TOO - Teekay Offshore Partners L.P.

[bjakes00]

Yes their average quarterly maintenance capex over the last 6 quarters has been $42m (min: $32m, max: $53m).

 

That being said, their average quarterly cash flow (pre. maintenance capex) is $70m and average EBITDA is $130m over the same six quarters, which provides the roughly $28m average distributable cash flow that I see.

 

My source for this are the Net Income to DCF bridges they provide at the end of their results presentations each quarter.

 

Two things to note in from the recent two quarters that you can clearly see from the same bridges:

1) The distributions on preferred units have come down 30% or so since the BAM refi (which is good)

2) The partnerships share of equity accounted JV's DCF has almost doubled (which is also good, but given the partnership does not control these DCFs it is difficult to count on the timing of the distributions).

 

Additionally, their Net Debt / EBITDA averaged 6.8x prior to the BAM recap, whereas it is now 5.8x currently.

 

Annualised DCF based on the current 6c DCF is 24c providing a c. 11% yield on the current price.

 

The key metrics I'll be watching are the leverage ratios, and the (EBITDA - capex) to DCF conversion.

 

Let me know if you have any other views as I really need to hear all sides to this story.

 

The other point I am not fully comfortable with is that there is "no oil price risk" - whats clear to me is that they did take some strain in 2014 when the price collapsed but that was also obviously because they were over levered (which is not to say they have a pristine balance sheet at the moment...)

 

EDIT: I have a lot more work to do on figuring out how the cash flow statement and the DCF bridge hangs together!

[Packer16]

Remember you have a good business (shuttle tankers) & an OK to bad business (everything else).  In the OK bad business, you have unused vessels & contracts with counterparties at reduced rates (on the order of $50 m per year through 2019).  Looking at this in the aggregate is difficult especially given the Brookfield will invest in the good business but not in the bad business.  Looking at as 2 business with an option to run-off as much of the OK to bad business IMO is the best way to look at this.

 

Packer

[Guest Schwab711]

Yes their average quarterly maintenance capex over the last 6 quarters has been $42m (min: $32m, max: $53m).

 

That being said, their average quarterly cash flow (pre. maintenance capex) is $70m and average EBITDA is $130m over the same six quarters, which provides the roughly $28m average distributable cash flow that I see.

 

My source for this are the Net Income to DCF bridges they provide at the end of their results presentations each quarter.

 

Two things to note in from the recent two quarters that you can clearly see from the same bridges:

1) The distributions on preferred units have come down 30% or so since the BAM refi (which is good)

2) The partnerships share of equity accounted JV's DCF has almost doubled (which is also good, but given the partnership does not control these DCFs it is difficult to count on the timing of the distributions).

 

Additionally, their Net Debt / EBITDA averaged 6.8x prior to the BAM recap, whereas it is now 5.8x currently.

 

Annualised DCF based on the current 6c DCF is 24c providing a c. 11% yield on the current price.

 

The key metrics I'll be watching are the leverage ratios, and the (EBITDA - capex) to DCF conversion.

 

Let me know if you have any other views as I really need to hear all sides to this story.

 

The other point I am not fully comfortable with is that there is "no oil price risk" - whats clear to me is that they did take some strain in 2014 when the price collapsed but that was also obviously because they were over levered (which is not to say they have a pristine balance sheet at the moment...)

 

EDIT: I have a lot more work to do on figuring out how the cash flow statement and the DCF bridge hangs together!

 

Then you get credit for the growth depreciation in cash flow without ever considering the cost of growth. If there's no growth, we can't use a valuation multiple since the company would be finite-lived. I think maintenance capex is a good starting point but it's a minimum bound of whatever 'true' LT capex is.

 

I agree with Packer in that I think it's easier to look at the shuttle tankers biz separate from the other biz lines. The shuttle tankers portion should probably be valued at 10x EBITDA like KNOP. What's the value of RemainCo is the question.

[bjakes00]

Looking at as 2 business with an option to run-off as much of the OK to bad business IMO is the best way to look at this.

 

Thanks this is super helpful and will put some work into understanding what the good business is worth first. Cheers

[petec]

Preliminary thoughts on this. FYI I'm a shareholder in SSW so it's a natural compare. I want to like this because I like buying cheap cash flows run by very smart people - but so far I'm not quite there. My major concerns are below:

 

- These vessels are clearly more specialised than Seaspan's but to my surprise they're also (on average) older vessels on shorter contracts. That reduces the visibility of cash flows and also reduces the value of the termination payments should any arise.

