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Marco Polo Marine: Termination of rig construction contract.

Saturday, November 21, 2015

It has been more than a year since I blogged about how I managed my exposure to Marco Polo Marine. 

I believe that it is a good example of how we could size our investments not only based on our motivations and whether the investments meet those motivations. It is also a good example of what we could do if the investments' ability to meet our motivations should change over time.

Marco Polo Marine had a very good track record even through the Global Financial Crisis a few years ago. I was also impressed by their foresight to move into the business of OSVs and not just stick to tugs and barges. Things were looking good and they started paying dividends. 

To me, as an investment, Marco Polo Marine provided a nice combination of growth and income.

Without a working crystal ball, I definitely did not see an order for a jack up rig coming. It was a huge commitment and this is probably putting it rather mildly. Of course, if things were to pan out nicely, Marco Polo Marine would probably do even better to have an asset like a modern jack up rig which would bring their business to the next level.



However, I decided that the deal introduced a certain amount of speculation. I also decided that it would be difficult for Marco Polo Marine to continue paying a meaningful dividend with a heightened borrowing level. So, based on the way I allocate my resources, it would require that I thin my exposure to Marco Polo Marine and I did.

Of course, for a while now, we know that things did not pan out nicely, with the price of crude oil having plunged quite suddenly and plunged badly too. 

It does not look like things are going to improve until global demand rises enough to address the current oversupply of crude oil. Although the Cabotage Law in Indonesia will expand to cover jack-up rigs as well in the new year, there is no guarantee that Marco Polo Marine would benefit from it in such an environment. 

I still have a position in Marco Polo Marine and I actually added to this position in recent months as the stock price declined but only to a level at which I feel comfortable with a more speculative position. 



Now, with the news that Marco Polo Marine has terminated the contract with PPL Shipyard for the construction of the jack-up rig, what do I think?

The reason given for the termination is PPL Shipyard's "failure to comply with certain of its material contractual obligations". I believe it had to do with some quality issues found with the rig that is still under construction.

Apart from terminating the contract, Marco Polo Marine is also going to try and take back the 10% deposit it paid for the rig. Will they be successful? I don't know.

I do know that without the rig in the picture, Marco Polo Marine's balance sheet would be stronger. Their profit would also be higher. Yes, despite what some might think, Marco Polo Marine is still a profitable company.

In an environment of prolonged low crude oil prices, the rig order cancellation is probably more of a good thing, realistically. Of course, with the speculative overhang removed, how is Mr. Market going to treat Marco Polo Marine's stock? 



Sell? Buy? Hold? You tell me.

Marco Polo Marine's NAV per share is 52.8c and their EPS (9M FY2015) is 3.42c. 

4Q FY2015's results should be out soon and if we were to assume zero earnings in that quarter, at 19c a share, we have a PE ratio of 5.56x.

With the rig order cancelled and if there are no severe ramifications because of this, I think that Marco Polo Marine should eventually shake off the more speculative air that surrounds it as an investment.


See announcement: here.

Related post:
Managing exposure in investment portfolio.

13 comments:

Sillyinvestor said...

Hi AK,

I think it is very unlikely that there is limited consequences in this attempt by MM to cancel the order.

SM has already counter-sue MM

Of course, no one knows if the rig really has a serious quality issue or that MM is just trying to be a chow ka( wriggle its way out) since the rig is speculative without a charterer at the first place.

SM have the resources to fight a long drawn legal battle and both will lose and lawyers stand to gain.

But if Mr Market view is to be considered, he believed it is lose lose and MM is a chow ka if u look at the manuitude of falls of these 2 counters

Tigerz said...

Hi, I know its a bit off topic.
But can you comment on this article about CRT.

http://sbr.com.sg/commercial-property/more-news/croesus-retail-trust-books-jpy137m-loss-in-q1

AK71 said...

Hi Mike,

I agree that the people who will stand to benefit from this would be lawyers.

Is MPM going to win or is SMM going to win? Only those who have access to inside information might be able to tell.

I will simply wait and see. :)

AK71 said...

Hi Tigerz,

I believe that it has to do with the currency hedging done by Croesus Retail Trust. If the JPY goes up, their hedge will lose money. If the JPY goes down, their hedge will make money but it doesn't affect the distributable income, either way.

AK71 said...

An RHB Bank analyst note projects that the contract termination with SembMarine's 85-per cent-owned PPL Shipyard would result in a S$35-40 million profit reversal in SembMarine's Q4. "This prompts us to lower FY15F earnings by 9%," said RHB.

RHB research report noted SembMarine "did not deny that cracks existed on the rig's legs" even as it disputed Marco Polo's said allegations.

"Important details - such as the number, severity, exact locations of the cracks and whether the classification societies have had a chance to perform non-destructive testing to verify structural integrity - have not emerged," the report said.

Sources speaking to The Business Times on the condition of anonymity said that the tests - understood to have taken place under full pre-load conditions - on Marco Polo's rig were performed to assess the integrity of its legs and jacking system, which are critical to the safety of its eventual offshore drilling operations.

PPL was granted the opportunity to remedy the cracks spotted in the legs after the first test was performed, but more cracks were found after the second test. These were severe enough to give Marco Polo great concerns and had prompted the call for unilateral contract cancellation.

Marco Polo is seeking a refund of the 10 per cent deposit, or S$21.4 million placed with PPL for the jack-up rig construction. A second 10 per cent instalment originally due in February 2015 has been deferred on mutual consent as a result of a sectorial weakness, said the spokeswoman.

