Saturday, May 09, 2009

Swiber – AGM and EGM FY 2008 Highlights

I attended the AGM cum EGM of Swiber Holdings Limited held on April 30, 2009 at 9 a.m. Due to the fact that there was quite a heavy torrential shower in the morning and also the presence of an accident near the AGM venue (which was the Company’s headquarters), several directors as well as shareholders arrived late. Due also to the fact that there was a lack of signs pointing to the location of the AGM and also a lack of hourly parking lots (the carpark at Swiber’s HQ was all season-parking), this also caused quite a bit of disgruntlement and there were some accusations that the AGM was not organized well. Management acknowledged the issues and said that they would learn from the experience and that all feedback would be noted and that FY 2009’s AGM would be a better experience.

The entire AGM and EGM lasted about 3 hours in total, with Management candidly answering questions from several shareholders who took to the microphone. I also managed to clarify some doubts I had with regards to certain issues which had been nagging me since the late deliveries of Swiber Concorde and Swiber Supporter, as well as some recent corporate activites. I shall now proceed to give a point by point review of the queries which were raised, issues discussed and explanations given.

1) Late Deliveries of Swiber Supporter and Swiber Concorde – Management has explained that these delays were unfortunate and unforeseen as the yards were unable to cope with so much work and did not have the capacity to finish the vessels on time. This resulted in delays and deferred revenues while costs escalated due to commissioning and de-commissioning as well as third-party vessel charters. When quizzed if this would be a one-off scenario, Management mentioned that this was unlikely to happen in the near future as yards are now begging for business as the slowdown has meant that many customers are cancelling contracts. I also asked if there would be any penalties involved as the oil majors who had contracted Swiber would have suffered delays in the commencement of the contract. Management assured that they work very closely with the oil majors and have obtained their understanding that such delays were an inevitable part of business and oil majors accept this as part of the cost of doing business. Moreover, there are a lack of incumbent players in South-East Asia who can perform such EPCIC work, which also means Swiber has better bargaining power. To date, these vessels have been delivered and are being prepared for their respective jobs (see FY 2008 Annual Report Page 28).

2) Oil Prices – One shareholder did bring up the issue of a breakeven price level for oil which would make Swiber’s business viable. The reply was that should oil fall to an improbable US$20 per barrel, this would certainly curtail E&P activities and would trickle down to affect Swiber’s core business. However, Management mentioned that they think this to be unlikely as most analysts are of the consensus that oil prices would hit about US$70 to US$80 per barrel by end-2009. Even then, Management reiterated that Swiber was doing good business back in the late 1990’s (before listing) when oil prices were much lower, and had been profitable then as well.

3) Contract Wins and Sustainability of Order Book – I did bring up the fact that Swiber’s order book seems to be drying up as no recent contract wins were announced on SGXNet. Mr. Raymond Goh did mention that US$70 million worth of contracts had been won for Jan-Feb 2009 but these were all made up of smaller individual contracts and each by itself was not material enough to warrant a press release. Management also said that their current order book would last them for the next 2 years till end-2010 and that they were currently bidding for projects in 2010 as their new fleet arrives. Their order book was currently filled by Brunei Shell’s extension contract as well as CUEL’s 5-year US$50 million per annum contract. In addition, there are possible “spill-over” contracts from joint-venture partners which Swiber has established in Brunei and Saudi Arabia.

4) Offshore Drilling Services (ODS) Division Plans – I was enquiring on the future of ODS now that it was announced that the Equatorial Driller would be postponed till economic conditions improved. It would have been a heavy burden for Swiber to finance this vessel and there were also no shipyards at the time to take up this project which involved the design of a radically new type of drilling vessel (different from the normal semi-submersible). Management also made the wise choice of deferring the construction of this vessel as the recession would mean cheaper construction costs in the near future should they take up this task again. My question to them was about their plans for this division in the interim as Swiber had hired a full drilling team headed by Mr. Glen Olivera. They said that ODS was now providing drilling expertise services and moving forward, there were plans to restart the Equatorial Driller project once conditions improved. I suspect gross margins and prospects for drilling expertise services would not be as good as being able to own and charter out a cost-efficient drilling vessel, but that would be the best move which Swiber can make in the meantime while waiting out the recession.

