3. RISK FACTORS 3. RISK FACTORS In evaluating an investment in the IPO Shares, prospective applicants should carefully consider all information contained in this Prospectus including but not limited to the general and specific risks of the following investment considerations:3.1 RISKS RELATING TO THE INDUSTRY IN WHICH THE DELEUM GROUP OPERATES Deleum Group is a provider of supporting specialised products and services for the exploration and production of oil and gas. These specialised products and services supplied by the Group are primarily utilised in the upstream sector of the oil and gas industry, which focuses on exploration and production of oil and gas. The level of oil exploration, development and production activities in the oil and gas industry has a direct impact on Deleum Group’s operations. The factors which may affect the level of oil exploration, development and production activities include, inter alia: (a) Volatility of Oil Prices Oil is an internationally traded commodity which price fluctuates with the constant interaction between supply and demand. Unforeseen supply disruptions, geographical and political factors are amongst an entire host of factors that may influence the market price of oil. There exists a direct correlation between oil prices and the level of activity in the oil and gas industry. Exploration, development and production of crude oil reserves accelerate or decelerate with fluctuations in correlation to global prices of crude oil. The event of a prolonged period of lower oil prices may discourage various exploration, development and production activities reSUlting in lower demand for product and services provided by oil and gas support companies such as Deleum Group. For example, the Group experienced in 1998 a deferment of projects in the period subsequent to the Asian Economic Crisis of 1997 due to the downward spiral of crude oil prices which resulted in lower activity in certain areas of the Deleum Group’s business base. Nevertheless, the Deleum Group was able to sustain its operations due to a well diversified portfolio of specialised product and service offerings. However, in the event of a significant prolonged period of depressed oil prices, there can be no assurance that the Group will not be materially affected by this risk. An upward trend in oil prices could result in an increase in oil exploration, development and production activities as the potential returns from the upstream activity increases. The sustained current high crude oil prices is the present market driver of the oil and gas industry, motivating oil companies to further explore and develop new oil fields and/or fields that were previously considered not commercially viable. Consequently, the level of activity in the industry has increased resulting in a higher demand for Deleum Group’s products and services. (b) Activity in the Malaysian Oil and Gas Industry Pursuant to the PDA, PETRONAS is vested with exclusive ownership to Malaysian oil and gas reserves. The PDA provides for all exploration and exploitation of petroleum by PETRONAS in Malaysia, and accordingly, any initiative to undertake the exploration and extraction of crude oil and gas in Malaysia can only be carried out via a PSC with PETRONAS. 23 3. RISK FACTORS (Cont’d) Consequently, any new terms that may have an adverse impact to the regular terms of a PSC such as reduction of profit sharing of the contractors under the PSC may lower the level of oil exploration, development and production activities as the contractors will be less motivated to carry out crude oil exploration and extraction activities in Malaysia as well as preclude investors from future ventures. This reduction in the level of oil exploration and extraction will lower the demand for products and services provided by oil and gas support companies such as the Deleum Group. In the event PETRONAS does not react to change the terms of the PSC to reflect the current market, global conditions or economic situations that affect the oil and gas industry, many PSCs may be discouraged to enter the Malaysian oil and gas market, resulting in a downturn of market activity and consequently affect the performance of the Deleum Group. However, in the event PETRONAS reacts timeously to the current market conditions, the resultant outlook will be favourable for the Group. The oil and gas industry is one of the major contributors to the Malaysian economy, both as a source of energy and a major foreign exchange earner, and as such, it is expected that there will be continued growth in the industry in terms of steady stream of contracts and in turn, revenue and growth in the long term. (c) Currency Risks The oil and gas industry in Malaysia significantly depends on specialised products and services imported from abroad. As a result, service companies in the oil and gas industry, like the Deleum Group, depend on overseas suppliers to effectively conduct and sustain their businesses. As such, fluctuations in the foreign currency rates may have an impact on the price of specialised products and services imported by the Group to be supplied to its customers. However, the Group mitigates its exposure to foreign currency fluctuations by entering into contracts for both the supply and sale in the same currency. This forms a natural hedge, ensuring that the Deleum Group is not adversely affected by unfavourable foreign currency movements. Notwithstanding the above, there can be no assurance that foreign currency fluctuations will not adversely affect the Group. (d) Depletion of Natural Resources Hydrocarbons are non-renewable sources of energy. In that connection, all hydrocarbon producing regions, including Malaysia, will eventually be depleted, if no new finds are progressively discovered. As at 1 January 2006, hydrocarbon reserves in Malaysia were as follows: (i) Reserves of crude oil (including condensates) totalled 5.25 billion barrels of oil equivalent. If these reserves were extracted at a constant rate equal to the Crude Oil (Including Condensate) production rate recorded in 2006, production is projected to continue for twenty (20) years.
