TOO - Teekay Offshore Partners L.P.

[BG2008]

 

The thing about "too hard" is that at somepoint, paying 6% cap rate for a trophy NYC building would've been "too hard" for me.  At one point, paying 10X FCF for a low cap ex, high switching cost, $5 bn company was too hard for me.  One of the things that I regret in my investing career is not aggressively learning as much as can about better/great companies.  In hind sight, there were a lot of cheap $1-20 billion market cap companies trading at 10x FCF that subsequently went on to become multi-baggers.  I was invested in almost entirely small caps.  What I have learned over time is that if you have to explain capital allocation and why share buybacks is actually good for the shareholders, maybe it's worth it to pay 2-3x more in FCF to a management team who will have the right capital structure and who will allocate incremental capital correctly.  Another concept that I learned overtime is that companies that stay at $200mm in market cap for 10-20 years in the capital markets tend to have good reasons.  It could be that the CEO is subpar or it could be that the business itself is subpar.  When you start to find billion dollar companies that command 30-50% of its market, it likely has some real leadership and structural advantage.  This is not a causation, but there is often a correlation. 

 

Yes, FRP was a no brainer.  But it was a no brainer after I thought about FRPH for 6 months.  How does anyone put a $200mm valuation on a bunch of rock pits that throws off $6-8mm of EBITDA?  I remember an analyst putting a $30mm valuation on the rock pits and used a DCF analysis.  That was a $17 delta in valuation back when the stock traded at $30 a share.   

 

I actually recently found a few other names that are cheaper and easier to understand.  So, yes, I may swap out of TOO into other names.  But I think the exercise is important.  The exercise is necessary to continue to expand the circle of competence.  Now, I understand that certain companies are simply not worth the time to understand, i.e. O&G production companies or generic shipping.  But as a value investor, one owe it to him/herself to keep expanding his/her knowledge base.  Given that this is a duopoly, it is extremely interesting to me.  The math that I laid out earlier is also helpful that TOO could potentially trade at the same price despite having $350mm of EBITDA in the shuttle tanker segment.  In that case, the risk has been significantly lowered.  But I agree that TOO likely has too much leverage for my liking in its current form.  Then again, the really good investors tend to own investments that has "ick" factors. 

 

 

I thought the above is excellent. I wholeheartedly agree with you. I guess I can clarify partly as I perhaps take into consideration the situations guys like us are in and didn't explain fully the context. You definitely put in a ton of time with your due diligence. But I'm sure you can also relate to not having 25+ analysts at your disposal and the fact that often all the work they'd be doing falls on you. Thus there is a value to the time you have to spend on an investment. That is part of the risk to reward equation. I think one should always try to expand their circle of competence. But there's also a bit of a time management skill involved and being able to determine when one is climbing Mt. Everest and getting paid $15 an hour to do so, just doesn't make sense.

 

Totally understand the sentiments here.  Frankly, I have missed out on a few big opportunities because I do not have a team of 25 analysts at my disposal.  Think big banks etc.  In hindsight, the big banks got really strict with underwriting.  I still can't refinance my mortgage.

 

Part of my journey into TOO is also tied to my background which specialize in hard assets.  The circle of competence starts at real estate and expands further out to pipelines (MLPs) and to some shuttle tankers.  It is a natural progression for me. 

 

Being a small fund, it is critical to decide and have a gut feel for what deserves your time and what doesn't.  None of us has the luxury of learning for the sake of learning.  That in itself is an art that gets refined over time.  The best way that I can describe TOO is that I think it sits above the risk/reward curve as you go up in leverage.  I think a lot of Brookfield investments tend to look very hairy at first.  I suspect there will be another entry point for TOO which may or may not be at a higher price but the leverage a lot more manageable today.  Hence, I could potentially swap out of TOO into something that's safer.  But it would be hard to achieve 5 year 3 bagger elsewhere. 

[peterHK]

Great thoughts and math BG.

 

I haven't done the math yet, but I agree with you on the following:

 

1) BAM is the signal. Asked if I would look at this the same way without BAM I would say that 1) capital allocation is better with BAM controlling the board and LP and; 2) yes, I would look at the underlying business the same way, BAM just found it before I did. What BAM (and I) want are the floating pipelines because of the superior economics. 

 

2) Goodco vs. badco is a good way to look at this (and I can see easily the differentiation between FPSO/Shuttle businesses). The other nice thing about goodco & badco structures is that the market tends to be lazy and not look through the financials. At some point you start getting inflection in the financials where goodco starts to take larger and larger share, and the metrics improve, and that's an additional catalyst to deleveraging that we can look forward to.

 

3) on oil/commodity risk. I think that's a risk on the growth side of things, but if we look how the company fared through 2015, revenues were remarkably stable, so in terms of business risk here, I think on the shuttle side it's relatively low. If you can buy it for a low enough value, then your margin of safety is that even with no growth, a 10% or 15% FCF yield results in pretty decent returns if the company pays out dividends or buys back shares.