5) Sale of 51% of Swiber Victorious to ICON Capital – I was asking about the rationale behind the sale of 51% of this vessel to ICON Capital for US$19.125 million. Management said that this helped to lighten their capital commitments, but it does not mean that only 49% of the contract value would be recognized for Swiber. The reason for ICON buying 51% of the vessel was to look for a fixed, steady return which Swiber would provide; but technically the vessel was still contracted under Swiber to carry out its contracts and so 100% of the earnings will still accrue to Swiber. In other words, Swiber was farming out some of the cost of the vessel while enjoying the full benefit of the contracts which the vessel was engaged in; thus it was a win-win solution for both ICON (which received a fixed return on its investment in the vessel) and Swiber (which could lower its ownership costs yet partake in the full benefits of each contract). It was also reported in Upstream Online that CUEL had agreed to buy Swiber Chai for an undisclosed sum, after which Swiber would probably lease it back from them for use in its contracts. Swiber’s partnership with CUEL meant that there was mutual sharing of assets and the synergy would continue to work for both parties as each benefited from vessels as well as co-operation on contracts.

6) Divestment of Swiber’s 30% stake in OBT – It was announced that Swiber had divested its entire 30% stake in OBT at cost, netting them a total of S$3.9 million. I questioned the rationale for this sale and Management replied that OBT was actually used for coal transhipments using coal and crane barges. Now that coal prices were coming down, this made owning OBT less attractive (I assume the margins would become much thinner) and Indonesia was also becoming more stringent on such barges. In view of these negative developments, Management made the decision to divest OBT and they viewed it as fortunate that they could divest it at cost instead of at a discount (i.e. loss).

7) Offshore Wind Power Potential – Swiber is exploring this business opportunity as it presents a very lucrative proposition for the Company should they be able to break into this growing market. Many countries are rooting for clean energy and wind power was a growing source of capex for companies which are keen to ride on this trend. Swiber would mainly be the contractor to provide barges and cranes to transport wind turbines, which could be very large and heavy indeed. Although it is too preliminary to talk of securing any contracts, Swiber is in discussion with several companies on the possibility of providing their vessels for such wind power projects. There was no mention of the gross margins, size of contracts or duration.

8) Joint Ventures with Strategic Partners – Swiber’s tie-ups with partners in Thailand (CUEL), Vietnam (Vietsopetro), Brunei (Rahaman) and Saudi Arabia (Rawabi) are ways for them to break into a new market. The aim is also to share assets (to lighten the debt burden as vessels are costly assets) as well as to partake in mutual contracts. It was mentioned that Rawabi was a very good partner as they had connections with Saudi Aramco and thus could garner good contracts which would probably flow through to Swiber. As to whether there will be any future JV, Management said this was a possibility but could not give further details.

While the above may not signify a rosy future for Swiber, at least it provides some comfort that the Company is not in danger of collapse due to over-leveraging, as their capital commitments of US$318 million have already been covered by existing cash, sale and leasebacks and bank loans. Management’s assertion of contracts stretching till late 2010 also gives some comfort on revenue visibility, while the non-deliveries of the 2 vessels can be construed as a one-off event; implying that margins will improve in the near future (they have been trending down for 3 consecutive financial years since FY 2006 and this is a worrying sign).

Still, I am waiting for 1Q 2009 results to see if there is any spillover effects from the late vessel deliveries, or if any more unforeseen issues haunt the company. As at this writing, the future is still murky and uncertain and even though oil and gas companies are still spending on capex as oil reserves are expected to run out in 50 years time, there is no confirmation that Swiber is able to snare contracts of sizeable value to boost its order book any time soon. I am hoping that Management remain prudent and conservative with regards to cash flow management, in order to see the Company through this difficult period.