(ii) Reserves of natural gas totalled 14.66 billion barrels of oil equivalent. At the current daily rate of Natural Gas production, production in Malaysia is projected to continue for 34 years.
(Source: Independent Assessment of the Supporting Specialised Products and SeNices for the Oil and Gas Industry prepared by Vital Factor Consulting Sdn Bhd) 24 3. RISK FACTORS (Cant’d) However, the National Depletion Policy introduced to safeguard the exploitation of the natural oil reserves by postponing development and control of the production of major oil fields will ensure that the extraction of hydrocarbons is carefully managed and sustainable over the long term. PETRONAS has also stepped up exploration efforts, especially in deep-water exploration, in an effort to prolong the lifespan of the industry. In addition, current reserve estimates tend to be conservative and may underestimate the actual amount of hydrocarbons that is ultimately extracted, as they do not take into account the existence of undiscovered oil reserves as well as the technological advances which increase the amount of oil which may be commercially extracted from existing reserves and the production from previously inaccessible regions. The Group seeks to mitigate these risks through, inter alia, securing long term contract agreements in terms of provision of services, equipment and parts to its various customers. The Group also intends to expand its overseas activities and is currently pursuing markets outside of Malaysia, which includes amongst others, the ASEAN region, Middle East and African countries where opportunities in oil and gas industry exist, in order to reduce dependency on any single geographical market. (e) Political, Economic and Regulatory Considerations Changes and developments in political, economic and regulatory conditions in Malaysia and the countries in which the Deleum Group operates could materially and/or adversely affect the profitability and business prospects of the Group and industry in which it operates. These uncertainties include, but are not limited to, the changes in political leadership, changes in investment policies and taxation, expropriation, nationalisation, changes in interest rates, changes in regulatory structure, risks of war and global economic downturn. The Group’s revenue and its ability to achieve and sustain profitability depend on the overall demand for the products and services that the Group offers. Any economic slowdown in the world, region or national economy may cause the Group’s customers to defer purchases of the Group’s products and services. Uncertainty in the global economic environment may cause some businesses to curtail or eliminate spending and as such may have an impact on the Group where certain customers may curtail their procurement of products and services. Although the Group practices efficient operating procedures and prudent financial management, there can be no assurance that adverse political and economic developments, which are beyond the Group’s control, will not materially affect the performance of the Group or the industry as a whole. (1) Regulatory Compliancel Dependence on Licenses/ Permits All service providers wishing to participate in the oil and gas industry in Malaysia are required to obtain the necessary licenses, or registrations with PETRONAS and other relevant authorities. All of these licenses and registrations are only valid for a stipulated time frame which is renewable subject to compliance with the relevant conditions. The requirements set out by PETRONAS and the authorities may be subject to changes, which could then affect certain operations of the Group. Failure by the Group to renew, maintain or obtain the required licenses and registrations may have an adverse effect on the Group. 3. RISK FACTORS (Cont’d) As such, there can be no assurance that the licences and registrations will be renewed within the anticipated time frame or without any new terms and conditions imposed, nor the future legislative or regulatory policy changes will not affect the operations of the Group. Nevertheless, the Group will continue to ensure that it is compliant with the relevant requirements/regulations at all times. In addition, any fundamental changes to PETRONAS’ policy with regards to the regulation of the oil and gas industry may occur. These changes either by restricting or liberalising the regulations governing the oil and gas industry may have an adverse or favourable impact on how the Deleum Group operates. If restrictive, there can be no assurance that the business of the Group will not be materially affected by these changes. (g) Profit Margins The Deleum Group has a broad business base in the oil and gas industry spreading across its three (3) business segments as highlighted in Section 1.1 of this Prospectus. The profit margins generated by these three (3) business segments consist of a combination of revenue with relatively low gross margins and revenue with relatively high gross margins. Notwithstanding the above, the Group seeks to mitigate this risk by increasing the profit margins of the Group. It is the management’s objective to increase the Group’s business base further in the higher margin business segments, primarily in the value added and services sector. 