximum scenario, the share base will increased by 3x, from 6bn to 18.4bn shares. With warrants conversion, the enlarged share base will increased to 19.4bn. This will result in a huge EPS dilution to shareholders, which is not value accretive as a whole.

Settle Old Debt, But New Debts Will Likely Come

A leaner balance sheet, post exercise will help SAPE to be more competitive in new contract biddings. However, we believe additional debt may be necessary in the near future to fund new projects. From our understanding, SAPE is required to provide a 10% upfront performance bond for projects secured. Effectively, for every US$1bn contract secured, SAPE may likely need to raise RM400m of new debt. On the bright side, SAPE will have 2 more years to improve their financials as the next bullet repayment will only fall due beyond 2021. The indicated ASX listing of the Energy division will likely help to pare down more of its current debt, although not much details have been shared.

Downgrade to SELL

After imputing the debt repayment which will reduce the net debt position by ~RM4bn and factoring in the enlarged share base, we derive our new target price at RM0.32 (from RM0.65). We maintain our earnings forecasts pending finalisation of the deal but have provided a simulation below (Fig 3). Similar to Velesto Energy, we believe this exercise will be a huge overhang to the share price. Downgrade the stock to a SELL.

Risks to Our SELL Call

Key upside risks include (i) bigger contracts win than expected, better rigs utilisation rate, and stronger US$.

Source: Affin Hwang Research - 27 Aug 2018