Sold Mermaid Maritime, a disappointment

We sold our meagre holdings in Mermaid Maritime (5000 shares at $0.41), which has been a disappointment. Since the loss of key management, the company has been trying to restructure as a drilling company with the purchase of two oil rigs from Keppel Corp, but we believe that without credible management, it will be difficult for the new entity to succeed. We have reluctantly cut our losses on the stock, and the experience will serve as a reminder that companies with suspect management should not feature prominently in an investment portfolio.

Mermaid buys rigs, price appears a good deal

Mermaid Maritime today announced that it has entered into a letter of intent for the construction of two new jack-up rigs with Keppel Corp, under a proposed new entity “Asia Offshore Drilling Limited” (AOD). The contract is for US$360 million, which works out to about US$180 per rig, and is based on Keppel FELS proprietary Mod V-B class of jack-up rigs. Mermaid is in the process of seeking other investors to form a JV under AOD, and will likely be the major shareholder of the new entity.

We have talked about Mermaid’s huge cash reserves, and the company has now indicated its intent to invest in new rigs to form an offshore drilling entity, likely focused in the Asian region. Is the price paid too high? We dug out old contract values for similar (or identical) Mod V-B class jack-up rigs from Keppel Corp:

On a price basis, the US$180 million per rig price tag appears substantially lower (a 30.5% discount) compared to the US$259 million average paid by other customers from 2005 to 2010. Relative to the price of WTI Crude oil (taken as a simple ratio of rig price in USD millions to oil price in USD), the low ratio for the AOD deal suggests that Mermaid got a good deal on this one. We are slightly puzzled by the disparity in the contract value; the rig appears to be of the same make (under Keppel FELS’ Class B design) as others detailed in prior contracts. With oil prices above US$80, we would also assume that Keppel Corp would have more pricing power.

We own both Keppel Corp and Mermaid Maritime in our portfolio, and read this as a positive development for Mermaid, as the company has now indicated its intent to deploy cash in an area within its expertise. The price paid also appears cheap in comparison with other similar rig contracts. While it looks like Keppel Corp makes out worse on this one, the deal will add to Keppel Corp’s rapidly declining order book, and the positive sentiment associated with the contract is possibly more important than the associated profit.

Mermaid secures work for MTR-1

As previously guided by the management, the MTR-1 has secured work as an accommodation barge, at a day rate of US$20,000, paltry compared to the US$80-90,000 which the rig should be able to obtain as a tender rig. Nevertheless, the contract means that the MTR-1 will no longer sit idle for the next 160 days, and will bring in revenue of about US$3.2 million.

Further disposal by Mermaid Maritime

Mermaid Maritime yesterday announced the disposal of its 22.5% interest in Allied Marine & Equipment Sdn. Bhd., a provider of subsea engineering services to the offshore and gas industry. Mermaid will receive RM75,537,524 for its stake in the company (approximately US$23.4 million), which will result in a gain of about RM38,388,453, a profit of almost US$12 million.

There is certainly serious "house cleaning" going on in Mermaid Maritime, and the proceeds of the sale (expected 15 September 2010) will add to the substantial cash balance. As an investor in the company, we can only hope (and pray) that the management will use the cash well.

Mermaid cuts losses on KM-1

Mermaid Maritime announced on 21 June that it had sold off its stake in the KM-1 tender rig project, which has been plagued with delays. The disposal will result in a loss of US$7.35 million to the company, about a $0.013 hit to tangible book value of approximately $0.72.

The KM-1 was expected to be a key source of earnings going forward, which explains the sharp selloff following the news. While the move is highly disappointing, valuing the company based on its book value (and huge cash horde) shows that the stock now trades at a 35% discount to book (factoring in the loss on KM-1). At such a steep discount, we are reluctant to sell, but we are cognisant that how management deploys its current cash holdings (as well as the cash to be received for the disposal transaction) will be critical to the company's success.

The stock has certainly been a major disappointment, but the company is likely to have over $110 million in cash at the end of 2010 (current market value is $365 million), and we will watch to see what opportunities this cash horde will buy at the end of the year. We are not keen on adding to our small holding in the company given the lower conviction we have in the management (which recently saw the departure of its Managing Director), but will look to see how the company deploys the vast funds it has at its disposal.

Mermaid Maritime extends contract for MTR-2

Mermaid Maritime (a beleagured performer in our portfolio) today reported an extension of its MTR-2 rig's drilling contract with Chevron in Indonesia. The rig was originally contracted until June 2010, and the rig's services have been extended for another 9 months. The company cited a potential contract value of US$24.5 million, which works out to about a US$90,700 day rate, up slightly from the US$88,814 gross day rate for 2009.

While the day rate was not up substantially, it is comforting to know that Chevron's contract has been extended. MTR-1 remains a disappointment, having not secured any work since September 2009, and the 6-month lull period anticipated by the management has been too optimistic a scenario. However, a third rig (KM-1, 75% owned by Mermaid) is slated for delivery this year (after originally scheduled for a 4Q 09 delivery), and will be contracted for 5 years drilling for Petronas.
 

Portfolio drops 8.1% in May, STI down 6.9%

The portfolio fell 8.1% in May (to $0.978 per unit), against a 6.9% drop for the STI (on a total return basis). On a year-to-date basis (at 31 May 2010), the portfolio is 2.2% lower, compared to the STI's 3.6% decline. The month of May was a very poor month for our investments, as Greek debt fears and Korean tensions compounded negative investor sentiment. Most major markets were lower for the month, while small cap stocks suffered huge losses as investors fled riskier assets.

On a month-to-date basis, F&N, WBL, STI ETF and Capitaland were the best performers, falling 0.8%, 3.1%, 4.7% and 4.8% respectively. The worst performers were Mermaid Maritime (-34.9%), Memtech (-25.1%) and Guocoleisure (-18.5%).

We have obviously made very poor investment decisions with our small cap picks, and our investment in Mermaid Maritime looks particular disasterous. The company reported a larger-than-expected quarterly loss, and its unutilised tender rig now appears to be on the market for use as accommodation (day rates of about US$20-30k, rather than drilling activity (US$70k and up). Coupled with the woes in the gulf of Mexico due to the Deepwater Horizon spill, drillers are not having the best of times despite the relatively high price of oil (which appears to be sustained above US$65). While Mermaid's activities are largely in South East Asia, the poor earnings announcement and negativity on offshore drilling at present are weighing down on the stock. We admit our failure to cut losses on the position, but we are very reluctant to sell the stock at a near-40% discount to book (about $0.77 a share). 

Memtech obviously suffers from a lack of liquidity, and has fallen 25.1% in May on relatively low volume. The business appears to be turning around (the company made US$967,000 in 1Q 10, from a $746,000 loss in 1Q 09). The company continued to generate cash in 1Q 10, and its cash balance stood at US$40.32 million at the end of the quarter, before the payment of the annual dividend. 75.1% of the stock's market cap is covered by cash (after the dividend is deducted), and the stock trades at a 56.5% to NAV.    

Added Mermaid Maritime to the portfolio

Added 5,000 shares (at $0.725) of Mermaid Maritime, the Thai offshore company. Company owns two tender rigs and has a third to be delivered later this year. Currently, one existing tender rig is awaiting a new contract; strong oil prices could see the rig secure a higher charter rate, which could be a catalyst for share price performance in the near term. The stock trades slightly below book, has a long track record of specialisation in the area of offshore services, and has a strong parent (Thoresen Thai Agencies), so corporate governance issues are unlikely to arise.