3.2 RISKS RELATING TO OPERATIONS AND BUSINESS OF THE DELEUM GROUP (a) Business Risks The Group is subject to business risks common to the industry at large. This may include amongst others, changes in government policies, shortages in skilled workforce, fluctuations in demand for its products and services, market acceptance of new products and services, changes in general economic, competitive conditions in the industry, business and credit conditions and other business risks common to going concerns. The Group has to a certain extent experienced some of the business risks mentioned above which had affected the operations of the Group particularly during the post Asian Economic Crisis period, in 1998, mentioned in Section 3.1 (a). However due to the diversity in its provision of supporting services and specialised equipment, the Group was able to continue sustaining its operations profitably. The senior management of the Group have in excess of twenty (20) years relevant experience in the industry and further the other management and technical personnel of the Group having in excess of ten (10) years of relevant experience as well. However, no assurance can be given that any changes in these factors would not have any material adverse impact on the Group’s business and profitability. 3. RISK FACTORS (Cont’d) (b) Operational, Health and Safety Risks Like any other business involved in the oil and gas industry, the Deleum Group’s operation of its business is subject to disruption by a variety of risks and hazards, which are beyond its control such as fires, explosions, leakages, energy crisis and other accidents at the oil and gas facilities. These risks could ultimately result in personal injury, business interruptions and potential legal proceedings. To address these risks, the Group has established a safety policy that clearly sets out the safety measures that must be strictly adhered to by its employees and contractors. Refer to Section 4.2.14 for the Group’s Health, Safety and Environment (“HSE”) policies. The Directors believe that these risks are mitigated through the periodic audits of its health and safety procedures and practices, drills, continuous health and safety meetings and reviews, training and other measures. While the Group places heavy emphasis on health and safety throughout all levels of its operations and undertakes continuous health and safety training for its employees, there is no assurance that incidents and damages will not occur. The Directors of the Group will use their best endeavours to ensure that an adequate level of insurance coverage against such risks is maintained. Notwithstanding the above, no assurance can be given that any insurance coverage arranged will be adequate and available to cover all and any claims arising therefrom. (c) Reliance on Suppliers, Partners and Principals Oil and gas support service companies like the Deleum Group are dependent on their suppliers, partners and principals for the supply of certain supporting specialised products and services. The Group relies on its partners and principals for the supply of certain products and services as disclosed in Section 4.2 of this Prospectus. These partners and principals are internationally renowned corporations supporting the oil and gas industry, namely STI, Vetco, S8M and ReedHycalog. Any severance of these relationships will have a negative impact on the Group’s ability to supply those specific supporting products and services to their customers. Although there is no assurance that the Group will be able to maintain these partners and principals, the Group currently enjoys long-standing relationships with its partners and principals, majority of which have been dealing with the Group for five (5) years or more and some for twenty (20) years or more. In addition, the Group seeks to mitigate this risk by maintaining good working relationships and ensuring obligations are fulfilled. In addition, this is further mitigated by establishing joint ventures with local operations, thus enhancing the local support and operations of these partners and principals. (d) Dependence on the Domestic Market The Deleum Group is an established player in the provision of specialised products and services supporting the domestic oil and gas industry. The Group also has all the relevant licenses and registrations pertinent to its operations. For the financial year ended 31 December 2006, 93.35% or approximately RM403.6 million of the Group’s proforma revenue was derived from Peninsular and East Malaysia. The balance of 6.65% was derived from the Joint Development Area. However, the local oil and gas industry is still very active with new and existing PSC operators increasing activity through deepwater exploration and development activities, marginal field developments and enhanced recovery. 3. RISK FACTORS (Cant’d) Thus it is expected that the local oil and gas industry will continue to be active and grow in the near future. Further as mentioned in Section 3.1 (d) above, the Group is looking at expanding its current operations overseas, where opportunities in oil and gas industry exist, to mitigate against any over dependence on the domestic market by spreading its revenue base over a greater geographical area. (e) Foreign Operations Risk Currently, the Group’s only foreign operation is an IPP in Phnom Penh, Cambodia, operated by its associate corporation, CUPL. The risks affecting CUPL are mitigated as follows: • The power purchase agreement is signed with a take-or-pay clause, which would sufficiently protect its business profitability as far as market risk is concerned;
• CUPL’s only customer, Electricite du Cambodge, is a wholly owned government agency, and as such credit risk is less likely to materially affect CUPL’s income; and
• There are also separate agreements signed with its suppliers for fuel, spare parts and lubricating oil to ensure continuity of plant operations.
