[Please note that this is my 2nd article on the Swiber saga. I have published a 3rd article titled “DBS’ loans to Swiber: What the 1990 Oscar Best Actor told us“.]
Following my earlier article on Swiber’s liquidation published on 29 July 2016, we now know that Swiber Holdings Limited (“Swiber”) did a back-pedal last Friday (29 July 2016) and said it would be placing the company under judicial management (“JM”) instead. In a statement to the Singapore Exchange (“SGX”), Swiber said its board of directors and the provisional liquidators held discussions with the company’s major creditor, who indicated that they are supportive of an application for JM instead of liquidation. The major creditor was not named but Singapore’s DBS Bank confessed that it has a SGD700 million (US$522 million) exposure to Swiber.
For readers who are unfamiliar with the corporate rescue regime of JM in Singapore, one can get a quick grasp of its mechanism at this website which provides a briefing on Singapore’s restructuring and insolvency regimes. In layman terms, the key effect under JM is that creditors are not allowed under the law to commence or continue legal proceedings against Swiber (e.g. to demand repayment), nor can the creditors enforce their security over assets belonging to the company, unless the court or the judicial manager approves it. This is known as the “statutory moratorium” under JM.
The news commentaries since this abrupt turn has generally been one of approval, on the conventional thinking that unlike liquidation — which effectively sounds the death knell for a company — JM and its moratorium will allow Swiber the breathing space to continue operating and be rehabilitated back to financial health via a court-supervised process. Some news commentaries have also questioned why Swiber’s board did not opt for JM as a first move instead of liquidation.
I must confess that my career training in financial analysis (apart from legal training) has endeared me to relying on quantifiable empirical facts when we promulgate our views. As such, I tend to seek out opinions that are verifiable with hard data rather than anecdotal, gut-feel or consensual ones. Judging from the private messages and comments that I have received from readers (to whom I am thankful for) after my earlier Linkedin publication on Swiber, I believe the one pertinent question bothering the minds of Swiber’s many unsecured creditors, suppliers, contractors and other stakeholders like employees and customers should now be: does JM really give Swiber a good chance of being rehabilitated back into a going concern?
I. WHAT THE HISTORY OF JM CASES IS TELLING US
Unfortunately, the historical data does not bode well for Swiber or its unsecured creditors. Since its introduction in 1987, the JM regime in Singapore has not secured a very successful track record in relation to the rehabilitation of financially troubled companies. There are few reported or documented cases of companies that have gone into JM, restructured themselves under the control and management of a judicial manager, and emerged from JM as financially viable businesses. This is the finding of the Report of the Insolvency Law Review Committee (the “Report” and the “Committee”) published in 2013. This Committee was appointed by Singapore’s Ministry of Law in November 2010, chaired by Senior Counsel Lee Eng Beng of Rajah and Tann (a leading Singapore law firm), and comprised leading insolvency lawyers, academics and stakeholders to review the existing corporate insolvency regimes before making recommendations on an Omnibus Insolvency Bill. According to this Report, between 1996 and 2010 (a span of nearly 15 years), of 135 JM cases granted by the Singapore court and reviewed by the Committee, only 52 cases (or 38.5%) were “successful”. A “successful” JM was defined by the Committee as one when “all the debts of the company were paid and management was returned to the board of directors, and/or those which fulfilled the purposes of the JM order (the purposes being the survival of the company or the whole or part of its undertaking as a going concern and to carry out a more advantageous realisation of the company’s assets than on a winding up). In this regard, where a company had filed for JM to facilitate a better realisation of its assets than in a winding up, any subsequent winding up of the company was not viewed as a failure.” It must be pointed out that (i) the Committee’s definition of “success” is actually quite broad (contrary to what the low success rate may imply); and (ii) the above 38.5% success rate includes those companies which eventually still underwent winding up after what was likely a more advantageous realisation of the company’s assets — which I interpret to mean a more patient, organised sale instead of a fire-sale under liquidation. This also means that the percentage of JM cases that continued as financially viable going concern, be it in whole or in part, would be smaller than 38.5%. What happened to the other 61.5% of “unsuccessful” JM cases? These unsuccessful cases were, according to the Committee, “wound up for reasons such as where the JM order was brought about by deception or where the purposes of the JM order were incapable of achievement.”
II. REASONS FOR THE LOW SUCCESS RATE OF JM CASES
So what have been the causes of this low “success” rate for companies that had undergone JM in Singapore? There are a few possible explanations:-
- The JM regime is usually resorted to far too late down the road when the operating conditions and financial health of the company have already deteriorated so much that the company is left with little reasonable hope of reversing the tide.
- While we have no doubt that KPMG, or any court-appointed judicial managers, are very competent professional accountants and financial managers, it is inevitable that they will lack the necessary experience and expertise in managing an offshore oil and gas services business. The judicial manager’s understandable lack of practical industry expertise will add to the difficulty of genuinely rehabilitating Swiber back to financial viability at this very late stage.
- The abovementioned moratorium on creditors’ legal actions against Swiber does not prevent Swiber’s counterparties from applying remedies such as contractual termination clauses and contractual set-off to protect their own commercial and legal interests. As such, a company in JM may find its debtors or customers offsetting what they may owe the company against any liabilities owed by the company to them. Such offsetting deprives the company of much-needed working capital that goes towards boosting the company’s cash flow from operating activities — the most dependable type of cash flow I emphasised in my earlier publication on Swiber. It denies the company’s finance manager the option of stretching the payables cycle while shortening the receivables cycle — a useful technique of improving operating cash flow.
