This article first appeared in The Edge Malaysia Weekly on April 25, 2022 - May 1, 2022
The Edge has reported extensively on the troubles plaguing Sapura Energy Bhd in the past few years. This week, we present our most comprehensive and detailed analysis of key events from the time of the mega merger of Sapura Crest Petroleum Bhd and Kencana Petroleum Bhd in 2012. We have our view on what went wrong and what can be done (The Edge Says, Page 60). Readers can also make their own conclusions from the facts and figures we have compiled from the company’s annual reports and other official announcements.
SAPURA Energy Bhd is on the verge of bankruptcy, only three weeks shy of the 10-year anniversary of the mega-merger between SapuraCrest Petroleum Bhd and Kencana Petroleum Bhd, which created SapuraKencana Petroleum Bhd in mid-May 2012. Its name was changed to the current one at end-March 2017.
From a merger valuation of RM11.85 billion, Sapura Energy’s market capitalisation swelled to RM28 billion in early 2014, following the acquisition of Seadrill Ltd’s rig business and Newfield International Holdings Inc’s Malaysian assets. At its peak, Sapura Energy was the world’s second largest integrated oil and gas service provider.
However, oil prices crashed in mid-2014 and with that, Sapura Energy’s fortunes followed suit. The company started chalking up losses in the financial year ended January 2016 (FY Jan 2016) and has been loss-making annually since then except for one year (FY2017). Its market capitalisation today is a mere RM639 million, even after a RM4 billion cash call — the rights issue in 2019.
How has Sapura Energy fared since the merger?
Looking at Sapura Energy’s financials for the past 10 years since its merger exercise, a lot can be concluded (see Table 1).
From FY Jan 2013 to FY Jan 2022, Sapura Energy has:
EARNINGS:
Generated total revenue of RM68.6 billion from continuing operations
Earned total earnings before interest, taxes, depreciation and amortisation (Ebitda) of RM12.7 billion from continuing operations
From which, it charged off depreciation of RM9 billion
Made total impairments of RM14.9 billion plus a write-off of deposit of RM173 million for the cancellation of its proposed Vietnam oil and gas (O&G) acquisition from Petronas
Earned interest income of RM228 million and paid interest expenses of RM6.4 billion
Received associate income of RM2.3 billion
In total, reported pre-tax losses of RM15.2 billion from continuing operations
Paid taxes of RM1.3 billion
Suffered total net losses of RM16.4 billion from continuing operations
Reported RM3.1 billion in total net profit from discontinued operations, including a gain on disposal, resulting from the sale of 50% of SapuraOMV Upstream Sdn Bhd
Suffered total net losses after tax and attributable to shareholders, from continuing and discontinued operations, of RM13.1 billion
BALANCE SHEET:
Net debt rose from RM4.9 billion in FY2013 to RM16.4 billion in FY2016, and RM10 billion in FY2022
Net gearing increased from 73% in FY2013 to above 100% annually from FY2014 to FY2022, except for FY2019 (64%) following the RM4 billion rights issue
Equity reduced from RM6.7 billion in FY2013 to just RM254 million in FY2022. At its peak, it was RM13.1 billion in FY2017 (pre-rights) and RM13.9 billion in FY2019 (post-rights).
CASH FLOW:
From FY2013-2022, Sapura Energy generated net excess cash from operations of only RM7.2 billion (barely 56% of Ebitda) but used total cash of RM21.5 billion
This resulted in a cumulative deficit cash flow of RM14.3 billion
It spent a total of RM19.5 billion on capex, acquisitions and investments in joint ventures (excluding debt assumed in acquisitions). Most of this was for the Seadrill (US$2.9 billion) and Newfield (US$895 million) acquisitions.
It paid total dividends of RM480 million to shareholders
The cumulative deficit in cash flow of RM14.3 billion was mainly funded by RM3.9 billion in net proceeds from the rights issue, RM3.9 billion in additional net bank borrowings (excluding debt assumed in acquisitions), net additional income of RM3.6 billion from the sale of 50% of the exploration and production (E&P) business and RM1.6 billion from the private placement in FY2014.
Note that the above statistics include the impact of a private placement in 2013 that raised RM1.6 billion, the rights issue of RM4 billion in 2019, and the disposal of 50% of the E&P business to OMV of Austria for US$975 million in 2019.
Oil prices crashed
Crude oil prices crashed in mid-2014 (see Chart 1). Crude oil prices had been steady, mostly above US$100 per barrel from 2011 to 1H2014, but halved in 2H2014, due to slowing demand, coupled with a sharp increase in supply from the US — thanks to booming shale production — and Organization of the Petroleum Exporting Countries (Opec) production moves, and so on. Oil prices slumped further in 2016 and 2020 before the recent sharp recovery due to the Russia-Ukraine war.
Looking back, the SapuraCrest-Kencana merger was undertaken at the peak of an oil price cycle. Its merger was proposed in July 2011 and completed in May 2012.
