SembMar - Customer defaults on final payment for semisubmersible

Sembcorp Marine has announced that it has terminated the contract for the recently completed semi-submersible rig, PetroRig I, originally built for PetroMena, as final payment was not made under the construction agreement. In accordance to its rights under the contract, SMM will now proceed to sell the rig in the open market.

The rig is a 6th generation ultra-deepwater semi-submersible rig, capable of operating in 3,000 metres water depth and harsh environment drilling conditions. The contract was originally secured in October 2005 and was valued at US$423m. We understand that the final payment outstanding amounts to around US$200m.

SMM says it is confident that it will be able to sell the rig and to recover all outstanding amounts owed to the shipyard, and that the event will not have any material impact on SMM. We believe that SMM will be able to secure a good price for the rig, as demand for deepwater assets still remains relatively buoyant. We estimate that the rig would be worth around US$550m, in the current market.

We also clarified with SMM that if it is able to secure a better market price for the rig, it will not be entitled to an extraordinary gain – it is only allowed to recover its contract value as well as administrative and legal costs, with the surplus to be returned to bondholders who are financing the rig building.

In addition to this rig, SMM had subsequently undertaken another 2 semisubmersibles newbuild contracts from Petromena, with the same specifications as PetroRig I. These are due to be delivered in September 2009 and January 2010 respectively. The second contract was secured in March 2006, with a value of US$480m, and the third was secured in Jan 2007 for US$524m. However, despite the default on Petrorig I, SMM is obliged to continue construction work on these other 2 projects, as these contracts itself are not in default. Essentially, the non-payment on the first rig by the same customer has no legal bearing on these contracts, as they are considered separate. SMM has already secured a 50% payment for the two rigs, and will be entitled to dispose of these rigs in the same manner as the first rig, in the event of non-payment. We will keep tabs on the progress of these two other rigs.

While this incident demonstrates that SMM has protected itself against payment defaults, the situation still increases the risk burden on SMM, as it is now subject to market pricing of these assets in order to secure payment. This incident reinforces our cautious outlook on the offshore sector. We are maintaining our Hold recommendation on SMM, with a target price of S$2.07.

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