 

4)  If we wanted to look at this really conservatively, then I'd start by taking the FPSO business down to $0, loading the debt on the shuttle business, and seeing how much of the current share price that justified and how they'd manage the debt. That's sort of your downside case really because of how stable the shuttle business is.

 

5) a wise investor with a 20 year track record of beating the TSX by 3% annually said to me "there's no investment where there's nothing wrong". The thing that's wrong here is leverage, but I think I tend to agree with how BAM is likely looking at this: it's much more like a pipeline than a shipping company (high capex, high value of in situ assets, contracted revenue stream, relatively stable earnings), and a pipeline can stand this sort of leverage if it's run well.

 

On the math, don't know if I'd agree or disagree as I haven't run the numbers myself. But qualitatively I think this is very interesting and has a lot of signs of what can be a very good business that is currently trading at a depressed multiple due to I think a capital structure issue that BAM and time can fix.

 

 

[petec]

On the pipeline analogy, do the contracts actually look similar? My understanding is the pipelines tend to have long term (but I don’t know how long), take or pay, inflation linked contracts. Is that the same for the shuttles?

[bjakes00]

Pg 13 and 14 from the latest quarterly has some detail on the contracts but still leaves a ton of questions:

https://www.teekay.com/wp-content/uploads/2018/04/Teekay-Shuttle-Tankers-Second-Quarter-Financials.pdf

 

There is some reference to the contract being inflation linked for time charters and reimbursement of costs under the Contract of Affreightment. The actual pricing mechanism is less clear and I suspect more information can only be gleaned from someone in the industry.

 

In terms of contract duration, their new builds that are going to the East Coast of Canada all have 15 year contract durations to get a sense for the length. That being said, the companies stated strategic goals are "contract extension" and the contracts are obviously linked to the life of the field that the shuttles are attached to.

[BG2008]

If you take the FPSO and Badco assets down to $0, you're insolvent today.  Keep in mind, some of the FPSO assets have contracts in place.  Overall, TOO has something like $6 bn of contracted revenue.  You can't stress test all investments by attributing segments with $0.  In this case, Badco has roughly $1.8bn of debt atttributed to it.  I guess you can assume that there is no net equity and all the future cashflow will merely pay down the debt.  I can live with that.  Then you ask yourself, what's the shuttle tanker business worth in the long run. 

 

Great thoughts and math BG.

 

I haven't done the math yet, but I agree with you on the following:

 

1) BAM is the signal. Asked if I would look at this the same way without BAM I would say that 1) capital allocation is better with BAM controlling the board and LP and; 2) yes, I would look at the underlying business the same way, BAM just found it before I did. What BAM (and I) want are the floating pipelines because of the superior economics. 

 

2) Goodco vs. badco is a good way to look at this (and I can see easily the differentiation between FPSO/Shuttle businesses). The other nice thing about goodco & badco structures is that the market tends to be lazy and not look through the financials. At some point you start getting inflection in the financials where goodco starts to take larger and larger share, and the metrics improve, and that's an additional catalyst to deleveraging that we can look forward to.

 

3) on oil/commodity risk. I think that's a risk on the growth side of things, but if we look how the company fared through 2015, revenues were remarkably stable, so in terms of business risk here, I think on the shuttle side it's relatively low. If you can buy it for a low enough value, then your margin of safety is that even with no growth, a 10% or 15% FCF yield results in pretty decent returns if the company pays out dividends or buys back shares.

 

4)  If we wanted to look at this really conservatively, then I'd start by taking the FPSO business down to $0, loading the debt on the shuttle business, and seeing how much of the current share price that justified and how they'd manage the debt. That's sort of your downside case really because of how stable the shuttle business is.

 

5) a wise investor with a 20 year track record of beating the TSX by 3% annually said to me "there's no investment where there's nothing wrong". The thing that's wrong here is leverage, but I think I tend to agree with how BAM is likely looking at this: it's much more like a pipeline than a shipping company (high capex, high value of in situ assets, contracted revenue stream, relatively stable earnings), and a pipeline can stand this sort of leverage if it's run well.

 

On the math, don't know if I'd agree or disagree as I haven't run the numbers myself. But qualitatively I think this is very interesting and has a lot of signs of what can be a very good business that is currently trading at a depressed multiple due to I think a capital structure issue that BAM and time can fix.

[peterHK]

If you take the FPSO and Badco assets down to $0, you're insolvent today.  Keep in mind, some of the FPSO assets have contracts in place.  Overall, TOO has something like $6 bn of contracted revenue.  You can't stress test all investments by attributing segments with $0.  In this case, Badco has roughly $1.8bn of debt atttributed to it.  I guess you can assume that there is no net equity and all the future cashflow will merely pay down the debt.  I can live with that.  Then you ask yourself, what's the shuttle tanker business worth in the long run. 

