TOO - Teekay Offshore Partners L.P.

[heth247]

That is a good question and I have no answer.

 

The market didn't give a hoot about the stock with the dividend. I am guessing whatever they do with the money will be more beneficial.

 

Here is another theory - BBU probably wanted to cut to zero from the very beginning. But in before, TK the parent company needed the distribution from TOO, but now since the other daughter company TGP is going to raise the distribution (from 14c to 19c), which more than offset TK's loss of distribution from TOO, they agreed to cut for now.  TK really need the distribution from its daughters to pay for SGA and interest on its debt because its 3 FPSOs cannot cover it.

 

 

[RadMan24]

Well, the way this has played out, it looks like 2019 will have to include some resignings and contract wins, and stable cash flows (although the word "largely" in the press release was odd).

 

Just some recent articles if any interested in reading:

 

http://www.defesanet.com.br/naval/noticia/31680/Odebrecht-agora-Ocyan-avalia-fornecer-plataformas-a-Petrobras/  (use google and translate)

 

https://brazilenergyinsight.com/2018/11/17/compliance-issues-may-take-exmar-from-buzios-v/

 

https://www.oedigital.com/news/443910-mero-field-ultra-deepwater-challenges

 

https://www.oedigital.com/news/460637-chevron-gets-green-light-for-captain-eor

 

 

[walkie518]

That is a good question and I have no answer.

 

The market didn't give a hoot about the stock with the dividend. I am guessing whatever they do with the money will be more beneficial.

 

Here is another theory - BBU probably wanted to cut to zero from the very beginning. But in before, TK the parent company needed the distribution from TOO, but now since the other daughter company TGP is going to raise the distribution (from 14c to 19c), which more than offset TK's loss of distribution from TOO, they agreed to cut for now.  TK really need the distribution from its daughters to pay for SGA and interest on its debt because its 3 FPSOs cannot cover it.

 

I wonder if they halt payments on pref shs too?

[BG2008]

That is a good question and I have no answer.

 

The market didn't give a hoot about the stock with the dividend. I am guessing whatever they do with the money will be more beneficial.

 

Here is another theory - BBU probably wanted to cut to zero from the very beginning. But in before, TK the parent company needed the distribution from TOO, but now since the other daughter company TGP is going to raise the distribution (from 14c to 19c), which more than offset TK's loss of distribution from TOO, they agreed to cut for now.  TK really need the distribution from its daughters to pay for SGA and interest on its debt because its 3 FPSOs cannot cover it.

 

I wonder if they halt payments on pref shs too?

 

HAMILTON, Bermuda, Jan. 08, 2019 (GLOBE NEWSWIRE) -- Teekay Offshore GP LLC, the general partner of Teekay Offshore Partners L.P. (Teekay Offshore or the Partnership) (NYSE:TOO), today announced that the Partnership is reducing its quarterly common unit cash distributions to zero, down from $0.01 per common unit in previous quarters, in order to reinvest additional cash in the business and further strengthen its balance sheet. There are no changes to the quarterly cash distributions relating to any of the Partnership’s outstanding preferred units, which were declared today and announced under a separate news release.

[walkie518]

That is a good question and I have no answer.

 

The market didn't give a hoot about the stock with the dividend. I am guessing whatever they do with the money will be more beneficial.

 

Here is another theory - BBU probably wanted to cut to zero from the very beginning. But in before, TK the parent company needed the distribution from TOO, but now since the other daughter company TGP is going to raise the distribution (from 14c to 19c), which more than offset TK's loss of distribution from TOO, they agreed to cut for now.  TK really need the distribution from its daughters to pay for SGA and interest on its debt because its 3 FPSOs cannot cover it.

 

I wonder if they halt payments on pref shs too?

 

HAMILTON, Bermuda, Jan. 08, 2019 (GLOBE NEWSWIRE) -- Teekay Offshore GP LLC, the general partner of Teekay Offshore Partners L.P. (Teekay Offshore or the Partnership) (NYSE:TOO), today announced that the Partnership is reducing its quarterly common unit cash distributions to zero, down from $0.01 per common unit in previous quarters, in order to reinvest additional cash in the business and further strengthen its balance sheet. There are no changes to the quarterly cash distributions relating to any of the Partnership’s outstanding preferred units, which were declared today and announced under a separate news release.

interesting...wonder if it stays that way

[heth247]

I wonder if they halt payments on pref shs too?

interesting...wonder if it stays that way

 

Unless they run into a liquidity issue, why would they suspend preferred dividend since it is accumulative? That will probably push the common below $1 instantly.