- The moratorium also does not prohibit contracts already signed between Swiber and its customers and/or suppliers from being unilaterally terminated by the latter, since Swiber going into JM is likely to be treated as an “event of default” granting right of termination under the typical terms of such agreements. Such unilateral termination will disrupt or hamper Swiber of its ability to perform revenue-generating works. Even for contracts that are not terminated, being in JM does not change the fact that the profit margins on some of these so-called EPIC (Engineering, Procurement, Installation & Commissioning) contracts are anything but epic. It is no wonder that Swiber’s gross profit margin has steadily fallen from 17.3% in 2011 to 11.0% in 2015. Executing such EPIC projects will only continue to strain Swiber’s balance sheet because the company will have had to pump in cash to foot sub-contracting bills while waiting on slow and lumpy payments from end clients. The judicial manager cannot do much to change such industry practices and shorten the cash conversion cycle. Last but not least, the moratorium also does not prevent key management and employees from leaving the company for more secure and greener pastures. All these add up to challenges for the non-expert judicial manager to maintain continuity in the company’s business.
- Another potential, intangible damage done to a company under JM is the ensuing bad press and witch-hunt which denigrate the company’s reputation, existing and potential business relationships and prospects, and then cause counterparties to avoid procuring from, supplying to or any form of dealing with Swiber — unless strictly on an upfront cash basis which is the very thing that Swiber does not have in abundance. The counterparties cannot be blamed, because there is no clear statutory provision that confers priority on debts incurred by the company in the course of its JM — see Section 227J(3) of Singapore’s Companies Act (the “Act”). In such circumstances, counterparties will have no direct claim against the judicial manager (who will typically exclude any such personal liability) but will have to look to the company for payment — which is a credit risk that they will no longer want to assume. To use George Soros’ theory of reflexivity, the initial perception or expectation finds expression in various forms of action or behaviour, which then continuously reinforces the perception or expectation in feedback loops.
III. WHAT ABOUT A “MORE ADVANTAGEOUS REALISATION” OF THE ASSETS?
Theoretically, one of the 3 objectives of JM is “a more advantageous realisation of the company’s assets” than would be effected on a winding up” — see Section 227B(1)(b)(iii) of the Act. Some observers have expressed hope for achieving this objective because, on paper, the total assets of the company (US$1.99 billion) exceeds its total liabilities (US$1.43 billion), according to Swiber’s 1QFY2016 report as at 31 March 2016. However, a meaningful analysis will require us to drill down into Swiber’s balance sheet on a line-by-line basis, read with the Notes to Accounts in its 2015 annual report for a detailed composition of its various types of assets.
The biggest question mark will be the realisable value of its Property, Plant and Equipment (commonly called “PPE”) with a book value of US$677.7 million as at 31 March 2016 (unaudited). Of this, an amount of US$230 million is in respect of assets held under finance leases (see page 97 of Swiber’ 2015 annual report). The bulk of Swiber’s PPE is its fleet of 13 construction vessels and other support vessels. It is highly uncertain how much more advantageous prices that a patient sale (instead of a fire-sale) of those owned construction vessels can fetch in the current distressed and oversupplied market for offshore construction and support services for shallow water oil and gas field development. It is also highly uncertain when this market will recover sufficiently, as even a further rebound of crude oil prices may not translate into quick return of sizeable, high margin works as the industry attempts to cut its excess capacity and costs. That said, Swiber does have a relatively young fleet which makes for easier selling, with 11 of its 13 construction vessels being less than 10 years old. .
Secondly, for the US$141 million of “Investments in associates”, about half is contributed by Swiber’s 27% shareholding in SGX-listed Vallianz Holdings Limited, which share price has fallen by approximately 50% year-to-date and this stake is worth only about US$16 million at the time of writing, i.e. less than 25% of its approximate book value as at 31 March 2016.
Thirdly, the US$741 million of receivables under its current assets may also need provisioning for potential execution and collection risks, considering the current low level of provisioning (less than 2% only) vis-a-vis the heightened collection risk from counterparties in the same industry —- unless we believe that Swiber’s customers have zero cash flow problem themselves. I know Swiber’s auditors audited that impressive receivables figure in the 2015 annual report, but they also didn’t tell us that the group was already having issues as a going concern, did they? And I won’t even get started on other items like Inventories and Goodwill.
A “more advantageous realisation” of the company’s assets should by no means mean sale at or even near the last reported book values of these assets. All the abovementioned prudent write-downs to the assets’ realisable values will likely cut the amount of total assets to below the amount of total liabilities on Swiber’s balance sheet. Buying more time with JM may bring better prices on these assets, but waiting could just as likely bring worse prices too.
WHAT’S THE BEST-CASE SCENARIO?
Now, as a down-to-earth type of guy, I’m not used to wild dreaming and hoping, so I’m ruling out a filthy-rich China sugar-daddy or Dubai oil sheikh coming in with a voluntary general offer for the shares of Swiber at 0.5 times price-to-book (by the way, the stock is now trading at less than 0.1 times of its book), and then taking on all the debt owed by the company. Nevertheless, I suspect the best-case scenario for Swiber may be a combination of the following:-
(a) a white knight in shining armour offering to buy part or all of its owned construction vessels, properties and investment in Vallianz etc. at fair prices vis-a-vis their recorded book values (e.g. 50% of book value for the owned construction vessels);
(b) DBS Bank recovering a substantial part, if not all, of their S$403 million working capital loans to Swiber for two large projects, if these projects are completed and payment duly collected from the customers (please see my 3rd article on DBS’ loans to Swiber);
(c) Swiber winning new sizeable contracts (in the order of a few hundred million USD) with better-than-recent profit margins, which will represent a drastic improvement from the current situation of companies performing work at break-even levels just to repay the interest on their debt; and
(d) that long-delayed US$710 million West African project awarded by an as-yet anonymous party coming back on stream and some more.
But, as history is telling us, the probability of a mix of (a), (b), (c) and (d) happening is only 38.5%.