- There is no commentary in the 20F or quarterly releases on the pricing cycle. Perhaps that means there isn't one but that would surprise me, and the fact that the company has taken major writedowns as they have adjusted DCF assumptions for each asset suggests prices have been falling. I find it very hard to tell whether contracts will roll on to higher or lower prices, which matters given the short contract durations.

- The writedowns suggest this isn't all that insulated from oil prices (indeed several of the contracts have explicit links to prices).

- One of the things I like about SSW is that the combination of consolidation and low orderbook might lead to better price discipline, and I'm not sure I can make the same argument here.

- P:BV (once you adjust for prefs) isn't much below 1.

- Free cash flows will be enormous compared to market cap if capex drops. Another thing I really like about SSW is that newbuild capex is pretty much over and maintenance capex is low. TOO is still ordering vessels so investing capex will continue (but fall). What confuses me badly is the maintenance capex figure in their quarterly releases. If that's a real, sustained maintenance capex figure then the FCF isn't all that exciting. Understanding capex is my major project.

 

The other thing I am wary of is assuming shuttles is a "good" business and assigning a 10x multiple to it. Certainly there's some specialised kit on these vessels but none of it is rocket science in this technological age. There's no moat there. And it's a small market - less than 100 vessels worldwide - so it doesn't take a lot of newbuilds or many field shutdowns to create overcapacity. Fundamentally this is, like containers, a business where the major barrier to entry is access to capital and ROCE's won't be high. The way to make money is to capture a high (>>20%) FCF yield to equity and ride the deleverage as debt paydown causes equity value to grow within the EV.

 

More work to do and all thoughts welcome.

 

P

 

 

[Packer16]

I was once a SSW shareholder so a top level comparison is the shuttle tanker market is shuttle tankers is a duopoly primarily defended by reputation & operations of shuttle tankers.  The oil companies number one concern is safety & prevention of an oil spill then price.  This the opposite of containers.  For containers price is everything & the appealing point of SSW was the longer term contracts they had with creditworthy counterparties.  However, if pricing competition rears it head again & the levered shippers run into financial difficulties the contracts will be renegotiated.

 

Since shuttle tankers are more of a mission critical part of offshore transportation value chain, the contract durations are not as important as with Seaspan when you have a least a half dozen other folks that can provide similar services versus 2 for shuttle tankers.  Since there are only 2 rational competitors the orderbook has been small.  I think the Knot Offshore presentation has some data on orderbook size.

 

IMO specialized ships can be more valuable to the owner than commodity ships as the commodity ships always have alot of being deployed because the ships are bankable.  Specialized ships require customization that customers will pay for when there are few competitors like RoRos & shuttle tankers.  Look at the returns for RoRo shippers and shuttle tankers as an example versus containers.  Although I like SSW management and contracts, it is a commodity business with a great jockey.  RoRos & shuttle tankers are better businesses.  The return on assets for shuttle tankers is in the low teens.  You can see the economics of this business via there financial statements on TOOs site.

 

The FPSO/FSO side of the business is different.  This business is more competitive than the shuttle tankers and key part of the value here is the option to no longer invest or maybe sell FPSO/FSOs & re-invest in shuttle tankers.  The write-down have primarily been in this part of the business.  The valuation of players here is lower than 10x EBITDA for shuttle tankers close to 6x.  This is also where TOO has had to provide price concessions.

 

Packer

[petec]

That’s useful, thanks. The FPSO market is part of what worries me. FPSOs are mission critical bits of kit. Why do shuttles earn teens ROAs when FPSOs can’t? Sorry if I’m missing something obvious.

 

Broadly agree with your assessment of SSW, btw. I just like jockeys with cash flows.

[Packer16]

The FPSO may be able to make those returns if oil prices stay high.  There are a few engineering firms that provide for leasing of ships designed for offshore oil fields (MODEC, SBM Offshore & BW Offshore) so the competition here is higher.  The other ships are owned by the oil companies.  The FPSO/FSO market is driven by oil prices but are still a part of offshore infrastructure.  Part of the thesis here is Brookfield is going to make the right capital allocation move here.  Part of the reason they won the deal is they were willing to accept keeping the FSO/FPSOs versus selling them off in today's down market.  If oil prices stay high, there may an opportunity to sell them.  As a worse case, the FPSO/FSOs can be cash flowed into run-off & the capital returned to shareholders with re-investment only occurring with the shuttle tankers.