However, the merged entity went on to acquire more O&G-related assets and undertook exploration works, all at the peak of the oil cycle. Looking at its books, Sapura Energy paid premium valuations (with large goodwill) and took on large debts. As oil prices fell, the valuation of these assets had to be impaired, while projects suffered losses.
Kencana management left, control concentrated in Shahril
Looking at Sapura Energy’s plight, many questions need to be asked. A key one is — was there a lack of checks and balances within the company?
Sapura Energy was a merger of almost two equals, although Kencana was actually valued slightly higher at RM5.98 billion versus RM5.87 billion for SapuraCrest. However, a series of events in 2013 saw the departure of some of Kencana’s top management, leaving the company almost solely in the hands of president and group CEO Tan Sri Shahril Shamsuddin and his team from 2014 onwards.
Notably, Chong Hin Loon died on Oct 14, 2013, at age 65. He was executive director and executive vice-president, fabrication, hook-up and commissioning, of the merged company. Previously vice-chairman of Kencana, Chong was a seasoned O&G player and the founder of Kencana, which had its roots in Hin Loon Engineering, which Chong founded in 1982 and in which Tan Sri Mokhzani Mahathir invested in 2001.
Key executive directors from Kencana — Mokhzani and Datuk Yeow Kheng Chew, better known as KC Yeow — took a step back on Dec 4, 2013, and were redesignated to non-executive directors. In March 2015, both resigned from the board.
Incidentally, FY2014 was also the year that saw Shahril’s remuneration jump from just RM5 million in FY2013 to a whopping RM81.4 million (and increasing further in later years). That year also saw Sapura Energy embarking on major acquisitions and stretching its balance sheet, just before crude oil prices crashed.
Huge impairments
Between FY2016 and FY2022, Sapura Energy made total impairments of a whopping RM14.9 billion (see Table 2). Breaking down the impairments into segmental asset classes, it would appear two-thirds, or some RM9.8 billion, were related to the drilling operations. Another RM3.9 billion were for vessels, engineering and construction (E&C) and E&P, and RM1.15 billion for others.
A closer look at Sapura Energy’s segmental profit and loss shows that most of the losses were indeed from the drilling segment. From FY2015 (when drilling was segmented separately) to FY2022, this division reported total pre-tax losses of RM8.62 billion, while E&C chalked up total pre-tax losses of RM4.05 billion (See Table 3 on Page 59).
Bad acquisitions, especially drilling assets
In a nutshell, Sapura Energy’s losses were the result of bad strategic decisions and acquisitions, especially the major acquisition of Seadrill’s drilling assets.
In 2013, Sapura Energy acquired Seadrill’s rig and drilling operations for US$2.9 billion (RM8.82 billion), paying with cash, shares and a placement exercise. The acquisition gave Sapura Energy a 55% share of the global tender rig market. Unfortunately, the acquisition severely stretched the company and with the crude oil price crash, drilling activities suffered substantially.
Prior to the acquisition, Sapura Energy owned six tender rigs, five of which were owned and managed through a 51% joint venture with O&G and shipping billionaire John Fredriksen’s Seadrill. The other tender rig, KM1, was wholly owned following the merger with Kencana.
Under the Seadrilll transaction, Sapura Energy acquired an additional six semi-tender rigs and four tender barges from Seadrill as well as the remaining 49% equity interest in the existing five rigs. The number of operating tender rigs owned by Sapura Energy increased to 16, with the number of new builds increasing to five, making it the world’s largest owner of tender rigs.
Seadrill Ltd, the parent company listed in New York and based in Norway, itself has since gone into US Chapter 11 bankruptcy proceedings twice.
Other acquisitions made by Sapura Energy include Newfield’s Malaysian assets for US$895 million in 2014. It had also proposed to purchase Petronas’ Vietnam operations for US$400 million, but the deal was later aborted and Sapura Energy forfeited the 10% deposit, with RM172.5 million recognised as a loss in FY2016.
Note that prior to the merger exercise, Shahril and the former SapuraCrest already had a long history of mergers and acquisitions (M&A). SapuraCrest itself was formerly known as Crest Petroleum and was part of the debt-ridden Renong Group. Sapura Telecommunications acquired a 38.6% stake in Crest Petroleum Bhd from the Renong Group for RM105 million back in 2003 and renamed it SapuraCrest Petroleum.
SapuraCrest went on to acquire 80% of Australia-based Total Marine Technology Pty Ltd in 2005 and Labuan Shipyard and Engineering in 2011, among others. Just before the SapuraCrest-Kencana merger, SapuraCrest in 2011 acquired Clough Ltd’s marine construction and offshore engineering operations in Australia, the UK and the US for a cash consideration of A$127 million.
Incidentally and despite high crude oil prices then, Clough’s marine construction business that was to be acquired suffered a net loss of A$10.4 million in the financial year ended June 2011, according to SapuraCrest Petroleum’s circular to shareholders dated Nov 29, 2011. According to the circular, the Clough acquisition would have resulted in a loss of RM52.7 million for SapuraCrest Petroleum, from the A$10.4 million (RM33.7 million) net loss and RM19 million for expenses relating to the acquisition.
