NEPTUNE MARINE SERVICES: THE TURNAROUND ACQUISITION The business. Neptune Marine Services is a subsea services operator. Its services include dry underwater welding, subsea and pipeline engineering, offshore asset integrity management, ROV services, hydrographic surveying, commercial diving, rope access and platform IRM (inspection, repair, maintenance). Singapore-listed peers in a similar line would be Kreuz Holdings and Mencast’s Unidive segment. The price. MTQ is effectively purchasing Neptune at a potential maximum price of A$59.6m, equivalent to a 31% discount to NAV and a 6.6% premium over Neptune’s tangible book value. This effectively writes down A$26.97m of intangibles out of A$30.66m on the books today. As of 11 Jan 2013, MTQ controls 80% of the total outstanding Neptune shares. The valuation. We believe that the subsea business is an attractive one, with operators like Kreuz and Mencast’s Unidive enjoying an upswing in business, driven by a global macro picture of increasing offshore oil & gas expenditure. Figure 12 Now leaner and getting meaner FYE 30 Jun (A$m) 2008 2009 2010 2011 2012 Cash and cash equivalents 18 24 22 11 8 Trade and other receivables 20 38 43 29 27 Inventory 3 5 6 3 3 Other current assets 1 2 8 8 9 Current Assets 42 70 78 51 47 Property, plant and equipment 23 69 82 25 25 Intangible assets and goodwill 115 146 164 63 31 Other longterm assets 118 151 169 70 34 Non-Current Assets 141 221 251 95 59 Total Assets 183 290 329 146 106 Trade and other payables 21 47 42 22 15 Borrowings: Current 2 13 39 4 1 Other current liabilities 4 9 2 1 1 Current Liabilities 28 68 83 27 18 Borrowings: Non-current 4 24 20 0 0 Other longterm liabilities 18 16 6 2 2 Non-Current Liabilities 22 40 25 2 2 Share capital 139 158 206 271 273 Other equity -6 24 15 -154 -186 Total Equity 134 182 221 117 87 Total Liabilities and Equity 183 290 329 146 106 Source: Company Neptune Marine Services is an asset-light business – its key assets are its divers, welders, and skills. On its books, physical equipment account for only A$25m out of A$106m of total assets. As such, we believe that the acquisition price of 69% NAV and 1.066x NTA represents a very attractive entry point. Five years of indigestion. As can be seen in the income statements below, 2008 and 2009 were good and better years for Neptune. However, in the three years 2008 to 2010, the previous management of Neptune went on an acquisition binge. Total investing outflows in those years were A$187m, causing physical assets to balloon from A$23m to A$82m and intangible assets to jump from A$115m to A$164m. Figure 13 The good old days FYE 30 Jun (A$m) 2008 2009 2010 2011 2012 Revenue 86.7 189.0 179.4 118.2 116.4 Cost of sales (41.5) (99.8) (124.9) (73.9) (78.5) Gross profit 45.2 89.1 54.5 44.3 38.0 Other income 1.9 2.0 2.3 1.1 0.0 Marketing expenses (0.5) (1.0) (0.8) (0.4) (0.2) Occupancy expenses (2.1) (4.4) (4.9) (4.3) (3.7) Corporate, shared services and Board expenses (10.3) (50.7) (48.1) (16.9) (12.1) Business operating expenses (21.4) 0.0 0.0 (36.1) (19.2) Technical expenses (0.0) (0.3) (0.2) (0.3) (0.3) Forex gains and derivative gains (0.1) (0.1) 2.7 0.0 0.0 Other operating expenses (0.5) 0.0 0.0 (6.9) (0.5) Finance costs (2.4) (4.9) (5.2) (3.7) (0.1) Profit before tax 9.8 29.9 0.3 (23.1) 1.9 Income tax expense (2.4) (8.9) 0.6 (2.1) (0.7) Exceptional losses 0.0 0.0 0.0 (103.2) (35.0) Discontinued operations 0.0 0.0 0.0 (14.9) (6.1) Profit after tax and minority interest 7.4 21.0 0.8 (143.3) (39.9) Source: Company Like every case study in business school, the financial consequences came quickly. 2010 saw a top line similar to 2009, but the sharply increased cost structure created a mere breakeven performance. Neptune bit the bullet and made a massive A$103m writedown in 2011 on the back of a A$23m loss before tax, and took another $35m charge in 2012, discontinuing certain operations in both years. Back to basics. Today, Neptune is convalescing. Having written down almost all its intangibles (and with the further writedown implicit in MTQ’s offer price), the downside risk to accounting profits has been capped. Following the sales of the Australian fabrication business and the US diving business, Neptune has refocused onto its core business of subsea services. The slide below is from a Feb-11 presentation by Neptune management titled “Back to Basics”, and we note that all the actions have been implemented as of today. Figure 14 Neptune’s Rationalisation plan: Businesses and assets Source: Company The doctor is in. With MTQ now controlling Neptune, an interesting set of opportunities opens up. Management has indicated that a key strategy will be cross-selling of services, and taking Neptune’s skills beyond Australia. We can easily see the synergies – MTQ’s equipment service business can be packaged with Neptune’s IRM services in Australia. Neptune’s divers can be taken out of Australia and deployed in the region, inspecting and servicing equipment for MTQ’s customers. Balance sheet is clean. Neptune is debt-free, being in a A$6m net cash position. With A$47m of current assets and $17.5m of current liabilities, working capital is a strong A$29.5m and the current ratio is strong at 2.7x. Long-term liabilities are insignificant at A$2m. Having been recapitalised, Neptune is now an equity-funded entity with total assets of $106m and total equity of $86.6m. With such a strong balance sheet, MTQ is purchasing a company with negligible insolvency risk. Margin challenges ahead. While costs are down to 2008 levels, margins are not. The strong profits of 2008-09 were during the good days when margins were in excess of 50%. We do not think that there will be a return to those margins, but today comparables like Kreuz are delivering stellar bottom-line performances with gross margins at 34%. For Neptune, we think that gross margins will stabilise at the 30-35% range, similar to peers’. Figure 15 The good old days 0% 10% 20% 30% 40% 50% 60% 70% 2005 2006 2007 2008 2009 2010 2011 2012 Gross Margin Source: Company, OSK More importantly, future profits. Neptune has been slashing overheads with operating costs down from A$64m in 2011 to A$36m in 2012, back to 2008 levels. Figure 16 Costs are back to basics too 0.0 10.0 20.0 30.0 40.0 50.0 60.0 70.0 2008 2009 2010 2011 2012 Overheads (A$m) Source: Company, OSK Can management further slash overheads? We think so. While details are sparse, there are plans to relocate offices out of the expensive Central Business District area, and also to improve efficiencies in the business. We also think that duplicate functions can be streamlined. Now that Neptune is a subsidiary of MTQ, there are potential savings in the “Corporate, shared services and Board expenses” line. Neptune-overhead-to-MTQ-profit elasticity of -1.6. A small cost reduction could have a significant impact on MTQ’s bottom line. If Neptune can cut costs by another 10%, the A$3.6m savings translate into an after-tax S$3.2m, which is a fairly large 16.6% of our FY13F PATMI of S$19m.
All eyes on Neptune Marine Services. Neptune is a very large investment – at S$60m it is 55% of MTQ’s current market cap. While it offers a potentially very large upside to earnings, it could also become a performance drag like the engine systems segment. An ameliorating factor is cross-selling – this has potentially more synergy than the engine systems segment does with oilfield engineering.
NMS Price at posting:
3.2¢ Sentiment: LT Buy Disclosure: Held