In addition, as mentioned in Section 3.1 (d) above, the Group is looking at expanding its operations overseas to those markets where opportunities in oil and gas industry exist. Unfavourable developments in political, economic, government control and regulatory framework of these overseas markets may affect the Deleum Group’s plans for expansion. Any unfavourable developments not assessed or accounted for may cause disruptions to these future overseas operations. There can also be no assurance that any changes in the policies of the foreign governments with respect to foreign investment and repatriation of profits will not materially and adversely affect the operations and business of the Deleum Group. The Group will mitigate the abovementioned risks by collaborating with established and reputable local partners and associates as well as undertaking thorough due diligence, prior to the commencement of any overseas ventures or entering into any overseas contracts. (f) Dependence on Directors, Key Personnel and Skilled Workforce The nature of the oil and gas industry demands for high levels of skill and technical competency. The Deleum Group believes that its continued success in the industry will depend, to a significant extent, on the abilities and efforts to attract and retain specialised and skilled personnel. To date, the Group has been guided by its experienced Directors and managed by a team of qualified key personnel who have extensive knowledge and experience in the oil and gas industry. This is proven by the Group’s established track record as a provider of supporting specialised products and services in the oil and gas industry for approximately 25 years. The credentials and list of Directors and key personnel of the Group are set out in Section 5 of this Prospectus. In addition, the Group emphasises on-the-job training coupled with scheduled training, succession planning and incentive driven remuneration to motivate its employees to continue enhancing and supporting the Group’s operations. 28
3. RISK FACTORS (Cont’d) The Group continuously seeks to enhance its human capital by also importing new talent into the Group. Notwithstanding that the Group currently employs a broad base of personnel with varied and extensive experience in the industry, the Group will continually face the challenge of retaining its personnel and attracting new talent. There can be no assurance that the above measures will always be successful. If the Group is unable to attract and retain skilled personnel, the performance and future prospects of the Group may be adversely affected. However, the Group has and will continue to provide competitive compensation packages to its personnel and maintain a conducive working environment for them.
(9) Dependence on Key Customers The key customers which contributed more than 10% of the total proforma Group revenue for each of the past three (3) financial years are as disclosed in Section 4.9 of this Prospectus. Of note are SSB/SSPC, MDFT, PCSB, Murphy and PGB which collectively contributed to 74.4% of the total proforma Group revenue for FYE2006, PCSB and SSB/SSPC which collectively contributed to 53.8% of the total proforma Group revenue for FYE2005, and SSB/SSPC and EMEPMI which collectively contributed to 49.5% of the total proforma Group revenue for FYE2004. There are approximately ten (10) major oil and gas exploration and production companies in Malaysia and the Joint Development Area, including PCSB, SSB/SSPC, EMEPMI and Talisman. The Deleum Group, like any other service company in the oil and gas industry, is dependent to a certain extent on its relationship with these oil and gas exploration and production companies. The key customers of the Deleum Group in anyone financial year may change depending on the level of activity undertaken by any of the oil and gas exploration and production companies. However, the Group is confident that with its diversified range of supporting specialised products and services, it will be able to adapt to any changes in the level and field of activities in the industry by these major players and to continue offering a wide range of products and services to them to avoid over-dependence on anyone particular customer. Further, as at the financial year ended 31 December 2006, the average length of relationship the Group has with its top twenty (20) customers is nine (9) years, of which the Group has had a relationship of more than twenty (20) years with four (4) of its customers. However, there is no guarantee that the business relationships with these customers may not be disrupted. Nevertheless, the Group believes that its long-term business relationships with its customers will mitigate any possible disruption to such relationships.