 

Packer

[petec]

That (reallocating capital) makes a lot of sense.

 

Still makes my head hurt, though, that one business would have so much higher returns than the other. Both are fundamentally oil-related asset businesses. One has two competitors, one has several more, but I struggle to get confident that reputation is enough to prevent other operators coming in (or customers insourcing the shuttle function). And if I am right then both returns *and* multiple will fall (assuming you're starting at 10x) which is very dangerous.

 

I'll have a look at Knot.

[Packer16]

The shuttle business is not one can easily enter.  These 2 firms have been the duopoly for many years.  You have to get into the design process for these offshore transportation systems which is also not easy.  I am sure some have tried but given the expertise needed (you need to convince oil companies to change to someone new) & the small size of the market it does not make sense for the big boys to bother with.

 

Packer

[whistlerbumps]

There a few things that are going on here.  You have underearning FPSO/FSO assets that are being provided to some users on a temporary price reduction basis.  These price reductions should be unwound in 2019.  You also have some assets that are not generating any revenue.  These include some assets that may never generate revenues but if oil stays high there is a chance & finally the re-investment opportunity from FPSO/FSOs to shuttle tankers should be able to generate the before mentioned 20/25% DCF yield on today's prices.  The depreciation is high due to restating shuttle tanker life from 25 to 20 years and depreciation associated with some assets TOO would not invest in if they were investing today.

 

Packer

 

Agreed.. the two key issues here are when the Petrojarl starts earning full rates and whether they can new long-term contracts for the Varg, Spirit, Ostras, Arendhal Spirit etc.  If/when those things start to happen, DCF should inflect materially higher and we should see the impact of the incremental 200mln of EBITDA.

[bjakes00]

I hadn't seen the Massif Capital write up on this previously, including here:

https://static1.squarespace.com/static/55cbe47de4b0a1e3b9b911fe/t/5ae32b58575d1f4839c0056d/1524837208712/Teekay+Offshore.pdf

[Guest Schwab711]

Will IMO 2020 effect EBITDA margins for TOO?

[petec]

Any news today?

[peterHK]

I struggle with this one. I think the re-contracting risk of the FPSO's are higher than what most bulls are assuming, so that means no revenue growth, and FCF growth hard to come by. That then puts more in jeopardy the de-leveraging story which is really is what's going to drive this (ie until it's clear they can really deleverage, they're going to trade at depressed multiples).

 

I have a lot of faith in BAM/BBU, but because they own the debt and they own the majority of the LP, they have a few ways to extract value here for their investors that we don't by just buying the stock, so their risk/reward is a little more skewed IMO.

[Steven B]

I've become less certain about the FPSOs, I'll concede to that.

 

However, I came for 25% FCF yield. Having a hard time getting there as well. Packer, do you believe this lofty yield is only in play after the shift their focus from FPSO/FSO to shuttle tankers? Is there any way to ascertain what their true maintenance CAPEX is? They have plenty of older shuttle tankers as well. Will the new ship builds be growth or just maintaining the current cash flow?

 

That being said, these are all upside questions. A hell of a lot better than downside questions!

 

 

[BG2008]

Packer and I have debated about TOO extensively and it has forced me to really sharpen the pencil.  The question of maintenance cap ex is a real one and rather tricky to figure out.  I am sharing my thoughts in hope of further sharpening my pencil. 

 

At first glance, if you have a business with $309mm of D&A and the company claim that the maint cap ex is $200mm, it seems ludicrous.  I focus quite a bit on real asset investing, kind of similar to Brookfield but on a much smaller scale.  Real asset maint cap ex can be a funny topic.  Adding in GoodCo and BadCo dynamic can further muddy the water.  For example, there are apartments in Rome, Italy that were built in 700 AD that can still be rented out as AirBnbs.  The land, brick and mortar lasted for over 1,400 years.  When you apply a 30-40 year D&A on that, it produces an unrealistically high D&A that is not real.  This is largely the case when you own valuable real estate in desirable locations such as Rome and NYC.  On the other end of the spectrum is your personal auto.  Useful like is likely 10 years.  If you don't think that accounting D&A mirrors real expenses, I have a bridge that I can sell you.  Hence, both the FPSO and Shuttle Tankers have real finite lives.  I personally agree with Packer that FPSO, Towage, UMS, etc are all in run-off mode.  Perhaps, they get sold if oil prices goes higher.  Our understanding is that Teekay is a really good operator and very well respected in the industry (for shuttle tankers).  However, their capital allocation was severely lacking.  Marrying all of this with a yield driven structure is just a recipe for disaster.  The reflexivitiy works in both directions. 