Simon said...

i don't understand abt pt 5 regarding the 51% sale to icon capital. u sell 51% of the vessel and u get 100% of the earnings while incurring lower costs? it doesn't make sense and it's too good to be true. why not sell 100% of the vessel, 'farm out' 100% of yr cost and get 100% of the earnings instead?

let me quote...
'In other words, Swiber was farming out some of the cost of the vessel while enjoying the full benefit of the contracts which the vessel was engaged in'
and this...
'Swiber (which could lower its ownership costs yet partake in the full benefits of each contract)'

this sentences sound so good, especially the latter one.

i suspect they sell 51% of the ship to icon, but they have to charter it again from icon, hence the 'fixed, steady return' for icon. in that case, it DOES lower capital commitment, but INCREASES cost.! it definitely does not 'farm out' any costs. charter is definitely more expensive than operating yr own ship isin't? hence, we r looking at swiber's margins to dwindle even further if they keep engaging in this kind of deals...

musicwhiz said...

Hi Simon,

Actually, if you did note, Swiber DID sell 100% of their vessels in some cases. This is evidenced by the Sale and Leaseback transactions, whereby ownership of the vessels are sold to a ship financing company and then Swiber leased them back (thereby paying operational lease costs). So I don't see what's so unusual about this transaction where they sell 51% of their vessel and yet keep operational use of it.

This is in line with their asset-light strategy and can help them to conserve cash and also accelerate their fleet expansion. Of course, one thing they have to note is that gearing should not go up too quickly, otherwise this is very risky in the current environment.

Swiber will pay fixed operational lease costs to ICON for the 51% of the vessel which ICON owns. But as I said, Swiber can use this vessel for its contracts as though it were its own vessel. The only time they need to rely on "chartering" is when they do not have their own vessels (i.e. delayed or not delivered as what happened in 4Q 2008). In this case, they are still using their own vessel so margins will not be affected.

Hope this clarifies, but please do engage me on more issues should they crop up in your mind. I appreciate the exchange and views.


Simon said...

actually, i still dunno how this will lower the cost for swiber when they have to pay an fixed operational lease costs to ICON, considering that they don't have to foot this bill when they previously own 100% of the vessel. when u sell the vessel, or part of the vessel and lease it back, isin't the overall cost higher than operating yr own ship? if not, this defies the very purpose of building and operating yr own ship! everybody might as well just lease from somebody else since the cost is the same as operating yr own ship. it's not logical!

moreover, if in a sales and leaseback, u get to have lower cost, lower capital commitments and a large cash payout from the sale, and all these without any contractions in earnings.....then....isin't sales and leaseback the most wonderful and beautiful thing in the world?? i mean...if i have to use my common sense, and my common sense says that the lower capital commitments have to come at the expense of something else! there's no free lunch in the world.

moreover, from yr blog, it seems that swiber only states that the sale and leaseback will lighten their capital commitments, but you seem to be the one saying that this will 'farm out' some of the cost of the vessel. am i correct? did swiber actually say this will lower the cost or is it something that you think will happen? if swiber did say it lowers cost, i definitely want to know how they do it.

Simon said...

just to add another thing, it just seems to me that swiber needs cash, and is doing it at the expense of profit margins. you and i know that cash doesn't come free, it comes with a cost and in this case, the cost is lower profit margins. but in this case, if u say that the cash doesn't come with any cost, and not only that, it lowers the original cost! then...i think we have to grill management even harder to find out where the cost is. Im not an expert in sales and leaseback deals, but im sure there is a cost somewhere that swiber has to pay for getting the cash. EVERYTHING comes with a cost.

musicwhiz said...

Hi Simon,

I'd like to thank you for the comments, they are good so please keep them coming !

Well, let's put it this way. A Company can either choose to build and own and operate their own ships, or else they sell the ships and lease them back (and pay operating lease costs). If they build their own ships, then it's a high capital commitment for them (capex) and a cash drain. Therefore, companies such as Ezra and Swiber go through sale and leaseback with ship financing companies (akin to First Ship Lease Trust) to sell the vessel to receive the proceeds in cash, and then pay monthly operating lease payments to the lessor. So there is a trade-off here, you are right ! They have traded off owning the asset and paying upfront costs with monthly installment payments through non-ownership of the asset.

