We were not entirely surprised by the proposed consolidation plan between ICON and UMWOG as it has been encouraged explicitly by Petronas’s president and group CEO Datuk Wan Zulkiflee Wan Ariffin to increase the local services players’ competitiveness. Post consolidation, UMWOG will emerge as an integrated oil & gas service provider but valuations of the acquisitions on Orkim and ICON do not seem favourable to UMWOG. Additionally, the rights issue with free warrants is rather value dilutive given widening share base of 1-2x at steep discount to its current book value. In this regard, we believe UMWOG’s share prices will face selling pressure in the near-term while ICON’s share price could trade up towards the offer price. Going forward, we do not discount the possibility of further consolidation. However, we reckon that these mergers and acquisitions will only materialise with the backing of strong institutional funds such as EPF, PNB and etc, as most local O&G companies are geared up except for Petronas companies (PETDAG, PETCHEM, PETGAS), MHB, DIALOG, GASMSIA and DELEUM which are in net cash position or minimal net gearing of <0.1x. Overall, we maintain our NEUTRAL view on the sector with positive bias.

Proposed sector consolidation. Yesterday, UMWOG (Not-Rated) proposed to acquire Ekuinas’s entire 42.3% stake in ICON (Not-Rated) for RM0.50/share (14.9% premium to the last traded price of RM0.435) through issuance of new shares at issue price of RM0.80/share (9.6% discount to the last traded price of RM0.885). A mandatory general offer will be triggered to acquire remaining shares of ICON with the option to receive cash instead of UMWOG’s shares if the shares purchase agreement becomes unconditional. At the same time, UMWOG also proposed to acquire 100% of Orkim, a company which is 95.5% owned by Ekuinas and operates in clean petroleum product (CPP) tankers and liquefied petroleum gas (LPG) tankers business for purchase consideration of RM495.0m. Meanwhile, UMWOG’s largest shareholder, UMW (OP; TP: RM5.28) proposed to let go its entire 55.7% stake via “distribution in specie” to UMW’s shareholders.

Recapitalisation exercise to raise RM1.8b via rights issue. Following that, UMWOG is looking to pursue recapitalisation exercise via rights issue with free warrants to raise gross proceeds of RM1.8b at an issue price of not more than RM0.50/share (43.5% discount to the last traded price of RM0.885 and 67.5% to its existing net asset/share of RM1.54). The RM1.8b proceeds are intended to be utilised for repayment of RM850m bank borrowings, RM835m bridging facility for the abovementioned acquisitions, RM80m Orkim’s shareholders’ loan with the remaining for working capital purposes. We opine that the rights issue at such deep discount is rather value dilutive but essential to pare down its gearing level.

Owning more assets. UMWOG will emerge as an integrated oil & gas service provider with 7 jack-up rigs, 1 semi-submersible rig, 5 hydraulic workover units, 37 OSVs, 14 CPP and 2 LPG tankers. With that, the company is aiming to enhance its competitiveness through bundling of services. While the cost synergies impact is yet to be ascertained pending due diligence, we believe the bundling of services will allow UMWOG to enhance its chances to secure both drilling contracts and OSV chartering jobs given that oil majors would have to deal with lesser number of service providers to improve efficiency. However, this in return could lead to contract being charged on a lump sum/turnkey basis instead of daily charter rates and subsequently putting more pressure on services players’ cost management ability. Meanwhile, we see limited cost synergies from acquisition of Orkim but a diversification from upstream space given that its earnings exposure in mid-downstream segment.

Fair valuation of RM0.50/share on ICON… Despite the proposed acquisition price of RM0.50/share representing 14.9% premium to its last traded price of RM0.435, it is still way below the IPO price of RM1.85 in 2014. Valuation-wise, the offer price has an implied FY17-18E PBV of 0.78-0.72x and FY17-18E PER of 21.7-8.8x according to consensus forecasts. On the other hand, UMWOG’s new shares issuance price of RM0.80/share (9.6% discount to the last traded price of RM0.885, 71.4% lower than the IPO price of RM2.80) has an implied FY17-18E PBV of 0.67x-0.70x. Note that PER valuation is not applicable as consensus is expecting UMWOG to remain in red for the next two years. This higher valuation, in our view, is unfavourable to UMWOG but deemed reasonable because ICON’s fundamentals are stronger than UMWOG in terms of profitability, gearing and risk of impairment. Furthermore, a premium is needed to entice ICON’s shareholders in order to buy in the deal.

…but acquisition of Orkim seems expensive. While we have yet to obtain further information on Orkim’s earnings outlook in the next few years, the implied FY15 PER of 15.5x seems richer than the typical oil and gas small cap valuation of 7-9x. PBVwise, the purchase consideration with an implied FY15 PBV of 3.6x is also valued on par with Petronas stocks with market capitalisation of billions. Note that Orkim is chartering CPP tankers and LPG tankers to oil majors under long-term contracts, backed by RM637m orderbook until 2031 as of 4Q16. We reckon discounted cash flow valuation method is more appropriate to value Orkim, which is similar to our valuation method for companies such as ARMADA, YINSON and DIALOG. All in, we believe UMWOG’s share prices will face selling pressure in the near-term while ICON’s share price could trade up towards the offer price

Source: Kenanga Research - 20 Jan 2017