(h) Competitive Risks The Group faces competition from both local and global service providers in the oil and gas industry. Although there is competition between the local licensed service providers in the industry, the threat from new entrants is relatively low due to high barriers of entry in terms of initial capital investment and working capital resources, technical expertise, skilled workforce and the requirements for licenses and registrations with PETRONAS and other authorities. 3. RISK FACTORS (Cont’d) As a mitigating factor, the Group believes that its proven track record of approximately 25 years, and its team of experienced and skilled personnel will enable the Deleum Group to remain competitive in the future. Nevertheless, there can be no assurance that the Group will be able to maintain or increase its market share in the future in light of competition from existing players and/or potential new entrants into the industry. This risk is mitigated by the Group’s historical track record, dedicated, experienced and skilled personnel, ready access to technology, synergistic services and products through its strategic alliances with global players who are specialists in various fields to meet customer requirements, quality of services, high safety standards and prompt delivery. In addition, the Group has successfully established a reputable track record associated with quality, reliability as well as technical expertise.
(i) Control by Promoters! Substantial Shareholders After the IPO, the Promoters and substantial shareholders, as set out in Section 5 of this Prospectus will collectively control 74.4% of Deleum’s enlarged issued and paid-up capital. As a result, the Promoters and substantial shareholders will be able to exercise some influence over the direction and matters governing the Group requiring the vote of the Company’s shareholders unless they are required to abstain from voting by law, covenants and/or by the relevant authorities.
(j) Environmental Concerns The Group believes that its existing operations are in compliance with the relevant environmental legislation governing activities within Malaysia such as the stringently monitored Environmental Quality Act, 1974. Nevertheless, there is a possibility that the Government may change its regUlations with regards to environmental matters in the future which would require the Group to modify its facilities or incur expenses that could have an effect on the Group’s operating results.
(k) Litigation! Legal Uncertainties Save for the litigation disclosed in Section 14.5 of this Prospectus, the Group is not engaged in any litigation, claim and arbitration, either as plaintiff or defendant, which has a material effect on the financial position of Deleum or its subsidiaries and the Directors do not know of any proceedings pending or threatened or of any facts likely to give rise to any proceedings which might materially and adversely affect the position or business of Deleum or its subsidiaries. However, there can be no assurance that the existing legal action will not materially and adversely affect the position or business of the Group and that there would be no further actions that could adversely affect the positions or business of the Group in the future.
(I) Conflict of Interest Save as disclosed in Section 7.1 of this Prospectus, none of the Promoters, directors and/or substantial shareholders of Deleum are in positions which may give rise to potential conflict of interest arising from their directorships and/or shareholdings in Deleum Group as at 6 April 2007. 30 3. RISK FACTORS (Cont’d) To mitigate any potential conflict of interest, arising from common directorships, the Directors and substantial shareholders of Deleum will provide a declaration that all business transactions between the Group and the Directors and substantial shareholders and their related persons, shall be based on arms length basis and on commercial terms that shall not be disadvantageous to the Group and not to be involved in any new business in the future, which will give rise to competition/ conflict with the current business of the Group. (m) New Products and Services The development and introduction of new products and services into the Group’s existing portfolio of specialised equipment and services supporting the oil and gas industry is a continuous process and is coupled with the future plans of the Group in Section 4.11 of this Prospectus. The markets for the Group’s future offerings are often characterised not only by changes in customer requirements or needs, technological developments and enhancements, but also upon customers’ acceptance of its products and services as well as its ability to address the needs of its customers. As a mitigating factor, the Group continuously exercises due care in the evaluation of the market trend and customer requirements or needs over time and focuses on developing solutions to meet its customers’ need. (n) Investment Activities Risk and New Ventures If appropriate opportunities present themselves, the Group may from time to time acquire additional businesses or invest in synergistic new ventures. As such, there is a potential risk that these investments may have longer than expected gestation periods or may not be entirely successful. In this event, the Group may take time to recover or be unable to recover its initial investments. The Group plans to mitigate this risk by exercising due care with effective evaluation and assessment prior to the commencement of such business or ventures in relation to customer demand or market trends. 