O&G catalyst

Malaysian Business, Feb 16, 2008 by James S

WILL THERE BE NEW EXCITEMENT in Malaysia International Shipping Corporation Bhd (MISC)? The share price of Malaysia's largest shipping company has been stuck at around the RM9.00-RM10.00 level over the past one to two years, underperforming the bull run in the local Kuala Lumpur Composite Index (see price chart). Sentiment on the stock has no doubt been hurt by the fall in freight rates over the same period, although analysts are generally positive on its long-term prospects. For one, MISC is a subsidiary of Petronas, the national oil company, and will still get the bulk of its earnings and support from the latter's business. To put it in perspective, MISC is actually the world's largest owner of liquefied natural gas (LNG) carriers and is continuously looking to broaden its base of business beyond its parent to third party contracts. The LNG division of MISC operates 25 vessels currently, which should rise to 29 by 2009. In total, the group owns a total of 109 vessels and the number is expected to increase to 142 by 2011.

However, given weak freight rates and rising cost pressures at the group, MISC is seen as more of a lumbering slow giant in the short term. In addition, according to foreign research unit Citibank Investment Research, which has a `sell' call on the stock with a target price of RM9.00, forward contract renewals for MISC's LNG business may not be as lucrative as in the past. It says that rising competition and cost pressures could mean that pre-tax margins for this division will trend towards the low 50% level versus close to 60% previously. The LNG segment accounts for about 50%-60% of MISC's group profits, with the balance coming mainly from its petroleum and container liner segments, which are affected by weak freight rates in the market.

In particular, Citibank Research believes that MISC's container shipping division may continue to perform at around or just below the breakeven level, with the outlook for 2008-09 weaker due to a US housing downturn. Restructuring its container operations may also take a number of years. Tanker risks, it believes, are likely to be the highest for MISC in 2008- 09 compared with previous years due to a tanker over-supply scenario prior to a substantial rise in industry scrapping.

Ramunia: A sweet spot?

Still, some analysts are not discounting the ability of the group to inject some catalysts into its operations even amidst the current weak freight rates in the industry. A case in point is certainly the surprise proposal by MISC recently to inject its 100%-owned unlisted oil and gas (O&G) fabrication yard, MMHE, into listed O&G fabrication player Ramunia at a cost of RM3.2 billion. The consideration will be satisfied via the issuance of 1.4 billion Ramunia shares at RM1.00 each and RM1.8 billion RM0.50 seven-year unlisted ICPS-B.

MISC will then sell to other Ramunia shareholders 82 million shares to finance this reverse takeover (RTO), leaving it with potentially 76.2% of Ramunia if all the other instruments are exercised based on calculations by local research unit, OSK Investment Research. Analysts say that the rationale for the ICPS-B may be to avoid significant dilution of earnings upfront as there is a seven-year period for conversion. Under the terms of the deal, a waiver from a mandatory offer will also be requested by MISC.

Shipping and O&G analysts are generally positive on the deal. According to OSK Research, the pricing of MMHE at RM3.2 billion is at a historical price earnings ratio (PER) of 19.5x and prospective PER of 14.6x, cheap as O&G companies go. It adds that although Ramunia appears expensive on a historical basis at 30.3x PER based on the injection price, consensus forecasts are pointing to a 136% earnings growth in the company, and on this basis, the injection price also actually appears cheap. The research house says that the RTO will create the largest and most technically advanced O&G platform fabrication facility in Malaysia, which could well be valued at 21.0x PER, thus giving an indicative fair value of RM1.49 for the enlarged Ramunia.

The largest shareholder in Ramunia

With the 1.4 billion shares that MISC will obtain upon the RTO, it will initially have a 72.0% stake in Ramunia. It then proposes to pare down its stake by selling 82 million shares to the other shareholders as a means of financing the corporate exercise. Assuming that the outstanding warrants are exercised by the other shareholders and the ICPS-A and ICPS-B converted, MISC will eventually have a 76.2% stake in the full diluted shareholding of Ramunia, calculates OSK Research (see Table 1).

MMHE and Ramunia: A good fit

Foreign stockbroker JP Morgan is bullish on the implications of the deal for MISC. Its research unit believes that with the enlarged Ramunia being the largest fabrication yard operator in the country after the RTO, and MISC still having a 76% control of the enlarged entity, MISC will not only have crystallised the value of MMHE from the deal but would also have increased its control of yard capacity by 133% from 45,000MT a year to a total of 105,000MT in the takeover (see Table 2).