 

So, what are we really looking at today?  I think the method of thinking that is most representative of economic reality today is looking at Teekay as a BadCo in run off mode.  The cashflow from FPSO is used to pay interest payment and pay off debt.  Eventually, there will be no FPSO, unless the customers will agree to sign a 10 year contract or something that materially de-risk the capital investment.  Where it gets interesting is the shuttle tanker financials. 

 

The shuttle tanker segment does about $250mm of EBITDA on $1,445mm of net PP&E.  The total asset is about $1,977mm of total assets.  What is really interesting is that the total debt is $1,257.  Teekay Shuttle Tanker LLC was formed in July 2017.  It raised $250mm sr unsecured bonds in the Norweigian bond market on August 2017, on October 2017, it refied a $600mm five year facility with The Group (Brookfield and Teekay Corp).  In Oct and Nov, the Company took delivery on 3 shuttle tankers servicing the East Coast of Canada market.  I estimate that the cost is roughy $450mm.  It subsequently refi the debt tied to these 3 vessels for $266mm or roughly 60%.  The question then becomes why are the debt capital markets so willing to lend what seems like 87% of the net PPE of the shuttle tanker business and 60% of the 3 tankers servicing the East Coast of Canada.  Btw, the 3 shuttle tankers have 12.5 year contracts in place.

 

Let's do an inversion exercise, what appears to be a commoditized business with low barrier to entry actually have lenders who are willing to lend 60% to the assets.  Well, the contract is what is important.  It is not the assets. 

 

So, let's do some ROA and ROE exercises.  EBITDA/Net PPE is roughly 17% for the shuttle tanker LLC.  I don't use the total assets because current assets and current liabilities tend to wash each other out.  If we assume a 10% residual value for the tankers after 20 years.  A 20 year straight line depreciation will amount to roughly 4.5%.  So the assets are earning 12.5% real economic ROA.  If we look at a $250mm consistent EBITDA less $80mm of interest payment and then less $2,140mm of gross PP&E less 10% residual divided by 20 years straight line results in real D&A expenses of $96.3mm.  This results in a FCF of $73.7mm.  Dividing this figure by the book value of $516mm results in a ROE of 14.3%. 

 

Continue in next post 

[BG2008]

I believe Brookfield has made it very clear that they are looking to invest in more shuttle tankers that earns 14% ROE at a 60% LTV.  The proof is in the pudding.  Look at the following from the Q2 financials:

 

In July 2017, certain subsidiaries of the Company entered into shipbuilding contracts with Samsung Heavy Industries Co., Ltd. to

construct four Suezmax DP2 shuttle tanker newbuildings, for an aggregate fully built-up cost of approximately $602 million. These

newbuilding vessels are being constructed based on the Company's new Shuttle Spirit design which incorporates technologies to

increase fuel efficiency and reduce emissions, including liquefied natural gas (or LNG) propulsion technology. Upon expected delivery

in late-2019 through 2020, these vessels are to provide shuttle tanker services in the North Sea, with two to operate under the Company’s

existing master agreement with Equinor, and two to operate directly within the North Sea CoA fleet, which will add vessel capacity to

service the Company’s CoA portfolio in the North Sea. As at June 30, 2018, payments made towards these commitments were $25.4

million and the remaining payments required to be made are estimated to be $52.0 million (remainder of 2018), $333.1 million (2019)

and $192.0 million (2020). The Company expects to secure long-term debt financing related to these shuttle tanker newbuildings.

 

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. 

 

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.

 

At some point, the debt gets shifted from the BadCo over to GoodCo.  The GoodCo will have lower cost of financing.  There are opportunities to save on interest cost.  One thing that I forgot to mention is that preferred dividends.  That's going to be a $150mm cost over 5 years at an average of 8%.  I maybe wrong on that figure.  If you run any levered financial models, you will see that there is a compounding effect on the operating cashflow that grows at debt amount paid down x interest rate.  This could be meaningful. 