 

I don't stress test all investments by attributing segments with zero, but if you can show that the FPSO isn't really in the share price (ie trading at $0), but will generate cash flow in excess of the debt and thus have a positive NPV to the equity, that can be a nice margin of safety.

[gokou3]

Great discussion.  One thing I would note is that the price at which BAM bought the TOO shares is not really $2.50 but closer to $2.00.  If you look at Teekay's PR from July 27, 2017, by investing $610M for the common shares BAM also got ~62.43M warrants with an exercise price of $0.01, effectively free.  Thus, I would adjust their common purchase price to reflect the almost-free warrants.

[Steven B]

Great posts guys. I will raise my hand as one of the people who missed the Shuttle vs. FPSO goodco vs. badco. stuff that Packer and BG have highlighted. I knew that the Tanker was a less competitive business (hard time defining the duopoly/moat until I can reasonably explain it; I cant!) but missed the big picture. Thanks folks.

 

That being said I have some questions BG namely;

 

 

 

I believe the way to think about this capital allocation is that the $600mm will likely yield 17% EBITDA/Net PP&E.  Real economic ROA (net of 4.5% real D&A expense) will be 12.5%.  Thus, EBITDA will increase by $102mm in the shuttle tanker segment.  Now, the reality is that the company will also have some older shuttle tankers that will become obsolete.  There will be some cashflow that goes away.  The company typically sells the 20 year old tankers for 10% residual.  I don't know how much cashflow goes away due to the retiring of the fleets.  This is a piece of the puzzle that I have not been able to figure out.  Now extrapolating this out 5 yeas, if we assume that TOO invest roughly $300mm a year in shuttle tankers, this would equate to $1,500mm of shuttle tanker investments.  With a 17% EBITDA/Net PP&E return, this will generate $255mm more in EBITDA.  Of course, some of the older tankers will have to be retired.  But I can imagine that the run rate EBITDA for the shuttle tanker goes to roughly $400mm (assuming $250mm existing + $255 in newly acquired - $100mm in lost EBITDA due to retirement of tankers).  How much will this cost?  If we assume an overall 60% LTV, the equity needed would be $600mm for the $1.5bn of purchases.  The debt amount will increase by $900mm.  The additional interest cost will be $54mm.  TOO generates roughly $570mm of EBITDA as a company today.  The current interest payment is roughly $205mm.  In short, there is $365mm available for allocation towards debt pay down and new shuttle tanker purchases. 

 

 

Assuming that $1500M investment nets you 10 shiny new tankers, does it make sense that they contribute you the same about of EBITDA at the current fleet of ~25? I get some are older and have different ownership structures (I tried to adjust for that).

 

Additionally, isn't a healthy chunk of the $365M of leftover EBITDA earmarked for Maintenance CAPEX? 

 

 

Now let's be realistic, the FPSO, towage, and UMS and other badco assets have finite lives and they are worth less each year.  Their cashflow will also deteriorate over time.  But if we start with $570mm of EBITDA and $365mm available for cap ex and debt paydown.  It looks like we will generate $1,825mm of cash, and we will pay $600mm of equity for the shuttle tankers, and add on $900mm of debt into the shuttle tanker LLC segment.  This leaves roughly $1,225mm of cash available to pay down the BadCo debt.  Thus in five years, the GoodCo will have $400mm of EBITDA (some assumptions here) and roughly $1,257 + $900mm of debt which totals $2,157mm.  The BadCo will have paid off $1,225mm of debt.  Total net debt would be reduced by $325mm.  However, we now have a shuttle tanker business that does $400mm of EBITDA.  At a 10x multiple, that's worth $4 bn.  Better yet, let's examine the FCF generation of this segment.  With a $2,157mm of debt and at weighted average cost of 6%, the interest payment would be roughly $130mm.  Real D&A will be an additional $67.5mm.  We will have five years of D&A that runs off.  Let's say that the original D&A figure of $96mm gets cut by 25% (5 years out of 20 years).  So the maint cap ex will be $140mm.  $400mm less $130mm of interest payment and less $140mm of maint cap ex equals $130mm of true FCF in the shuttel tanker business.  Given that this figure likely approximates true FCF after adjusting for payments for cap ex, it likely merits a 15x FCF multiple for a duopoly business.  This is roughly $1,950mm of equity for the shuttle tanker segment.  On the BadCo side, there will be roughly $600-700mm of debt left.  Let's assume that the EBITDA is now only $150mm rather than the high $200mm.  Let's assume that this is worth 6x EBITDA.  The value would be roughly $900mm.  There is roughly $200-300mm worth of equity value in this segment.  The Towage and UMS segment actually generates losses currently.  But they are likely worth something.  In the next five years, 25% of the fleet will be scrapped and the proceeds will likely be $5mm-$10mm per shuttle tanker.  This is another $40-90mm of cash.  If you think that the FPSO is currently under earning by $50mm per Packer's comments, then that's another $250mm over five years.

