Swiber – Analysis of DBSV Report dated September 21, 2007

DBSV’s Chong Wee Lee had written a very detailed report on various aspects of Swiber on Sep 21, 2007 (CIMB GK Goh followed up on Sep 28, 2007 after the Vietnamese tie-up). As usual, I feel the analyst is being overly optimistic on various aspects of the business; insomuch that the target prices being set and the assumptions used are over-inflated, leading potential investors to purchasing without a decent margin of safety. This posting will attempt to highlight the various aspects of Swiber’s business which I feel the analyst has been too optimistic about, and also to sound out risks relating to the rapid growth of the business. Only then will investors be able to adopt a more balanced and realistic attitude towards the company and purchase when there is a margin of safety. My comments (as usual) will be in italics beside a summary of the points flashed out by the DBSV report.

On strengthening of Management team – DBSV writes positively about the appointment of Mr. Ronald L. Schakosky and Mr. Joseph Chen Hin Tin, who were recently appointed to head Swiber’s FSO operations and Brunei Operations respectively. While I agree that the new appointments are positive, one also has to note that these two new appointees would require time to familiarize themselves with the corporate culture and the company’s operations before being able to contribute positively. Every new staff (especially one of such a senior post) needs time to adapt to a new company and assimilate into the culture before he or she can start contributing. Thus, I prefer to assume that it will be at least 3 to 6 months before these new divisions can contribute something substantially positive to the Swiber Group (“The Group”).

On building up and increasing accessibility to financial resources – DBSV is explicit in this section where they mention the various modes of financing which Swiber had utilized in order to raise funds for expansion. The 2 sale-and-leaseback so far will provide upfront cash for the Group and the MTN program can be called upon to provide more debt financing to expand the Group’s fleet. They have also estimated the latest sale and leaseback transaction to be close to the one announced in March 2007. The risk here which is not mentioned in the report is one where Swiber over-extends itself in terms of raising capital through debt and equity markets. Note that there is significant dilution already from the issue of 55.35 million shares (thus increasing the total share capital to the current 424 million shares), while gearing is also rising due to their MTN program. In addition, the Group must also ensure that their operating cash inflows are sufficiently steady as DBSV mentions that they may need working capital equivalent to 25% of the proportionate value in each phase of an EPCIC project. Don’t forget that the Group also has to make progress payments for its currently constructed/converted vessels while paying interest on its medium-term notes too. Cash flow management is thus a very important aspect of the business and if mismanaged, will increase risks significantly.

On Swiber’s vessel fleet – DBSV mentions that Swiber will be able to handle a larger spread of contracts once their new construction vessels come on board. They have also mentioned about the refurbishment of existing vessels such as accommodation barges to crane barges, thereby saving costs (versus buying a newbuild). The risks to be highlighted here are the timely and scheduled delivery of each new vessel, as any delays may hamper the ability of the company to execute contracts on time and it may have to resort to relying on third-party vessel chartering again (which reduces margins). There is also the perennial question of whether there will be any demand for their new vessels, some of which will only be delivered two to three years from now. It is hard to estimate what the oil and gas E&P scene would be like in future, but I believe the CEO Mr. Raymond Goh is trying to make an educated guess based on current conditions (record-high oil prices above US$83 per barrel). Another aspect to consider if whether refurbished barges would be as efficient or effective as newbuild barges in terms of performance. As I am not technically inclined, I am unable to ascertain this but I will remember to bring it up at the next EGM (for the second wave of sale-and-leaseback transactions).

On Project Budget and Execution – For a newly-listed company like Swiber, the key attribute to look for is the successful and on-time completion of their projects within budget; rather than speculating too far on their growth prospects. It was mentioned that DBSV assumed another US$64 million worth of contracts for 4Q 2007, effectively closing FY 2007 with a total of about US$275 million of contract wins. Their targets are even more optimistic for FY 2008 and FY 2009 and there is no concrete basis for their optimism even though there has been a lot of positive news flow lately. I believe that right now, Swiber is on a strong growth trajectory but shareholders should not get too complacent and assume that everything is ginger peachy. By looking at it from a business perspective, going from the usual below US$50 million contracts to one which is worth US$146.6 million is indeed a big step for the company to take; and the risks cannot be understated. I will only feel more assured and confident when the company has successfully completed and delivered the entire project to Brunei Shell (by end-FY 2008), thus cementing their position as one of the leading EPCIC providers for the oil and gas industry.

Deployment of Vessels for Projects – DBSV states that Swiber is studying the possibility of bidding for projects in excess of US$500 million, and they have also guided that revenue visibility is high for the near-term. I have compiled the more recent facts and found that for the US$12 million Malaysia LOI, vessels will only be available in late Sep 2007. For the US$31 million LOI in Malaysia and US$21.3 million LOI in Indonesia, the vessels will only be free for re-deployment in Oct and Nov 2007 respectively. This would mean that there are limited means for re-deployment of their existing fleet of vessels for other EPCIC projects till after the year-end, implying that DBSV’s forecasts may be a tad too optimistic. As for the clinching of US$500 million projects, Swiber is still considered a small player and though it is good to be ambitious, such ambition should also be tempered by a dose of reality as this is not going to happen anytime soon. I would hazard a guess that FY 2009 is the earliest we can see them clinching a mega-project of this size, scale and amount.

From my analysis and understanding, it has been shown that time and again, analysts tend to be too optimistic in their assumptions and play up the numbers for future years based on current positive news flow. Shareholders and potential investors should be aware of the difficulties in managing a real-life business and temper their expectations with realism as well. The key, I personally believe, is to assess Management’s ability to deliver existing projects successfully and to manage their capex, cash flows and opex. Such juggling is by no means easy and if successful, will demonstrate Management’s skill in running a company. I will ignore all forecasts for now and concentrate on the facts, while waiting for the 3Q 2007 financial report to be out by early Nov 2007.

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