 

I estimate that there is a 150-200% upside over five years.  But let's not kid ourselves, we're dealing with a commodity exposure and high leverage.  I am still trying to wrap my head around this.  A couple observation is important.  Early 2016 is one of the worst O&G environment that I have seen.  It is almost as bad as 2008/2009.  Yet, the shuttle tanker EBITDA didn't really drop much.  That is a testament of a good business if I ever seen one.  Not many businesses operate in duopolies.  If outside firms can enter, why haven't they?  We've been told, that it is operating expertise etc.  I can imagine that no one wants an oil spill and no one wants to shut down production if their "floating pipeline" scheduled the wrong time for pick up.  I have watched some youtube video of shuttle tankers and it does look pretty complicated.  But then so is semi-submersibles and drill ships.  Anyhow, I am still trying to wrap my head around this. 

 

More on next post

[BG2008]

I will talk about a line of reasoning that I hate to use.  I believe that people do stupid things when they outsource their research to some investment guru, i.e. Brookfield, Buffet, etc.  Nonetheless, it is an interesting exercise to reverse engineer the guru's process. 

 

Brookfield restructured Teekay over a year ago at $2.50 per share.  They got some warrants.  Over the years, we have gotten to understand Brookfield better and their process.  They like getting involve when they are the only people who is looking to provide capital.  Think Brazilian pipeline 2-3 years ago.  Assets in India recently.  Obviously O&G in 2016 was a very troubled space.  Our understanding is that TOO involves Brookfield Business Partners.  BBU is one of BAM's more impressive partnerships.  Look at their involvement with Graphtec.  That was an 8x in about 3 years.  BBU likes to invest in unique businesses during distress times.  Shuttle tanker business seems to fit the mold.  It is our understanding that BBU typically require a 15-20% IRR on their investments net of fees.  We're getting to buy TOO at a discount to the $2.50 price one year after BBU's involvement.  If BBU is correct, there is a 15-20% headstart already in addition to any discount to $2.50.  I believe that BBU's involvement addresses one of the biggest risk for the TOO thesis, capital allocation.  I think that BBU absolutely understands the GoodCo and BadCo dynamic and as far as I understand, they do not have any orders for non-shuttle tanker assets.  I believe that BBU will only buy new shuttle tanker if they can lock into long term contracts.  All of this is messy and hard to decipher.  It took me weeks to figure out the ROA and it was Packer's astute commentary that I should be using the Net PP&E rather than total net asset figures.  More importantly, the capital markets is very willing to lend to the shuttle tanker business.

 

The downside is very obvious.  Too much leverage, capital intensive, and commodity exposure.  I also think many other analysts missed the GoodCo and BadCo dynamic and put a blanket $200mm FCF multiple on the business.  In my analysis, I think that FCF for the shuttle tanker in year 5 is $130mm.  But I think that's a FCF figure that I am comfortable with and am willing to put a 12-15x multiple on.  10x EBITDA and 15X FCF gets us to the same ballpark around $4 bn EV for the shuttle tanker business. 

 

What's the further upside?  What if the company can allocate even more capital to the shuttle tanker business?  What if they can allocate $3 bn in the next 7 years.  At a 17% EBITDA/Net PP&E, that could be a $510mm of incremental EBITDA + $250mm today - $150mm form obsolescence.  At 10x EBITDA, this would imply a $610mm of EBITDA.  At 10x, this would imply a $6.1bn of EV.  With 60% LTV, the equity required would be $1,200mm and the incremental debt would be $1,800mm.  There would be about $3bn of equity in the shuttle tanker segment.  Now we have to go back re-do the debt paydown, etc. 

 

My head hurts from the math. 

[BG2008]

BTW, feedbacks and comments welcome.  Please poke holes in the thesis. 

[Gregmal]

I'll play a little devil's advocate but first preface it with the following statement. I'll take your math at face value. Same as I would Brookfield. I've personally found that getting that granular is often just too time consuming relative to what's already out there(IE a larger investor already being there) versus the likelihood the numbers play out that way due to macro circumstances. In other words, all the time you've spent breaking it down and crunching projected numbers, how often is this justified vs just kind of getting a general view of consensus numbers and as Munger has said "not needing to know a man's weight to see if he's fat"? I know it's different, but it's why for an investment like BRK, AAPL, GOOG or AMZN(FD:I only currently own GOOG but have prior owned all at one point or another), I do zero number crunching because the likelihood I have an edge over every other market participant in the name, is zero.