 

Where did you get the estimated maintenance cap number from?

 

 

I estimate that there is a 150-200% upside over five years.

 

 

Gosh that would be nice.

 

Anyway, thanks again for the great posts and insight.

[BG2008]

Steven B,

 

Your question about 10 shiny new tankers versus the 25 is a great one and it is one that I am struggling with as well.  I think the best way to think about the concept is if you are in the rental car business.  Would 10 new shiny Mercedes earn more than 25 older ones?  Given that the useful life is 20 years instead of 10 years, it maybe more relevant.  My understanding is that the new shuttle tankers have more efficient features that makes them more productive.  Packer has spoken to this in his post.  In addition, Brookfield insist that they enter into long term contracts to justify a decent return on capital.  Trust me, my head hurts thinking about this dynamic and frankly, it is not like it's a building in NYC that I can go and see and figure out why people would pay $80/sqft for rent.   

 

Regarding the $365mm of leftover EBITDA earmarked for maintenance CapEx.  Given that this is a GoodCo and a BadCo, there is a conscious decision to runoff one division and invest capital in another one.  For the GoodCo, yes a portion will be for maint cap ex.  I have run some Excel analysis offline that shows what happen to cashflow if you generate a 17% EBITDA/Net PP&E over time.  It shows that the EBITDA will grow overtime.  There are a lot of sensitivity in the analysis.  Will TOO always get 17% EBITDA/Net PP&E on its invested capital?  The results will be great if yes.  Frankly, if you do $1.5 bn multiply by 17%, it shows you that you get $255mm of incremental EBITDA.  To be fair, I also add in an EBITDA decrease of $100mm ( I believe in my previous post) for the retirement and deterioration of the fleet over a 5 year time frame from the current $250mm figure.  When I did the Excel analysis, my conclusion is that if you're getting 17% EBITDA/Net PP&E, you need a cap ex figure that is lower than D&A to maintain your EBITDA figure.  This is largely because you're earning a real economic return on Net PP&E (think 17% less 4.5% real D&A a year). 

 

 

 

[BG2008]

In the interest of full transparency, I want to let people know that I have recently found a couple "one foot hurdles" and have since trimmed my position in TOO.  I think that TOO will work out great if it works out according to my math.  Given rate increase headlines lately, I have found some opportunities that are 100-200% upside in 5 years with much healthier balance sheets and businesses where the ROA and ROE are much easier to understand.  However, I will continue to monitor TOO because it fascinates me as an investment.     

[bizaro86]

While I know I personally have enjoyed your thoughts on TOO, if you've built positions would you consider sharing your 1 foot hurdles?

[walkie518]

In the interest of full transparency, I want to let people know that I have recently found a couple "one foot hurdles" and have since trimmed my position in TOO.  I think that TOO will work out great if it works out according to my math.  Given rate increase headlines lately, I have found some opportunities that are 100-200% upside in 5 years with much healthier balance sheets and businesses where the ROA and ROE are much easier to understand.  However, I will continue to monitor TOO because it fascinates me as an investment.   

like BAM itself  :P

[BG2008]

While I know I personally have enjoyed your thoughts on TOO, if you've built positions would you consider sharing your 1 foot hurdles?

 

Bizaro,

 

I'm still building my positions. 

[bizaro86]

Fair enough, I've appreciated your candor in the past, if you feel at some point you can share I'd certainly be interested.

[Gregmal]

Given the outcome here appears to be kind of binary(either a wipeout or a big gain), this to me seems like an options play. I've been looking at a very small lottery ticket position in the 2020 2's, 3's, and 4's.

[Pondside47]

Given the outcome here appears to be kind of binary(either a wipeout or a big gain), this to me seems like an options play. I've been looking at a very small lottery ticket position in the 2020 2's, 3's, and 4's.

 

I think viewing this as binary means one is not convinced on the staying power of the shuttle tanker business. Then if you are buying a lottery ticket with meaningful odds of 0, there are other options with better upsides than 2020 option on TOO.

 

Is it binary simply because of the leverage? Then a house is binary as well if financed the wrong way. I think Brookfield's approach in general is to finance great assets in a way that they will never be forced to sell at the wrong time. One should either be convinced on the moat of the shuttle tanker business or simply stay away from TOO and its derivates.

 

I'm gradually changing my view that BAM itself at around $40/share is a better option than TOO. The appeal to institutional money of investment options that don't mark to market and has proven track records of great return is just very obvious to me. If I still want to participate in the turn of offshore drilling, maybe tidewater is a better option at this point (trading at 1/3 of replacement value with net debt being zero)

[chrispy]

Positive quarter,

Settlement with Petrobras for $90m and a note that the agreement incentives Petrobras to give Teekay more contracts,

FPSO redployed in North Seattle (fixed contract) with life extension work payed for by Alpha.

