Publish date: Wed, 14 Mar 2018, 09:48 PM 

 

If there ever was a company that symbolized the excesses of debt fueled growth coupled with the sky high price of oil in 2014, it’s this company.

Just 4 years 3 months ago. This company had a Market Capitalization of RM29.72 billion. Just RM4 billion shy of Nestlé’s market capitalization today.

Its founders, were the poster boys of success. Using an insane amount of debt, as well as some level of competence on their end, Shahril and Mokhzani fuelled their incredible ascend to stratospheric levels of wealth.

Which in more ways than one is very similar to incredible rise by real estate companies in China like Country Garden, Longfor Properties and China Evergrande Group.

In terms of debt, Evergrande takes the cake. At one point, it had a debt to equity percentage of more than 432%. Its currently at a slightly less suicidal 232%.

If not for their names or the color of their skin, i might have mistaken them for Chinese!

 

A very brief valuation

Net Debt: RM 15,382,767 million, or RM15.4 billion. The famous number.

Currently, Sapura has net debt of RM 15.4 billion. Paired against equity of RM12.2 billion, it has a debt to equity percentage of 126%. That does not look too bad. Companies like YTL Power have a higher debt to equity percentage of 149%.

Except, YTL Power have assets that give out recurring income very very very reliably. Even the Chinese property company above, have actual assets that can be sold to meet these obligations.

What does SAPNRG have?

Sapura Energy is the largest provider of tender assist rigs in the world. They also have other assets that are mainly used for upstream drilling.

This is not that bad of a problem, for usage of these rigs may not be that high compared to the capacity they have, oil prices should go up again, in a year, 3 years, or 7 years. (Donald Trump is really expanding shale oil which is based on land, he’s likely to maintain this policy until he is voted out or at the end of his second term).

Also, even if oil prices stay at USD60 per barrel. That is lucrative enough for companies to start drilling again. Capex planning works is very very hot right now for O&G companies.

If they could wait, it’s not that big of a problem. But with RM15.4 billion in debt and RM1 billion a year in interest payments. Time is luxury they do not have.

Also, there’s another thing.

Almost RM8.25 billion of their assets, consist of this item call “Goodwill on Consolidation”. What is this?

When a company buys over a company, with Net Assets of say RM100,000 for a price of, let’s say RM200,000. The difference is recognized as “Goodwill on consolidation”. It basically means this is the value of the intangible qualities of the business. That’s the accounting perspective.

From the investors perspective, unless your name is Coca Cola, that is worthless. You’d rather your name be worth zero on paper, but billions in reality, like Coca Cola. Rather than billions on paper but zero in reality.

In my opinion, this RM8.25billion is basically the total amount overpaid by Sapura Energy for the acquisition of the other companies. With the vast majority from the purchase of tender rigs from Seadrill (another oil and gas company that has gone bankrupt). This entire amount should have been impaired in the first place, at least if one was coming from an investor perspective.

But from an accounting perspective, its a little different. I know how an auditor would justify this figure. Review an acceptable and reasonable (at least on a first level thinking level) DCF from the management about how the companies bought are still worth the price paid, if oil prices go back up. The thing about DCF’s is, it’s a Hubble Telescope, move it a millimetre and you’re looking at a completely different universe.

Which makes it really hard for me to understand why anyone would pay more than RM1 for it, even during the peak. For the record, in my infinite stupidity, for my 2017 stock pick, as well as my personal portfolio then, I actually bought this, without even looking the report because I knew oil prices should be going up, and this name was the first one i thought of. Also, a friend said he likes Sapura’s “courage”. Luckily i sold 3 days later at a small loss the moment i read the accounts.

It’s amazing how courage looks like foolishness when one fails.

If we were impair it. The debt to equity ratio is now 386%. Higher than Evergrande, the most indebted of the Chinese property developers, except, they also own assets that are yielding close to all time low and selling at all time low prices.

If only they could wait it out.

As Kcchongnz have pointed out, a company has value as long as the debt does not exceed the assets. That means even if the goodwill is fully impaired, the company should still be worth around RM4bil or 62 sen, theorectically.

Thats a 19% margin of safety at current prices. You can definitely find other investments with higher levels of margin of safety.

But as a bet, its almost incomparable.

 

The Gamble

Now, we know from an investor perspective, it’s may be too risky due to the debt, and there are other investments out there with a higher margin of safety.

However, I can see something similar like Airasia in 2001 happening to it. Back when Airasia was sold to Tony for RM1, it had negative equity of roughly RM40 million and the directors had to guarantee 50%. After Tony purchased the company, he found also investors to inject roughly RM123 million into the company.

So, im probably being stupid here. But i can see a very deep pocketed company or individual either buying the company outright for RM2-3 billion and recapitalizing it.

Either way,  there needs to be a major equity injection via rights issue. Or a debt to equity swap, except at the current market capitalization, I don’t think that a debt to equity swap will ever go through, if all the debt is converted to shares, all the shareholders will have their shares reduced by 6.26 times. Shahril will end up holding 2.8% or so of a company from 17.5%.

However, from a gambling perspective, if you think this company won’t go bankrupt while they dig themselves out and that the 2 year forgiveness given by the local banks can be extended.

It’s looks very lucrative. (for more info, please refer to my article “The Art Of Gambling in Speculative Stocks.”

Because in this case, its almost as if the majority of your bet is financed by the banks.

While the upwards movement in price of the company due to increased earnings, belongs to you, the shareholder. Even the profit belongs to you!

In Sapura’s case, the enterprise value of the company consist of 16% market capitalization and 84% borrowings. It’s as if the banks are funding and taking on 84% of the risk for your gamble that Sapura will survive long enough to take advantage of an increase in oil price and drilling activity.

In that situation, as an equity holder, it’s a heads I win, tails you (bank) lose situation.

Your only risk, is that the company goes bankrupt. Or the debt is swapped with equity, making your shares worth 6.26 times less in terms of % ownership of the company.

Personally, i don’t think the banks will ever push this company into a position where they need to declare bankruptcy, unlike Toys R Us, as unlike Toys R Us, i dont think its under threat from a fundamental shift in the world, or backed by assets worth far more than the company (a lot of great buildings and lands).

So the banks should still allow SAPNRG to live long enough to turnaround. But its a very tenuous assumption, relying on the goodwill of others to survive.

 

Conclusion

I’m almost tempted. But the sheer amount of discounts in the small to mid cap these days is mind-boggling and i’m saving cash for property when if the economy crashes. Stocks, you can always move to a margin account.

So I’ll pass. I’m a better investor than trader anyway.

But for those that go for it, or the traders in our midst, do let me know what you think. I’m curious about your perspective and i’d like to learn.