With these acquisitions, Sapura Energy’s geographical reach, as well as risks, expanded. In FY2013, the company derived 81% of total revenue from Malaysia. By FY2016, this ratio had dropped to 39%, and was 38% in FY2022 (see Chart 2).
Merger structuring saddled Sapura Energy with debt
The SapuraCrest-Kencana merger was structured to benefit shareholders of both SapuraCrest and Kencana, rewarding them with huge cash payouts funded by bank borrowings.
The newly merged company was saddled with extra debt during its restructuring exercise, with an extra RM1.96 billion of bank borrowings added to the merged entity, specifically for cash payments to shareholders of SapuraCrest and Kencana. As part of the exercise, shareholders of both companies received a total of RM1.84 billion cash, comprising RM875.08 million for shareholders of SapuraCrest and RM968.69 million for shareholders of Kencana.
Shahril had held a 40% stake in SapuraCrest and would have received an estimated RM350 million in cash payout for his stake in the company, apart from the shares in the merged entity — Sapura.
In the first post-merger quarterly financial statement, on July 31, 2012, the merged entity had gross borrowings of RM5.33 billion and cash of RM1.46 billion. Net debt was RM3.87 billion versus equity of RM6.45 billion, or a net gearing ratio of 60% — even before it embarked on several major acquisitions.
Debts continued to surge after major acquisitions
With a high starting debt level, the company went on to add even more borrowings through several major acquisitions, notably Seadrill’s rig operations and Newfield’s Malaysian oil assets — all in the space of a year and right at the peak of the crude oil price cycle.
Net debt jumped from RM3.87 billion (net gearing ratio: 60%) in July 2012 to RM4.92 billion (gearing: 73%) in FY Jan 2013; RM10.97 billion (gearing: 108%) in FY2014; RM15.7 billion (gearing: 131%) in FY2015; before peaking at RM16.38 billion (gearing 134%) in FY2016 (See Chart 3). Net gearing ratio crossed 100% in January 2013 and has not subsided.
Net debt eased in FY2019, falling to RM8.89 billion from RM14.7 billion in FY2018 following the RM4 billion rights issue and sale of 50% of SapuraOMV. Net gearing then was 64%, but it was not enough to address the issues, and net debt and gearing started to balloon again. As at January this year, Sapura Energy’s net debt was RM10 billion versus equity of only RM254 million.
Another question to ask is why banks aggressively funded so much of Sapura Energy’s expansion, especially when the company’s gearing ratios were already so high.
High salaries and related-party transactions
From FY2013-FY2022, Sapura Energy paid out total dividends of RM480 million. But huge salaries, incentives and payments were made out to Shahril and his vehicle Brothers Capital Sdn Bhd (co-owned with his brother Datuk Shahriman Shamsuddin), which wholly owns Sapura Holdings Sdn Bhd, which in turn now owns 12.82% of Sapura Energy.
Shahril drew huge remuneration and incentives from FY2014 onwards, even as the company posted losses from FY2016. His annual remuneration and incentives were between RM71.9 million and RM89.4 million from FY2014 to FY2018 (see Chart 4). His total income from FY2013 to FY2021 was RM443.9 million, or an average of RM49.3 million per year for nine years.
In FY2016, when Sapura Energy posted its first post-merger loss, Shahril’s remuneration was still a whopping RM83.4 million, down only marginally from the RM89.4 million in FY2015 when both Sapura Energy’s profits and his remuneration were at record highs. In FY2018, the company posted RM2.5 billion of net losses, but his remuneration was still a whopping RM71.9 million.
Apart from high salaries and incentives, there were also other forms of related-party transactions, with substantial payments made by Sapura Energy to both Sapura Holdings and Sapura Resources Bhd (a separate listed company controlled by Shahril and Shahriman), which owns an office building rented to Sapura Energy.
A notable feature was “intellectual property rights, trademarks and branding” fees, which totalled RM62.5 million in FY2013 and RM70 million a year in FY2014-2018 to both Sapura Energy and Kencana’s major shareholders (see Table 4).
From FY2013-2021, the company paid out RM438.4 million in such fees, of which RM295.8 million went to Sapura Holdings and RM142.7 million to Kencana Capital Assets. There was also total office rental of RM149.4 million paid in FY2013-2021 to both Sapura Resources and Kencana Capital Assets.
In total, excluding the related-party transaction office rental, we estimate Shahril and Shahriman’s Sapura Holdings received RM1.17 billion from FY2013-2021, comprising RM444 million in remuneration, RM296 million in IP rights and trademarks, RM350 million from the SapuraCrest-Kencana merger cash distribution exercise and RM79 million from dividends (See Table 5).
In comparison, all shareholders (excluding Shahril and Sapura Holdings) received just RM401 million in dividends. To cut a long story short, one single shareholder received three times what was paid to all other shareholders.
This amount of RM1.17 billion received by Shahril personally and with Shahriman’s companies, is equivalent to a hefty 9.2% of Sapura’s total Ebitda of RM12.7 billion earned over the past 10 years.
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