 

FWIW, the new Brazilian governemtn is a positive development for private offshore investment there

[Seth Lowry]

Hey guys, this is Seth from JDP. Overall, this is a great discussion and I just wanted to offer some additional perspective on a few specific topics:

 

1) Teekay Offshore is a Leasing + Logistics Business Model

 

I would submit that Teekay Offshore’s business model is more leasing-based than an asset owner and/or producer business model, which appears to dominate the perspective of some of the prior discussions.  TOO is essentially a collection of lease receivables and a logistics layer that resembles an Air Lease or containership lessor business model.

 

I would break down TOO’s value proposition into two main buckets:

 

a) Cost of Capital Management

 

TOO utilizes its highly visible cash flow streams from its customers to utilize higher leverage and cheaper leverage and splits these economics with its customers.  Keep in mind that lenders leverage the cash flow streams NOT the assets. TOO’s leasing fundamentals are based on long-term lease receivables (>5 years) with investment grade counterparties.  Moody’s reports are helpful reads for further information on how they view risks in both shipping and offshore leasing.   

 

The key in these types of business models is to manage the duration of your lease receivables and build it to outlast the cycle of whatever hard assets are being leased.  Clearly, in TOO’s case, the prior management team really forgot this and screwed it up.  Brookfield should not.

 

b) TOO offers its customers outsourced supply chain and logistics, enabling its customers to more greatly focus on managing their projects and more efficient working capital.

 

Offshore is more clearly more operationally intensive than pure equipment lessors, but Shell copied and proliferated the aircraft leasing + logistics business model for offshore, and Equinor (formerly Statoil) followed suit when it carved out and originated Teekay Offshore and its business model back in 2003.     

 

These are the primary value offerings of TOO’s business model, and when run properly, its business model should be both pro-cyclical (charter/backlog growth) and counter-cyclical (balance sheet management for customers)…these aren’t my words, GSL said it best

 

(http://www.globalshiplease.com/value-proposition) 

 

2) Compare TOO and SSW

 

I think it is also very helpful to highlight David Sokol and Prem Watsa’s investment in Seaspan.  The comparisons to both companies are striking, $6bn in lease receivables, 5 year receivable duration, maritime lease + logistics, SSW’s leverage is even a bit higher at >5x than TOO’s <5x. 

 

I think it is a good exercise to ask, what are Brookfield, David Sokol, Prem Watsa and Dennis Washington all seeing in these businesses.  I would contend that they are not just taking a flyer on “oil options” or “levered bets.”

 

3) No “goodco” or “badco” assets

 

I disagree that there are “badco” and “goodco” assets.  This line of thinking is incongruent with the long-term value proposition of TOO.  It is like running a firehose sales business and saying the nozzle of a firehose should be cut off and the store should just sell the rubber hoses because there is more margin on that part of the product for the moment.  Particularly as smaller independent operators and Private Equity players continue to step into the major basins, they will need partners with a full repertoire offshore supply chain to leverage versus simply leveraging an asset lessor.  I agree though, some assets are better than others and certain parts of the offshore supply chain are at different points in the cycle. 

 

4) More on FPSOs

 

For what it is worth, I am more constructive than most on the FPSO segment.  I base my findings in researching the developments in Brazil (Campos and Santos) and in particular the record setting offshore block auctions, Johan Sverdrup in Norway, Bay Du Nord / Newfoundland Canada, consistent North Sea UK redevelopments, and maybe even more speculative development plays in Latin America.

 

I have yet to hear a compelling reason why Teekay Offshore, run by Brookfield, would not keep its relative market share with their customers as they significantly ramp up supply chain spending and production in Teekay’s primary fields of operation, particularly given that consortium bidding is on the rise, IOCs/PE are more likely to utilize independent leasing and logistics indy’s as they are more focused on shareholder pressures to return capital, and finally, returns-focused private equity are redeveloping fields that are a fit for used offshore equipment that is up to 80% less than the cost of a newbuild and 20% quicker to deploy. 

 

I don’t know what the offshore business will look like in ten years, or what the future price of oil is going to be, but I do know that tens of billions have been/will be spent on the above projects and that alone will drive TOO’s fleet utilization closer to 100%, which is all that is needed for a much higher equity price. 

 

Hopefully Brazil becomes a bigger catalyst for TOO’s FPSOs.  With the Brazilian election behind us and the repaired relationships with PBR and contract incentives get things moving ASAP.  PBR absolutely has to improve its production in these mature fields or sell to smaller players to repay debt, both of which should catalyze FPSO demand for TOO. 

 

Finally, in terms of the PBR settlement and 3 potential FPSO redeployments in Brazil.  I would hope that Brookfield feels confident that they can redeploy all 3 FPSOs or a majority of them, especially considering the opportunity costs of just scrapping those vessels and repaying high cost preferred.  If they fail at this it would look disastrous for them as an organization and it would really call into question the value of their 100 years of operating experience in Brazil.

 

5) My thoughts on underperformance so far…

 

a) Brookfield has been too aggressive. 

