Contract cancellations confirmed. Keppel Corporation (Keppel) provided an update on the three contracts under review in a press release issued last Friday. Two of the contracts, namely Scorpion Offshore’s semi-submersible (Semi TBN), and Lewek’s Multi-Functional Support Vessel (MFSV), would be cancelled on mutually accepted terms, while the third contract with Seadrill on the newbuilding of two jack-up rigs (West Callisto and West Juno), would proceed with payment schedules renegotiated. The cancellations totalled US$455.4m, of which 22% would have been recognized in FY09, 38% in FY10 and the remainder in FY11. This would reduce our FY09’s and FY10’s revenue forecasts by 1.5% and 2.4%, as well as our FY09’s and FY10’s net profit estimates by 1.6% and 2.6%, respectively.

•Semi-submersible contract cancellation with Scorpion Offshore: We understand that Scorpion had paid a deposit of US$40m (10% of contract value) to Keppel. We think Keppel would appropriate this deposit, as a portion had been used to procure steel and machinery, which could be transferred for use in other projects. Keppel noted that it is currently assisting Scorpion in the discussion with third parties to take over the building of the semi-submersible. However, we believe the likelihood of this materialising is not likely.

•MFSV contract cancellation with Lewek Shipping. We note that Keppel had received a deposit of US$2.5m. We think this deposit is unlikely to be returned to Lewek Shipping.

•Continuation of jack-ups newbuilding with Seadrill on revised terms. We estimate a total deposit of US$73.5m had been collected from Seadrill, comprising of US$42m (20% of contract value) for the 1st 2nd jack-up and US$31.5m (15% of contract value) for the 2 jack-up. Keppel’s revised terms with Seadrill had been premised on the rescheduling of payments, which included deferred milestone 1st payments for the 1 jack-up and fully back-end loaded payments (ie. 2nd 85% payment upon delivery of vessel) for the 2 jack-up. No revisions are made to the delivery schedules of the jack-ups, expected in 2Q10 and 4Q10.

Seadrill’s revised terms not favourable to Keppel. While we see relief in Seadrill’s continuation to have jack-ups built at Keppel, we think the revised terms are not in Keppel’s favour, indicating a shift in bargaining power from 2nd yard owners to rig owners. This is especially true for Seadrill’s 2 jack-up, as we note that full payment would only be required upon delivery of the vessel and this does not come with a corporate guarantee. By having such an arrangement, we believe Keppel would be taking on asset pricing risk. This will be a concern if the values of jack-ups fall significantly. We also think it may set precedent and trigger more contracts to be renegotiated on similar terms.

Outlook remains cautious. We caution that Singapore yards, including Keppel, may continue to face potential cancellations from highly-geared rig owners that have difficulty to finance out of future operating cashflows. Owners building semi-submersibles on speculative intent are most at risk. With six semi-submersibles constructed at Keppel’s yard, three of which are not built on the back of period hire contracts, Ensco International is one such example.