This article first appeared in The Edge Financial Daily on April 26, 2017

UMW Oil & Gas Corp Bhd
(April 25, 64 sen)
Maintain hold with a fair value (FV) of 65 sen: The Edge Malaysia weekly reported over the weekend that the proposed merger between UMW Oil & Gas Corp Bhd (UMW-OG), Icon Offshore Bhd and Orkim Sdn Bhd may be difficult to conclude after UMW-OG extended the deadline to conduct due diligence on the other two companies to May 19 this year.

Also, the cut-off date to fulfil, waive or complete the conditions precedent for the merger will be extended by an additional three months to July 19 this year.

In our view, the cancellation of the merger is value-enhancing for UMW-OG. Recall that we viewed the proposed acquisition (together with the demerger from UMW Holdings Bhd) of Icon Offshore and Orkim at unjustified price-to-book values of one times and 3.6 times respectively, versus UMW-OG’s 0.8 times, as value-destructive for the group against the backdrop of an offshore sector still struggling with operating losses.

Without the acquisition, we estimate that the merged entity’s much-needed recapitalisation plan, via a RM1.8 billion renounceable rights issue at 50 sen per share with a free detachable seven-year warrant, could have been cut by 60%, resulting in a significantly lower dilution for minority shareholders.

Should the proposed merger be aborted together with the absence of value erosion from the high prices to be paid for Icon Offshore and Orkim, we estimate that UMW-OG’s fair value could be raised by 15 sen to 80 sen per share.

Operationally, there will only be two rigs in operation in the first quarter of financial year 2017 (1QFY17) — Naga 6 and Naga 8 — while Naga 2 and Naga 5 will be temporarily added on charter in 2QFY17.

With a fleet utilisation rate that can only reach 50% at best and impacted by significantly lower new charter rates, the group’s losses and negative cash flow are unlikely to abate in the near term unless there is a significant reversal in regional rig utilisation rates, which are currently below 40%.

Hence, the stock currently trades at a 38% discount to its latest book value of RM1.04 per share, which could still be eroded by further losses, together with the still likely scenario that the value-dilutive merger with Icon Offshore and Orkim proceed as planned. — AmInvestment Bank, April 25