 

Brookfield acquired an intercompany loan for $140M from Teekay ParentCo, and then put the full principal back to TOO at $200M and charged a make whole of $12M. 

 

I am very curious to hear BBU’s reasoning on why they needed to make a 51% return on this piece of capital in one year to the detriment of their $640M equity investment. 

 

Further, I am curious why this $140M was only written up to $168M and not the full $200M at the time of the BBU strategic transaction or when they took control a few months ago knowing it was going to be repaid in full??  A good question for TOO’s financial reporting policy. 

 

If they let me on the conference call again these will be my line of questioning.

 

However, the capital structure has been overhauled.  The opportunity for BBU to siphon more cash is much less going forward, and it seems, the pressure for them to manage for capital appreciation of their equity investment is much greater going forward as the stock is down 20% over the past 18 months, and their public target of 15-20% CAGR on investments puts them 43% to 51% behind target at the moment.

 

b) Transparency in this company is awful. 

 

The aforementioned Brookfield costs, NOK bond make wholes, PBR and Pirenema Spirit settlements, inflated G&A from trying to turn this company around have all caused massive confusion on shareholder returns. 

 

I believe management will improve visibility going forward, particularly now that Brookfield has taken its pound(s) of flesh.

 

6) I certainly admire all of the independent thinking on this blog.  However, at some point, I would just suggest considering that you’re likely not going to come up with a more informed view of intrinsic value than the insider view of Brookfield (whose basis is now >20% greater than your potential entry), and why Prem Watsa and David Sokol bought into a similar group of marine leasing + logistics assets that trade at 40% premiums in equity multiples (along with TOO's closest public peers).

 

7) Here is an update to our deck from last year…If you still want more…

 

https://jdpcap.com/when-1-1-too-updated/

 

Hope this is helpful!

 

Seth

 

[whistlerbumps]

Thanks for the detailed thoughts Seth... much appreciated and you lay out an interesting case... Couple of questions

 

1)"TOO utilizes its highly visible cash flow streams from its customers to utilize higher leverage and cheaper leverage and splits these economics with its customer"

Does this argument still hold water given TOO's much higher cost of capital (8.5% debt etc)

2) What do you think the best releasing opportunities are for Piranema Spirit and Ostras?

3) What would it take to get Towing/Accommodation more fully utilized and cash flow generating?

4) How do you bridge from current EBITDA to a more normalized state?

 

Thanks for a detailed analysis.

 

 

[BG2008]

Hey guys, this is Seth from JDP. Overall, this is a great discussion and I just wanted to offer some additional perspective on a few specific topics:

 

1) Teekay Offshore is a Leasing + Logistics Business Model

 

I would submit that Teekay Offshore’s business model is more leasing-based than an asset owner and/or producer business model, which appears to dominate the perspective of some of the prior discussions.  TOO is essentially a collection of lease receivables and a logistics layer that resembles an Air Lease or containership lessor business model.

 

I would break down TOO’s value proposition into two main buckets:

 

a) Cost of Capital Management

 

TOO utilizes its highly visible cash flow streams from its customers to utilize higher leverage and cheaper leverage and splits these economics with its customers.  Keep in mind that lenders leverage the cash flow streams NOT the assets. TOO’s leasing fundamentals are based on long-term lease receivables (>5 years) with investment grade counterparties.  Moody’s reports are helpful reads for further information on how they view risks in both shipping and offshore leasing.   

 

The key in these types of business models is to manage the duration of your lease receivables and build it to outlast the cycle of whatever hard assets are being leased.  Clearly, in TOO’s case, the prior management team really forgot this and screwed it up.  Brookfield should not.

 

b) TOO offers its customers outsourced supply chain and logistics, enabling its customers to more greatly focus on managing their projects and more efficient working capital.

 

Offshore is more clearly more operationally intensive than pure equipment lessors, but Shell copied and proliferated the aircraft leasing + logistics business model for offshore, and Equinor (formerly Statoil) followed suit when it carved out and originated Teekay Offshore and its business model back in 2003.     

 

These are the primary value offerings of TOO’s business model, and when run properly, its business model should be both pro-cyclical (charter/backlog growth) and counter-cyclical (balance sheet management for customers)…these aren’t my words, GSL said it best

 

(http://www.globalshiplease.com/value-proposition) 

 

2) Compare TOO and SSW

 

I think it is also very helpful to highlight David Sokol and Prem Watsa’s investment in Seaspan.  The comparisons to both companies are striking, $6bn in lease receivables, 5 year receivable duration, maritime lease + logistics, SSW’s leverage is even a bit higher at >5x than TOO’s <5x. 

 

I think it is a good exercise to ask, what are Brookfield, David Sokol, Prem Watsa and Dennis Washington all seeing in these businesses.  I would contend that they are not just taking a flyer on “oil options” or “levered bets.”