"Marco Polo has since lined up funding options and would have been in the position to make payment when it is due," she said. The company had also received in-principle understanding from a potential investor to co-own and co-operate the jack-up rig, she added.


Source:
http://www.singaporelawwatch.sg/slw/headlinesnews/73326-sembmarine-shares-lose-ground-on-rig-contract-spat.html#sthash.dTduBnMe.dpuf

AK71 said...

Marco Polo Marine has started the legal process to seek a refund of at least US$21.4 million from Sembcorp Marine (SembMarine) after the cancellation of a contract for a jack-up rig.

Marco Polo Marine on Tuesday said that its subsidiary MP Drilling has initiated the contractual dispute resolution process against SembMarine's subsidiary PPL Shipyard, which is provided for under the contract signed between both parties.

Marco Polo had on Nov 17 issued PPL a notice of termination of the contract, after the latter allegedly failed to comply with certain obligations.

Marco Polo said that it had found cracks on all three legs of the new rig during two rounds of tests, though repair works had been carried out by PPL after the first round of tests.

With the cancellation of the contract, Marco Polo would not be taking delivery of the new rig, it said in an update on the termination of the US$214.3 million contract. It is seeking a refund of the initial payment of 10 per cent of the contract price, which amounts to about US$21.4 million, and all other payments it had previously made to PPL, together with interest.


Source:
http://www.singaporelawwatch.sg/slw/headlinesnews/73642-marco-polo-starts-legal-action-in-rig-dispute.html#sthash.CdubnEwB.dpbs

sads said...

Singapore, 25 November 2015: Sembcorp Marine refers to the announcements made by Marco Polo Marine Ltd on 24 November 2015 and 17 November 2015, and the announcement made by Sembcorp Marine on 18 November 2015.
PPL Shipyard Pte Ltd’s (“PPLS”) position is that the contract is still subsisting and Marco Polo Drilling (I) Pte Ltd (“MPD”) is in repudiatory breach. PPLS did not accept MPD’s repudiatory breach. PPLS has elected to affirm the contract and PPLS’ lawyers have notified MPD’s lawyers of this election on 23 November 2015.

The contractual delivery date is 30 November 2015. When MPD purported to terminate the contract on 17 November 2015, the Rig was substantially ready to be completed for delivery. Based on the construction schedule, more than 98% of the Rig had been completed. The final phase of construction included a pre-load test and a jacking trial followed by non-destructive testing. Any defect discovered will be made good and retested to the satisfaction of the Classification Society and MPD before delivery. Notwithstanding the 30 November 2015 delivery date, the contract provided that PPLS has an additional 210 days after 30 November 2015 to deliver the Rig. PPLS therefore has more than enough time to make good any defect and deliver the Rig to MPD in accordance with the contract. In view thereof, MPD’s purported termination on 17 November 2015 is wrongful and without any justification whatsoever. PPLS is of the view that the purported termination by MPD is to avoid its obligation to pay the 2nd disbursement of 10% of the contract price (US$21.43 million), that has already accrued and due to PPLS immediately on the execution of the contract. This payment was deferred twice at the request of MPD, and is payable by 30 November 2015.

As for dispute resolution, as the contract is still subsisting, and the disputes are technical in nature, PPLS will be inviting MPD to refer the disputes to the Classification Society, whose decision shall be final and binding on the parties as provided for under the contract.

PPLS will also be seeking payment of the 2nd disbursement if MPD fails to make payment by 30 November 2015. All of the rights of PPLS are reserved.

Sembcorp Marine will make further announcements where necessary.

Above from Sembcorp Marine Announcement.

I have worked in this industry for 4yrs and when MPM announce the cancellation of the rig at such a late stage nearing delivery citing quality issues. The first thing that came to my mind is same as per PPL's view. It is not favourable to MPM from my humble point of view. There are class rules to be satisfied and all these technical issues can be settled, moreover with the 210 days after 30th Nov to deliver the Rig. PPL definitely had the time and resources (considering the lull period now) to repair the rig to the client and Class satisfaction (if there are). MPM will not have it easy this time

What is AK opinion?

AK71 said...

Hi sads,

Thanks for weighing in on this.

I am taking a wait and see attitude as this is now beyond my ken.

I only know as much as what is revealed in the media.

TangoXray said...

Do you think if Marco Polo loses the law suit they will be facing bankruptcy at worst case scenario? Guess?

The total value of the rig is higher than the current value of MP market value based on last price on 12/2. Not too sure if this is common scenario as I am not from this industry.

AK71 said...

Hi TangoXray,

Marco Polo Marine has the necessary financing tool in place to pay for the rig. So, it is unlikely that they would go bankrupt but their finance cost would escalate and if the rig was unable to be chartered out in a timely fashion, earnings would be negatively impacted.

ho2786 said...

Defects can be rectified.
Go to court most likely pay penalty of 30% of contract value to semcorp.
semcorp at best can sell at 50% of contract value if can find buyer.
both are losers.

Nightmare_Angel said...

Hi AK71,

Any comment on the drop in share price this week? Fundamentals still look ok but somehow the stock has taken a severe beating from the market. :(

AK71 said...

Hi NA,

It is probably a spill over effect from Swiber going bust.

If I were to hazard a guess, I think MPM would pull through this down cycle like they did before. The elder Lee now owns 62% of MPM's stock, after buying continually as the company's share price declined.

I have classified my position in MPM as speculative but I would be sorely tempted to add to this speculative position if its share price should decline further as its NAV per share is about 50c and, frankly, I cannot see oil prices staying low forever.

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