 

Second, is this not more or less a macro bet? Again, I own some cyclical stuff and IE GM have been hearing "peak auto" forever now, so I'm not saying macro bets are bad, but does this not more or less boil down to that?

 

I actually remember talking with you a while back and discussing an MLP that was boring but promising and buying after you spoke highly of it. It then got bought out. I owe you a beer! But generally MLP's, LP, etc are just kind of neglected areas that carry stigma's and seem to be out of favor since about 2015. I'm not sure I see a catalyst to that ending. Especially if rates keep rising.

 

Third, not saying this is the case with your investment, although I don't think one consciously does this, but I feel the longer the bull market rages on the further into complexity a lot of value investors tend to go. I mean earlier in the decade it was BAC and AIG. Now I see a lot of very different stuff. Last couple years it's been into highly levered companies/distressed assets. At the end of the day, if you are right, that's all that counts. But I've always personally steered away from companies with high debt/EV levels but have noticed a lot of value investors have moved to this space recently. Is this in any way a biproduct of something potentially being optically quite cheap, but at the same time a higher risk investment than you'd typically get into?

 

A lot of what you wrote seemed to be giving credit to Brookfield's track record. If Brookfield wasn't in this, would you look at it the same?

 

The assets in many cases as you mentioned depreciate and become worthless. I view this as time working against you.

 

So, I admire all the work and knowledge you have here, but isn't this kind of the classic "to hard" pile investment? It seems you disagree but I just think sometimes simpler is better and when there are too many moving parts that can move the needle rapidly, the investment becomes much more of a speculative gamble than anything else. I'll point to FRP, there just wasn't a way to lose with that investment. It was classic value. Here's I see a lot of ways I can lose. As you pointed out "The downside is very obvious.  Too much leverage, capital intensive, and commodity exposure. " Isn't this then just a tough business to be in? Or in other words, aren't there easier investments out there?

 

Just my 2c and a lot is simply general observations from a distance so take it with a grain of salt.

 

[petec]

Very useful reasoning BG2008 (although Gregmal raises some good points especially about value investor taking complexity and leverage risk at the top of the cycle - that’s me and it worries me).

 

My primary pushback is there’s no way I’d put Goodco on 15x FCF. 10x max, for me, but each to their own. That has to do with my lack of real confidence in the barrier to entry, plus at 15x I’d want higher FCFPS growth in steady state.

[chrispy]

That is very helpful BG. I'll need to read it one or two more times to digest it all.

 

I was also thinking, Brookfield is totally in tune with Brazil where a lot of the shuttle tankers operate. Modec has at least 2 25yr FPSOs in the works for Petrobras. Brookfield may be able to use their connections in that region to get better contracts for TOO.

[BG2008]

All very valid points and I'll address them within your comments.  I want to be absolutely open and transparent with TOO.  Despite my long analysis that goes into a lot of detail, there are pockets of value that I am finding that have lesser upside but the downside is significantly less.  So depending on the price of TOO and other opportunities, I may swap out of TOO into other investments. 

 

I'll play a little devil's advocate but first preface it with the following statement. I'll take your math at face value. Same as I would Brookfield. I've personally found that getting that granular is often just too time consuming relative to what's already out there(IE a larger investor already being there) versus the likelihood the numbers play out that way due to macro circumstances. In other words, all the time you've spent breaking it down and crunching projected numbers, how often is this justified vs just kind of getting a general view of consensus numbers and as Munger has said "not needing to know a man's weight to see if he's fat"? I know it's different, but it's why for an investment like BRK, AAPL, GOOG or AMZN(FD:I only currently own GOOG but have prior owned all at one point or another), I do zero number crunching because the likelihood I have an edge over every other market participant in the name, is zero.

 

Getting granular is about "trust, but verify".  I've met with Brookfield and we have exchanged some views on why they got involved.  Brookfield getting involved was the signal.  But being able to back into the 17% EBITDA/NET PP&E figures was a critical break through in my analysis.  Being able to independently arrive at a 12.5% real ROA is really really important for me.  In your case with Goog, Amazn, AAPL and BRK, I think it's a different animal.  IN Amazn and Goog, and Aapl, you've got businesses that has network effect and very high return on incremental capital.  These companies are a lot more qualitative.  You can't compare a network effect company to a distressed "floating pipeline" type company.