 

3) No “goodco” or “badco” assets

 

I disagree that there are “badco” and “goodco” assets.  This line of thinking is incongruent with the long-term value proposition of TOO.  It is like running a firehose sales business and saying the nozzle of a firehose should be cut off and the store should just sell the rubber hoses because there is more margin on that part of the product for the moment.  Particularly as smaller independent operators and Private Equity players continue to step into the major basins, they will need partners with a full repertoire offshore supply chain to leverage versus simply leveraging an asset lessor.  I agree though, some assets are better than others and certain parts of the offshore supply chain are at different points in the cycle. 

 

4) More on FPSOs

 

For what it is worth, I am more constructive than most on the FPSO segment.  I base my findings in researching the developments in Brazil (Campos and Santos) and in particular the record setting offshore block auctions, Johan Sverdrup in Norway, Bay Du Nord / Newfoundland Canada, consistent North Sea UK redevelopments, and maybe even more speculative development plays in Latin America.

 

I have yet to hear a compelling reason why Teekay Offshore, run by Brookfield, would not keep its relative market share with their customers as they significantly ramp up supply chain spending and production in Teekay’s primary fields of operation, particularly given that consortium bidding is on the rise, IOCs/PE are more likely to utilize independent leasing and logistics indy’s as they are more focused on shareholder pressures to return capital, and finally, returns-focused private equity are redeveloping fields that are a fit for used offshore equipment that is up to 80% less than the cost of a newbuild and 20% quicker to deploy. 

 

I don’t know what the offshore business will look like in ten years, or what the future price of oil is going to be, but I do know that tens of billions have been/will be spent on the above projects and that alone will drive TOO’s fleet utilization closer to 100%, which is all that is needed for a much higher equity price. 

 

Hopefully Brazil becomes a bigger catalyst for TOO’s FPSOs.  With the Brazilian election behind us and the repaired relationships with PBR and contract incentives get things moving ASAP.  PBR absolutely has to improve its production in these mature fields or sell to smaller players to repay debt, both of which should catalyze FPSO demand for TOO. 

 

Finally, in terms of the PBR settlement and 3 potential FPSO redeployments in Brazil.  I would hope that Brookfield feels confident that they can redeploy all 3 FPSOs or a majority of them, especially considering the opportunity costs of just scrapping those vessels and repaying high cost preferred.  If they fail at this it would look disastrous for them as an organization and it would really call into question the value of their 100 years of operating experience in Brazil.

 

5) My thoughts on underperformance so far…

 

a) Brookfield has been too aggressive. 

 

Brookfield acquired an intercompany loan for $140M from Teekay ParentCo, and then put the full principal back to TOO at $200M and charged a make whole of $12M. 

 

I am very curious to hear BBU’s reasoning on why they needed to make a 51% return on this piece of capital in one year to the detriment of their $640M equity investment. 

 

Further, I am curious why this $140M was only written up to $168M and not the full $200M at the time of the BBU strategic transaction or when they took control a few months ago knowing it was going to be repaid in full??  A good question for TOO’s financial reporting policy. 

 

If they let me on the conference call again these will be my line of questioning.

 

However, the capital structure has been overhauled.  The opportunity for BBU to siphon more cash is much less going forward, and it seems, the pressure for them to manage for capital appreciation of their equity investment is much greater going forward as the stock is down 20% over the past 18 months, and their public target of 15-20% CAGR on investments puts them 43% to 51% behind target at the moment.

 

b) Transparency in this company is awful. 

 

The aforementioned Brookfield costs, NOK bond make wholes, PBR and Pirenema Spirit settlements, inflated G&A from trying to turn this company around have all caused massive confusion on shareholder returns. 

 

I believe management will improve visibility going forward, particularly now that Brookfield has taken its pound(s) of flesh.

 

6) I certainly admire all of the independent thinking on this blog.  However, at some point, I would just suggest considering that you’re likely not going to come up with a more informed view of intrinsic value than the insider view of Brookfield (whose basis is now >20% greater than your potential entry), and why Prem Watsa and David Sokol bought into a similar group of marine leasing + logistics assets that trade at 40% premiums in equity multiples (along with TOO's closest public peers).

 

7) Here is an update to our deck from last year…If you still want more…

 

https://jdpcap.com/when-1-1-too-updated/

 

Hope this is helpful!

 

Seth

 

Seth,

 

Thank you for your awesome comments.  In your updated model, you have listed $240mm as the replacement and maintenance cap ex (I assume).  This is the biggest sticking point for me and many others who are invested in TOO.  How can replacement be lower than D&A and somehow the fleet can sustain itself in the long run?  The more detail and reasoning you can provide on this, the better.  If you have a I Banking style leasing model, I would love to see it and understand the input/outputs of a leasing model.  Love your work. 

[Seth Lowry]

Good questions...

