Temasek has walked away from its Keppel offer: What happens now?

Temasek Holdings has just dropped a bombshell on shareholders of Keppel Corporation Limited.

In an announcement released over the National Day weekend, the state-owned investment firm has decided that it will not proceed with the partial offer of the oil and gas conglomerate.

As a recap, Temasek first announced that it intended to acquire an additional 30.55 per cent of Keppel back in late Oct 2019.

The offer price was $7.35 and the intention was for Keppel to remain listed on the local bourse.

There were, however, a set of pre-conditions that had to be fulfilled before the offer could take place.

Early last month, we had written about whether the Temasek offer may be in jeopardy.

The main bugbear, known as “material adverse change” (MAC) clauses, requires Keppel to maintain a certain level of net profit and net asset value for the acquisition to proceed.

When Keppel released its second-quarter 2020 earnings on July 30, it reported a massive impairment of $930 million that caused it to report a net loss of $537 million for the first half.

CEO Loh Chin Hua of Keppel noted, in an analysts Q&A session, that the MAC clause in respect of net profit after tax has not been fulfilled.

Now that Temasek has formally withdrawn its offer, Keppel’s share price has slumped 11 per cent to close at $4.79, a ten-year low.

So, what’s next for Keppel? Can it pick itself back up again?

Non-cash adjustments

First off, investors need to understand that the aforementioned $930 million impairment is a non-cash item within the profit and loss statement.

In simple terms, a non-cash item has no impact on cash flow, which represents the lifeblood of any business.

If these impairments are excluded, Keppel would have made a core net profit of $393 million, which is around 5per cent higher year on year.

Taken in this light, it can be seen that Keppel, as a group, is suffering mainly due to its offshore and marine division.

The rest of its divisions are still profitable, which brings us to our next point.

Diverse revenue streams

Apart from offshore and marine, Keppel also has other divisions such as property, infrastructure and investments.

Together, these other divisions have all reported net profits for the second quarter.

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Being a conglomerate has its advantages – the different divisions help to cushion against a downturn in any one specific industry.

That said the property division is also facing tough conditions due to slower residential sales at Keppel Land. However, other major markets in China and Vietnam have done well.

Keppel Land’s commercial property portfolio has also remained resilient despite the pandemic.

With a residential land bank of around 45,000 units and a commercial portfolio with 1.7 million square metres (half of which are under development), Keppel’s property division looks poised to continue contributing positively to the group for many more years.

Infrastructure division has also reported a higher year on year net profit, though part of this came from a reclassification for Keppel Infrastructure Trust.

Keppel also managed to raise additional cash through the selling of units in Keppel DC REIT.

Vision 2030

Keppel’s management has announced its Vision 2030 plan back in late-May that will guide the long-term strategy and transformation of the group.

The plan will allow Keppel to evolve into one integrated business and a market leader for sustainable solutions.

The group’s business focus will shift to a more asset-light model, and capital allocation will take on a more disciplined approach based on four key criteria.

Prospective investments will have to contribute towards Keppel’s long-term 15 per cent return on equity target, possess scalability, be synergistic, and have an alignment with the group’s mission, vision and environmental, social and governance (ESG) goals.

The aim is to focus more on renewables and sustainable solutions as oil and gas’ role in the global economy diminish over time.

Other promising areas include green data centres and integrated smart district development.

The idea is to slowly but steadily grow Keppel’s recurring income while shifting away from lumpy, project-based earnings.

Get smart: A bold vision, but a long wait needed

The withdrawal of the offer by Temasek is a stumbling block for Keppel.

However, the group has already set in motion plans to transform the organisation.

Management has identified and singled out macro trends such as technology proliferation, ageing populations and rapid urbanisation.

The group is ready to identify opportunities arising from a post-Covid-19 world, which will see a changed landscape in the way we work, learn and live.

Keppel should be lauded for its bold vision, but investors must brace for a long wait as the group steers itself away from its legacy strengths and embraces new goals.

The group still has latent value within it, but it will take time and patience for this value to be eventually realised.

This article was first published in The Smart Investor. Disclaimer: Royston Yang owns shares in Keppel DC REIT.