 

Second, is this not more or less a macro bet? Again, I own some cyclical stuff and IE GM have been hearing "peak auto" forever now, so I'm not saying macro bets are bad, but does this not more or less boil down to that?

 

Given that this deals directly with O&G, the Macro bet was Brookfield getting involved in 2017 when there were no buyers of O&G assets.  The last 2-3 years has not been kind to the O&G sector.  I have been kindly reminded by smart investors that there is a bear market somewhere even in a raging bull market like we had.  But yes, TOO is sensitive to overall macro conditions as it affects the price of oil.

 

 

I actually remember talking with you a while back and discussing an MLP that was boring but promising and buying after you spoke highly of it. It then got bought out. I owe you a beer! But generally MLP's, LP, etc are just kind of neglected areas that carry stigma's and seem to be out of favor since about 2015. I'm not sure I see a catalyst to that ending. Especially if rates keep rising.

 

I have actually been hunting in this specific segment because people no longer want to or care to invest in MLPs.  You don't get a K-1 with TOO.  It pays a negligible distribution today.  Brookfield likely view it as a C corp in the current form.  I have many people mention this to mee.  Actually my whole book pretty much consist of off the beaten path companies in unpopular structure.  In the last 2-3 years, I have been hunting in this space specifically for this reason.  I think people eventually do care if you can demonstrate growth in distribution. 

 

Third, not saying this is the case with your investment, although I don't think one consciously does this, but I feel the longer the bull market rages on the further into complexity a lot of value investors tend to go. I mean earlier in the decade it was BAC and AIG. Now I see a lot of very different stuff. Last couple years it's been into highly levered companies/distressed assets. At the end of the day, if you are right, that's all that counts. But I've always personally steered away from companies with high debt/EV levels but have noticed a lot of value investors have moved to this space recently. Is this in any way a biproduct of something potentially being optically quite cheap, but at the same time a higher risk investment than you'd typically get into? 

 

Trust me, I worry about this constantly.  I actually just did a portfolio review.  About 80% of my portfolio is ultra conservative.  Think 8-25% LTV. TOO is my most leveraged holding and it's about 3-4% of the portfolio.  I generally think about Howard Mark's risk/reward curve.  I ask myself am I being compensated for taking on the extra risk.  If TOO is a 3-4x in 5 years, maybe.

 

A lot of what you wrote seemed to be giving credit to Brookfield's track record. If Brookfield wasn't in this, would you look at it the same?

 

Nope.  I need Brookfield for their parental guidance in capital allocation.  Brookfield is a signal.  Being able to verify the ROAs is the DD.  I'm still trying to figure out why there is a duopoly in this space. 

 

The assets in many cases as you mentioned depreciate and become worthless. I view this as time working against you.

 

Yes for the most part.  But being able to re-invest more capital into the shuttle tanker business and being able to earn a real economic ROA is a very important distinction.  I think most people who look at TOO basically thinks A) the FCF is $200mm today B) It's too hard to figure out and there is a lot of O&G and macro exposure.  This is a commoditity business.  If you want to see what a zero barrier O&G business look like, look at some of the E&Ps, equipment vendors, etc.  I used to own a seismic equipment vendor that is a net-net.  I figure out in early 2016 that the cashburn was too large and I have not way of knowing when the sales will return.  For an O&G company to go through 2016 with very little drop in EBITDA is very impressive (strictly shuttle tanker business.)

 

So, I admire all the work and knowledge you have here, but isn't this kind of the classic "to hard" pile investment? It seems you disagree but I just think sometimes simpler is better and when there are too many moving parts that can move the needle rapidly, the investment becomes much more of a speculative gamble than anything else. I'll point to FRP, there just wasn't a way to lose with that investment. It was classic value. Here's I see a lot of ways I can lose. As you pointed out "The downside is very obvious.  Too much leverage, capital intensive, and commodity exposure. " Isn't this then just a tough business to be in? Or in other words, aren't there easier investments out there?

 

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. 

 

 

Just my 2c and a lot is simply general observations from a distance so take it with a grain of salt.

[Gregmal]

 

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.