 

1)"TOO utilizes its highly visible cash flow streams from its customers to utilize higher leverage and cheaper leverage and splits these economics with its customer"

Does this argument still hold water given TOO's much higher cost of capital (8.5% debt etc)

 

Generally speaking, this isn't a competitive rate.  It is a shame that these make up 20% of the debt stack.  But the 8.5% is more Brookfield blood money than growth capital, which is an important distinction.  TOO shouldn't need much capital to redeploy its idle fleet (Varg, etc.) and for its six newbuild shuttle tankers on order, those utilize first lien ship mortgages based on the contract quality, not the lessor.  Therefore growth debt capital is not marginally priced at 8.5% or anywhere near it...thankfully.   

 

2) What do you think the best releasing opportunities are for Piranema Spirit and Ostras?

  They are trying to get long-lived contracts through Petrobras with the incentives from the settlement.  However, if they can't get those, there are PE outfits that have apparently expressed interest, for instance there are media reports that DBO (norwegian)  may take over the Pirenema Field and that the contract would be close to length of field for 11 years.  I am taking these reports with a grain of salt, but Petrobras has clearly opened the doors for very long contract durations.  The Marlim FPSOs are 22 years.  Brookfield needs to earn its keep in these negotiations and offset their fees and unsecured debt, that is for sure! 

 

3) What would it take to get Towing/Accommodation more fully utilized and cash flow generating?

I think these will inflect when the bigger projects I mentioned in my post above phase in.  Based on the CFO's comments on the call it seems like 1H19 will be breakeven-ish (which is actually a benefit considering the YoY comp, and 2H19 looks better. 

 

4) How do you bridge from current EBITDA to a more normalized state?

 

This is something TOO used to do.  If you look at their 2014 investor day they actually put out a ~$850M target with a smaller installed fleet base.  We are in different times now, so probably somewhere in between where we are now and there is the normalized range.     

 

 

[Seth Lowry]

Ahh yea, forgot to address the D&A versus replacement cost

 

Ultimately, the biggest thing to recognize is that the book value of these assets were journaled on the balance sheet based more on where the lease cycle was at the contract moment.  The values are not simply based on the metal.  Remember TOO aggressively ramped spending in late 2013/14 on about $1.6Bn in assets in a $100/bbl oil environment.  Also, Shuttle tanker useful life changing from 25 to 20 years. 

 

Check out some of the white papers out there on other maritime leasing structures like containers and clean product tanker leasing etc.  They have great data for comparison.

[Seth Lowry]

Lastly, on models, detailed sharing etc. there is information out there on every single asset.  How much TOO paid by asset, what it used to be chartered for, etc.  It is a ton of work to sift through but it is out there.  I am trying to make a living in this business (emphasis trying) and I have a consulting arrangement / incentive comp tied to my work on this name with JDP Capital, so I can't share my detailed proprietary work beyond what we put in those public decks. 

[Steven B]

Hi Seth,

 

Thank you for your color on TOO. It sounds like you really have boots on the ground on this one so I hope you'll humor me by answering some of this humble "generalist"'s questions. Thank you in advance and again, appreciate you hopping on here. Really cool of you.

 

1) Were you satisfied by the answer they gave to your question about buying back shares?

 

2) Do you feel there is any risk of mean reversion in CoA rates?

 

3) FCF yield that JDP uses is based on  EBITDA-interest,taxes, prefs, replacement. This number is significantly higher than DCF numbers and operating cash flow numbers on the Cash Flow statement (I'm disregarding changes in WC for sake of comparison and backing out replacement/Maint. CAPEX). It seems the discrepancy is based on  subtracting the unrealized gains on derivatives, FOREX, etc. from Cash Flow. (This normally wouldn't be a difference with a top of the line number like EBITDA, however the numbers added back on the DCF and CF statements are higher than than the gain on the income statement, so it's in there somewhere.) So which one is the economic reality? If I was TOO I definitely would much rather trumpet the JDP FCF numbers as opposed to DCF that's for sure!

 

In the same vein, the updated deck states that "Generalists are overly focused on DCF while missing Brookfield's strategy". It seems I'm the generalist that you refer to! Why shouldn't we be focused on DCF and what are we missing about Brookfield's strategy?

 

6)  I certainly admire all of the independent thinking on this blog.  However, at some point, I would just suggest considering that you’re likely not going to come up with a more informed view of intrinsic value than the insider view of Brookfield (whose basis is now >20% greater than your potential entry), and why Prem Watsa and David Sokol bought into a similar group of marine leasing + logistics assets that trade at 40% premiums in equity multiples (along with TOO's closest public peers).

 

While I agree 100%, what are you suggesting here? I'm sure you didn't mean that we should follow them blindly.  Is there some magical additional thesis that you're alluding to that you can provide color on? Maybe I'm hard headed, but seems like there is a subtle message here that I'm not getting.

 

Thanks.

[NorteCapital]

Hi Seth,

 

Thank you for your insights.

 

I wanted to know why you did not ask the management in the Q3 Call about the intercompany loan that BBU took from TK.