The pros are that cash is received and can be put to use to lower leverage and also build the business, while still maintaining operations of the vessel by being a lessee. The cons are that you do not own the vessel and have to pay lease payments every month to the lessor, so this is a recurring cash drain.

I would argue that sale and leaseback definitely has its drawbacks and the Company should NOT do this for its entire fleet, as this will increase its cash burden on a long-term basis. Thus, companies like Swiber and Ezra have only a portion of their fleet on S&L, with them owning the rest of their assets directly. S&L can help to lighten the balance sheet and provide immediate cash to scale up the vessel fleet, so it's used for that purpose. I do agree that you trade this off with less control over the vessel (as they become the lessee) and recurring cash outflows to lessor.

I think when I used "farm out", it refers to ICON taking off some of the burden of funding the vessel (i.e. Swiber is selling part of it for cash which will come in immediately). Swiber actually did say this will lower the cost of the vessel (as they only need to fund 49% of it). You can call it a partial sale as ICON now own a majority share of the vessel and Swiber has to pay a recurring cost to ICON for this 51% stake.

The "cost" in S&L is that you enjoy a lower margin, so you are correct to assert that. Ship financing companies require a certain return on invested capital (I know this from owning FSL Trust); thus the ship financing company needs to get a decent margin, so this increases the cost of capital for Swiber. However, looking at it from a strategic perspective; if Swiber is able to clinch more contracts of higher value through the usage of these leased vessels, they may in time to come be able to generate a higher return on equity than the cost of capital they are paying the finance company. So I think ultimately, this is the aim.

Of course, whether this can be done or not remains to be seen. A lot depends on Management's ability and future conditions. However, as mentioned, since Swiber are in a niche industry with few competitors, it is likely they do have significantly more bargaining power and may be able to negotiate better contract margins and values.

To conclude, the strategy is not perfect and there are indeed "flaws" and cons; but I am taking a longer-term view to see if their plans can pan out and from speaking to Management, I feel that they are able to handle the situation to a degree which gives me confidence.


Simon said...

musicwhiz, i also like reading yr comments. thank you for the explanations too! i was actually referring to the cost of running the vessel, not the vessel itself, hence i find it all a bit confusing.

I have to admit i don't really follow the company that closely, but may i know how Swiber Victorious came about? was it bought from another shipbuilder? or was it manufactured by swiber in their yard? was this 51% sale initiatied even before the ship was built?

Simon said...

and yes, i think margins will suffer in the short term since the contracts r the same, yet cost of running the ship will go up due to this s&l deals.

in the long term, margins will probably improve, but i doubt it will be significant because swiber doesn't own that much of the ship anymore. if the industry starts booming again, swiber can negotiate for better contracts, but so can ICON or the rest whom swiber has done s&l with. ICON will just jack up the rates being charged to swiber. so if swiber is so positive abt the future, s&l is the last thing that they should do. Hence, my view is that swiber is so desperate for cash, they r willing to do it at the cost of lower profit margins, even to the point of sacrificing LONG-TERM profit margins. hence, s&l is a short term solution, which conflicts with their long-term view. that's my take on the situation basically.

of course, a lot depends on what kind of terms they agree with ICON, but swiber is still worse off than not doing the s&l at all isin't? ICON, which holds a bigger chunk of the vessel, is the ultimate beneficiary, simply because cash is king right now, and they have cash, something that swiber does not have.

musicwhiz said...

Hi Simon,

As far as I know, Swiber Victorious is being built in a yard. They are using China yards (one shareholder did ask this).

I think the whole point of S&L and sale of 51% to ICON is to gather more cash to expand their fleet quickly. This will then enable them to bid for higher value contracts and contracts with more complexity too. I don't really agree that they are sacrificing long-term profit margins because the larger projects may mean better gross margins than the smaller ones, as long as they have the required fleet to tackle such projects. And being able to bid for them means they need the necessary assets.

I see the sale to ICON as a win-win situation. ICON gets their fixed return in a volatile uncertain market while Swiber gets immediate cash for vessel expansion. I would think that Swiber is not in such a desperate situation to engage in a win-lose deal, as their committed capex are all covered by bank loans, S&L ad internally generated cash.