The News

UMW Oil & Gas Corporation Bhd (UMW-OG) announced the following proposals:

1. Acquisition of 497.8mn (42.3% stake) Icon Offshore (Icon) shares for RM248.9mn via issuance of 311.1mn UMW-OG shares of RM0.50/share at an issue price of RM0.80/share.

2. Acquisition of 95.5% stake in Orkim for a cash consideration of RM472.7mn satisfied via issuance of shares.

3. Mandatory General Offer (MGO) for all remaining Icon shares.

4. Rights issue of new UMW-OG shares with free warrants on the basis of 1:4 to raise gross proceeds of RM1.8bn.

5. Proposed increase in share cap to 10bn from 5bn currently. The proposals are conditional on 1) satisfactory due diligence results, 2) UMWOG shareholders approval, 3) approval of debtors, 4) approval from relevant authorities, 5) major shareholder to take up the rights issue, 6) underwriting secured for rights issue and 7) UMW-OG controls at least 51% of Icon after MGO.

Our View

• The news comes as a negative surprise for us. This is due to 1) acquisitions being rather expensive, 2) heavy dilution after rights issue and share sale, and 3) minimal synergies from Orkim and Icon.

• Icon’s acquisition translates to CY16 P/B of 0.8x – which implies a 33% premium to peers’ average of 0.6x, Whereas Orkim is priced at 3.6x P/B, which significantly exceeds peers average’ of 0.7x P/B.

• We see limited operational synergies between these three distinct asset classes, namely drilling rigs, OSVs, and CPPs. Whilst OSVs and rigs are both deployed for the upstream E&P segment, CPP tankers are in an entirely different segment, (ie. downstream transportation). Furthermore, we believe there is marginal cost savings if UMW-OG deploys Icon’s fleet of OSVs to support rig operations for time charters.

• On the other hand, Orkim and Icon have rather robust operating cash flow of circa RM100mn per year. This should help UMW-OG survive through the O&G downturn. According to our estimates, post-consolidation, EBITDA will turnaround from RM100mn losses previously. In addition, net gearing will be lowered to 0.9x (previous: 1.3x). However, the merged entities will still report EPS losses of 3.9 sen/2.2 sen in FY17E/FY18.

• We estimate LPS dilution of 41%/30% as number of shares increase from 2,162.0mn to 2,897.6mn/2,473.1mn given 100%/0% of Icon shareholders choose to receive UMW-OG shares instead of cash.

• On the bright side, post-merger, UMW-OG will be the leading drilling company, tanker operator as well as one of the largest OSV players in Malaysia with the ability to provide integrated E&P upstream services.

• On the other hand, we note that UMW Holdings Bhd (UMW) demerger may present some downside risk to UMW-OG’s share price as shareholders (total stake: 55.7%) may dispose their bonus shares (redemption price: RM0.90/share) immediately to realise gains.

Impact

• Maintain earnings forecasts pending approval from shareholders and relevant authorities.

Valuation

• Maintain our TP at RM0.55 based on unchanged 0.45x P/B. Maintain Sell. On one hand, the merger will support UMW-OG’s balance sheet and cashflow in the near-term. On the flip side, there will be significant dilution, the acquisitions are expensive, and there are minimal merger synergies.

Icon Offshore Overview

Icon Offshore is the undisputed largest OSV provider in Malaysia and one of the largest in SEA based on number of vessels. It owns 34 vessels operating in Malaysia, Brunei and Thailand which include 1) twenty-one AHTS, 2) two PSV, 3) two AWB, 4) four AHT, 5) one tugboat, and 6) four SSV. Its fleet has an average age of circa 7 years, and recorded decent utilisation rate of 60% in FY15 (FY14: 78%). We understand from industry sources that DCRs for AHTS have fallen YoY from USD6k-7k to USD4k-5k currently. According to consensus’ estimates, Icon is expected to register RM4mn net profit in FY16. Subsequently, its bottomline is expected to jump significantly to RM32.3mn and RM61.4mn in FY17 and FY18 respectively.

Orkim Overview

Orkim owns and operates a fleet of 14 clean petroleum product (CPP) tankers and two liquefied petroleum gas tankers, ranging from c.3,000 to 10,000 DWT. Eight CPP tankers are currently chartered to Petronas and three to Shell under long-term contracts. The remaining 3 new tankers are currently finalising charter contracts with other oil majors. The three new CPP tankers were recently acquired and financed by a RM70mn follow-on investment by Ekuinas in January 2016. From the acquisitions, Orkim has become the largest CPP transportation provider in Malaysia, reportedly with a 30% market share. It currently has outstanding orderbook of RM637mn, with firm contract tenures up to 2021 and extension options up to 2024.

Rights Issue Overview

Following completion of the MGO, UMW-OG intends to carry out a right issue to raise gross proceeds of approximately RM1.8bn (issue price: not more than RM0.50/share). Please refer to Figure 4 for utilisation of proceeds. Free warrants will be issued based on 1-for-4 right shares subscribed. Given the low subscription price, coupled with bonus warrants, we believe the take-up rate will be decent. Note that Ekuinas has pledged RM550.0mn which is circa RM322.0mn more than its entitlement value. Combined with PNB’s entitlement of RM720mn, this enables UMW-OG to raise RM1.3bn which amounts to circa 72% of its rights issue.

Acquisitions rather expensive

For the MGO, Icon shareholders will have two options for payment should they take up the offer: i) cash consideration of RM0.50/share or ii) new UMW-OG shares issued at RM0.80/share. We note that the acquisition price of RM0.50 per Icon share implies CY16 P/B of 0.8x. This implies a 33% premium to peers’ average of 0.6x. We believe the premium is unjustified, compounded with the possibility of potential further asset impairments to Icon’s fleet. Furthermore, Orkim is priced at 3.6x P/B - which according to UMW-OG’s announcement significantly exceeds peers average’ of 0.7x P/B. Hence, we opine that UMW-OG is purchasing the two companies at a steep premium.

Largely Dilutive

UMW-OG’s minority shareholders’ stake will be diluted significantly post-acquisitions, MGO, and rights issue. We estimate LPS dilution of 41%/30% as number of shares increase from

2,162.0mn to 2,897.6mn/2,473.1mn given 100%/0% Icon shareholders choose to receive UMW-OG shares instead of cash. On top of that, the rights issue may further dilute shareholders stake if they choose not to subscribe to the rights.

Minimal Synergies

This news comes as a negative surprise to us, as we see limited operational synergies between these three distinct asset classes, namely drilling rigs, OSVs, and CPPs. Whilst OSVs and rigs are both deployed for the upstream E&P segment, CPP tankers are in an entirely different segment, (i.e. downstream transportation). We believe there is marginal cost savings if UMWOG deploys Icon’s fleet of OSVs to support rig operations during time charters. This would be largely limited to:- 1) ferrying supplies of fresh water, manpower, etc. at the offshore project site, 2) rig mobilization and demobilisation, and 3) rig towing services. Therefore, we believe there will be unsubstantial cost benefits from an integrated OSV and rig fleet.

Strengthening Balance Sheet

After the acquisitions, UMW-OG’s consolidated balance sheet will be significantly stronger. We believe this is the main driver for the proposals as UMW-OG struggles with its largely idle fleet. Post-consolidation, EBITDA will turnaround from RM100mn losses previously, according to our estimates (Figure 1). Furthermore, net gearing will be lowered to 0.9x (previous: 1.3x) as a chunky portion of rights issue proceeds are used to repay borrowings.

Source: TA Research - 20 Jan 2017