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.