In an April 2020 article published in this website, I named Sembcorp Marine Ltd (SGX: S51) as a company that could face a liquidity crisis.
“Another one of Temasek’s investments, Sembcorp Marine could face a similar fate to Singapore Airlines. Sembcorp Marine is highly dependent on the health of the oil industry and faces major disruptions to its business amid tumbling oil prices (oil prices are near 20-year lows now).
Like Neo Group, Sembcorp Marine has more short-term debt than cash on its balance sheet. That’s extremely worrying given that credit may dry up during this trying time. As of 31 December 2019, Sembcorp Marine had S$389 million in cash and a staggering S$1.42 billion in short-term borrowings. In addition, the company had S$2.98 billion in long-term debt.
And let’s not forget that Sembcorp Marine also has heavy expenses. In the quarter ended 31 December 2019, Sembcorp Marine racked up S$29 million in finance costs alone and also had a negative gross margin. The company also spends heavily on capital expenditures just to maintain its current operations. Sembcorp Marine was free cash flow negative in 2019 after spending S$316 million in capital expenditures.”
Surviving but at what cost?
Back then, it was pretty clear to me that Sembcorp Marine was in a fight for survival. The company was bleeding cash and had more than a billion dollars in debt to pay in the next 12 months. It didn’t have enough cash on hand to repay its borrowings and was also facing heavy ongoing operational expenses.
True enough, my guess that Sembcorp Marine would go down the same route as Singapore Airlines has played out. In the year and a quarter since my article, the company has raised a significant amount of cash through two rights issues, massively diluting shareholders.
On 2 September 2020, Sembcorp Marine closed its first rights issue, raising S$2.1 billion and at the same time, increasing its number of shares outstanding from 2 billion to 11.4 billion. Sembcorp Marine used S$1.5 billion to pay off debt and the rest to shore up its balance sheet but it also diluted existing shareholders massively. Even shareholders who bought up their full allotment of the rights issue would have suffered painful shareholder value destruction.
But this was not the end of it. On 24 June 2021, the company proposed to raise an additional S$1.5 billion through another rights issue of up to 18.8 billion shares. The full allotment will definitely be filled as DBS has underwritten a third of the shares and Sembcorp Marine’s major shareholder, Temasek (one of the Singapore government’s investment arms), has agreed to take its full allotment and any remaining rights. This second rights issue will increase the share count by another 150%.
When the dust eventually settles, the total number of shares outstanding would have risen from around 2 billion before the first rights issue to slightly more than 31 billion. That’s a staggering increase of more than 1,400%. Put another way, initial shareholders who owned the “original” 2 billion shares used to own 100% of the company. Today, these shares represent just under 7% of the company.
A tanking stock price
Unsurprisingly, the market has reacted appropriately to the massive dilution of Sembcorp Marine’s shareholders. Since I first wrote about Sembcorp Marine in April 2020, its share price has plunged by 72% from 33 cents per share to 9.3 cents per share.
Shareholders who bought into the first rights issue at 20 cents per share are already down more than 50% on that investment, even though the rights were priced at a discount to the “theoretical ex-rights price” back then.
And even after raising a combined total of S$3.1 billion through the two rights issues, Sembcorp Marine still has more debt than cash and is still facing the same old story of cash flow issues.
In the first half of 2021, the company, even with significant one-off working capital tailwinds, had a net cash outflow from operations of S$1.9 million. Excluding working capital changes, Sembcorp Marine had negative operating cash flow of S$479 million. Throw in the capital expenditure of S$23.7 million for the period to maintain operations, and the company is still burning significant amounts of cash.
Though the balance sheet is less leveraged now, the company is still not out of the woods yet. If things don’t turn around operationally, don’t be surprised to see another round of cash injections.
Just because a company is “too important to fail” doesn’t mean that shareholders will not face crippling losses. Although Sembcorp Marine seems to be a strategic asset that Temasek will continue to support, survival doesn’t mean shareholders are saved. On the contrary, while the company is in better shape today than in 2019, its shareholders are much worse off.
There were clear red flags for investors. Sembcorp Marine’s worsening free cash flow generation, poor near-term liquidity, and dependence on external factors that were beyond the company’s control (such as oil price movements) were major warning signs that investors should have been looking out for.
I feel for Semcorp Marine shareholders who have lost a chunk of their investment. But this episode also serves as an important lesson and a handy reminder on what red flags to look out for and how to avoid the next investing mistake.
Note: An earlier version of this article was published at The Good Investors, a personal blog run by our friends.
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Disclosure: Jeremy Chia does not own shares in any of the companies mentioned.