Friday, November 09, 2007

Swiber – New Focus on Deepwater Drilling Business

On November 6, 2007, Swiber announced that they were expanding their scope of business to include deepwater drilling activities as well. Thus far, Swiber has only focused on the niche market for oil and gas EPCIC activities to be carried out in shallower waters in South-East Asia. By teaming up with an offshore oil and gas veteran, Mr. Glen Olivera, they have incorporated a company called Swiber Offshore Drilling Pte Ltd in order to sharpen their focus on the deepwater drilling segment of the market.

Swiber Offshore Drilling will be 90% owned by Swiber and 10% owned by Mr. Olivera; and I see this as a good move on Swiber’s part to give a stake in the company to Mr. Olivera (at the same time putting him in charge of the division) as shareholder and management goals will thus be aligned. According to the press release, Mr. Olivera has 35 years of experience in the oil and gas drilling business and has supervised onsite drilling projects as well as managed drilling groups which have drilled in waters from 800 to 2,400 metres in depth. He also has experience in cutting costs substantially and therefore will make a valuable addition to the Swiber Management Team.

With this announcement, it begins to make sense as to why Swiber had, on October 11, 2007, ordered 4 new vessels which had subsea and deepwater capabilities. Apparently, the company was already gearing up for this strategic move into a new business segment which would signal a new revenue and earnings stream. Deep water oil production is set to increase to 20% of current worldwide oil exploration by 2011 and Swiber are gearing up 4 years in advance to tackle this growing demand. I recall a conversation with Mr. Raymond Goh during Swiber’s FY 2006 AGM at Raffles Hotel back on April 30, 2007. I was asking about Swiber’s EPCIC activities and Mr. Goh mentioned that they were mainly confined to shallow waters as most of the oil and gas exploration in South-East Asia consisted of shallow water. When I asked if Swiber would move into the deepwater segment soon, he replied at the time that Management “was looking into it” to see if this was a good growth area. Apparently, Management’s research has shown that this would indeed be a promising growth area in future, and hence has decided to sink US$108 million to buy the 4 new vessels and also pumped in capital of US$90,000 (90% equity) to form the new Offshore Drilling company.

While I would agree that the company is very aggressive in expanding their vessel fleet and is undertaking positive steps to build up its network and strategic alliances, the practical point remains that so far these efforts have so far been a “paper exercise” in that it has not translated into contract wins or LOI. Perhaps as a shareholder, I am impatient for Swiber to realize some tangible benefits from these corporate moves over the last 4 months; but I have always believed that such “uplifting” news without the requisite revenue or earnings visibility would imply that the company’s efforts have yet to bear fruit. I can appreciate the fact that Management is pro-active in securing alliances and joint-ventures and also in growing their vessel fleet; but my main worry now is whether there will be sufficient demand moving forward for these vessels not to remain idle. As mentioned before, unlike Ezra, I do not think that Swiber orders vessels based on a client’s potential future usage. Probably they are just purchasing these vessels in anticipation of higher demand in the foreseeable future, but I have to clarify this with Management or it would not be fair to just assume this.

Although some shareholders may cheer the latest news about Swiber’s foray into the deepwater drilling segment, there are pretty high risks moving forward which I have identified:-

a) The demand for deepwater drilling is still unknown at this point and the 20% figure provided in the press release is at best, an estimate. Should demand not move in tandem with supply, Swiber will be in trouble as their vessels sit idle incurring operating costs.

b) Margins from this business are also uncertain at this point, as there may be high costs involved in providing deepwater EPCIC services, as compared to their current shallow water offerings.

c) There is no guarantee that competition will not come in to make Swiber’s plans go awry and to take away a chunk of the market share which Swiber has enjoyed thus far in South-East Asia. The mitigating factor is that barriers to entry are very high in this industry as high capex is required.

With the above uncertainties and lack of earnings visibility moving into FY 2008, I would say the intrinsic value of Swiber should remain the region of S$2 to S$2.50 per share, which is an estimate based on their business growth and earnings so far. A good margin of safety would be to purchase below S$1.60 for a 20% margin of safety (for prudent investors) or around S$2 if you are slightly more optimistic.

Note: Views expressed on intrinsic value and margin of safety are personal and do NOT constitute a recommendation to buy or sell the shares in Swiber. For proper professional advice please consult your nearest lawyer, stockbroker, accountant or analyst.


Anonymous said...

Hi musicwhiz,
What about Ezra, what do you think is its intrinsic value?
I noticed that you bought it at a very good price previously.

The value of a good share would always be going up. Just wondering your thoughts on this:Do you reevaluate the intrinsic value or would you rather look for new finds?

musicwhiz said...

Hi there Anonymous,

Good questions you posed here, I will be glad to answer them. :)

For Ezra, its intrinsic value would be based on its core recurring earnings plus extra value for its full supply chain vessel fleet as well as additional value attributable to their Saigon Shipyard in starting up a new business unit. The fact that they own 48.9% of an Oslo-listed unit also makes valuing it easier, as there is a ready market price (or to be conservative, you can use NAV per share). I have not computed it in detail yet so I cannot give a number, but my gut feel is that anything below $2.50 should give a comfortable margin of safety.

Yes, the value of a good company would keep going up, as people are more and more willing to pay increasingly higher prices for higher returns which the company can generate. For each dollar of capital invested, the company has to churn out a good, decent return for shareholders (this is called Return On Equity) without depending too much on debt financing.

I will evaluate intrinsic value when I look for a company to invest in. As for companies in which I already have part-ownership, my main job is to monitor its strategies and progress to see that things do not go wrong. A signal for me to sell would be when things go dreadfully wrong or Management screws up big time along the way (see my post on "Knowing When To Sell"). The fact that I keep track of the company news so closely also means that I am aware if the company has potential to grow its earnings in the future (but accidents still do happen, touch wood !).

I am always on the lookout forgood opportunities and am always evaluating companies. This is something I do daily and have a passion for. I also obtain Annual Reports discarded by my friends and read through them for more ideas.

Regards, Musicwhiz

Anonymous said...

You've mentioned one of the reasons to sell is when the stock is fully value, isn't Swiber is in this situation right now given your intrinsic value?

musicwhiz said...

Hi there,

Actually the pertinent question should be "when do you realize a company is fully valued based on all available information ?"

For Swiber, the latent potential of its vessel expansion and strategic joint ventures underscores its growth in the future. From this perspective, there is still room for value enhancement assuming more contract wins (more frequent or of higher value, better margins). The same can be said for Ezra, who are building their business further by going into fabrication as well as their core business.

Thus, "fully valued" is a concept which must continually be asked based on current conditions and what is known about the company's future prospects.

So to answr=er your question, no I do not think Swiber is fully valued from a future intrinsic value perspective. What I mean is that with the current order flow and no further earnings visibility, the market price seems too high to achieve a decent margin of safety. Hope this clarifies !

Regards, Musicwhiz