3.3 OTHER RISKS RELATING TO THE DELEUM GROUP (a) Achievability of Forecast Results It should be noted that the profit forecast are based on various assumptions with respect to the levels and timing of revenues, cost and various other matters of an operational or financial nature, which the Directors of the Company believe to be reasonable. A forecast, by its very nature, is subject to uncertainties and unexpected events, many of which are outside the control of Deleum Group and its Directors. Also, events and circumstances often do not occur as anticipated and therefore actual results may differ from the forecast either positively or negatively. Accordingly, the Directors cannot and do not guarantee the achievement of the forecast. The consolidated profit forecast should be reviewed in conjunction with the description of the business, the historical financial information and other material contained in this Prospectus. Potential investors should note carefully the bases and assumptions to the profit forecast. 3. RISK FACTORS (Cant’d) (b) Disclosure Regarding Forward-Looking Statements Certain statements in this Prospectus are based on historical data, which may not be reflective of the future results, and any forward-looking statements in nature are subject to uncertainties and contingencies. All forward-looking statements are based on forecasts and assumptions made by the Company, and although believed to be reasonable, are subject to unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements to differ materially from the future results, performance of achievements express or implied in such forwardlooking statements. Such factors include, inter-alia, general economic and business conditions, competition and the impact of new laws and regulations affecting the Group. In the light of these and other uncertainties, the inclusion of any forwardlooking statements in this Prospectus should not be regarded as a representation of the Company or its adviser that the plans and objectives of the Group will be achieved. (c) No Prior Market for Securities There is currently no public market for the Company’s Shares. There can be no assurance that an active market for Company’s Shares will develop and continue to develop upon or subsequent to its Listing on the Main Board of Bursa Securities or, if developed, that such a market will be sustained. The IPO Price of RM2.55 for the Public Issue and Offer Shares has been determined after taking into consideration a number of factors, including but not limited to, the Company’s financial and operating history and condition, its prospects and the prospects of the industry in which the Company operates, the management of the Company and the market prices for shares of companies engaged in business similar to that of the Company. There can be no assurance that the IPO Price will correspond to the price at which Deleum’s shares will trade on the Main Board of Bursa Securities upon or subsequent to its Listing. (d) Capital Market Risks
The performance of the local bourse is very much dependent on external factors such as the performance of the regional and world bourses and the inflow or outflow of foreign funds. Sentiments are also largely driven by internal factors such as the economic and political conditions of the country as well as the growth potential of the various sectors of the economy. These factors invariably contribute to the volatility of trading volumes witnessed on Bursa Securities, thus adding risks to the market price of the listed securities. Nevertheless, the profitability of the Deleum Group is not dependent on the performance of Bursa Securities as the business activities of the Group have no direct correlation with the performance of securities listed on Bursa Securities.
(e) Failurel Delay in the Listing
The occurrence of anyone or more of the following events may cause a delay in or cancellation of the listing of Deleum Shares on the Main Board of Bursa Securities: (i) The identified investors failing to subscribe to the portion of Shares intended to be placed to them;
(ii) The Sole Underwriter exercIsing its rights pursuant to the underwriting agreement to discharge itself from its obligations thereunder; or
32 3. RISK FACTORS (Cont’d) (iii) The Company being unable to meet the public spread requirement as determined by “Bursa Securities, including a minimum of 1,000 public shareholders holding not less than 100 Deleum Shares each upon completion of the IPO and at the point of Listing. (f) Delay between Admission and Trading of the Issue Shares The date of Admission will normally occur at least two (2) clear Market Days after the Issue Shares have been allocated to investors’ respective CDS Accounts in Bursa Depository. Delays in the Admission and the commencement of trading in shares on Bursa Securities have occurred previously. In order for Deleum to return monies to investors in respect of Issue Shares following their allotment and issue, a reduction of Deleum’s share capital would be required. This would require a special resolution of its shareholders and such resolution would have to be confirmed by the Malaysian High Court. There can be no assurance that monies can be recovered within a short period of time or at all. If Bursa Securities does not admit the Deleum Shares for the listing, the market for the Deleum Shares will be illiquid and it may not be possible to trade the Deleum Shares. This may also have a material adverse effect on the value of Deleum Shares. THE REST OF THIS PAGE IS INTENTIONALLY LEFT BLANK