 

I am actually surprised how well common hold up yesterday after the announcement. Today is actually not bad either, considering the downgrade from Wells Fargo analyst Michael Webber.

[BG2008]

I wonder if they halt payments on pref shs too?

interesting...wonder if it stays that way

 

Unless they run into a liquidity issue, why would they suspend preferred dividend since it is accumulative? That will probably push the common below $1 instantly.

 

I am actually surprised how well common hold up yesterday after the announcement. Today is actually not bad either, considering the downgrade from Wells Fargo analyst Michael Webber.

 

I can see them turn off the prefer to horde cash and pay for new shuttle tankers. 

[heth247]

I can see them turn off the prefer to horde cash and pay for new shuttle tankers.

 

Can you explain why and in which situation, BG?

 

Here is a list of their 2019 obligations from latest 6K and how I think they can be handled:

1. Bond repayments $74.9MM (this can be simply paid off from CFVO)

2. secured debt      $366MM  (this can be refinanced against the ships)

3. secured debt        $85MM  (this can be refinanced against the ships)

4. unsecured revolver $125MM (this is sponsored by TK + BBU, so I assume it can be extended??)

5. Norwegian bond    $10.5MM (this can be simply paid off from CFVO)

6. new building        $377MM (assume 60% will be funded by new secured debt, 40%x377=150MM needs fund by CFVO)

 

So if I add (1), (5), (6) together, that is 74.9+10.5+150=235MM that need to be funded by CFVO. With 640MM CFVO, after interest expense and other, they probably have $350-$400MM left to work with. In addition, they should also have received $50MM in 4Q from the Petrobra settlement. So I don't see any difficulty there to cover the 235MM. They probably can even pay off the revolver (4), at least partially. 25MM of the 125MM revolver was sponsored by TK, who definitely need cash to handle their own debt maturity.

 

Turning off preferred only saves like $28MM/year, and they will need to pay it back in the future because it is accumulative. So I don't see it is necessary.

 

 

[BG2008]

I can see them turn off the prefer to horde cash and pay for new shuttle tankers.

 

Can you explain why and in which situation, BG?

 

Here is a list of their 2019 obligations from latest 6K and how I think they can be handled:

1. Bond repayments $74.9MM (this can be simply paid off from CFVO)

2. secured debt      $366MM  (this can be refinanced against the ships)

3. secured debt        $85MM  (this can be refinanced against the ships)

4. unsecured revolver $125MM (this is sponsored by TK + BBU, so I assume it can be extended??)

5. Norwegian bond    $10.5MM (this can be simply paid off from CFVO)

6. new building        $377MM (assume 60% will be funded by new secured debt, 40%x377=150MM needs fund by CFVO)

 

So if I add (1), (5), (6) together, that is 74.9+10.5+150=235MM that need to be funded by CFVO. With 640MM CFVO, after interest expense and other, they probably have $350-$400MM left to work with. In addition, they should also have received $50MM in 4Q from the Petrobra settlement. So I don't see any difficulty there to cover the 235MM. They probably can even pay off the revolver (4), at least partially. 25MM of the 125MM revolver was sponsored by TK, who definitely need cash to handle their own debt maturity.

 

Turning off preferred only saves like $28MM/year, and they will need to pay it back in the future because it is accumulative. So I don't see it is necessary.

 

We need to check if it is merely cumulative or if it compounds as well.  Cumulative just means that it acrrues.  But compounding makes a big difference.  They say prefer is the hybrid of debt and equity and that's exactly what it is.  You can turn off the dividends without a lot of penalty unlike interest payment where people will seize your asset. 

[heth247]

We need to check if it is merely cumulative or if it compounds as well.  Cumulative just means that it acrrues.  But compounding makes a big difference.  They say prefer is the hybrid of debt and equity and that's exactly what it is.  You can turn off the dividends without a lot of penalty unlike interest payment where people will seize your asset.

 

Most preferred just accrues. But I think suspending the preferred is definitely a distressed move that is unnecessary at this point. Not sure if it will affect their credit ratings.

[chrispy]

Heth, I appreciate the work you have shared here

[heth247]

Heth, I appreciate the work you have shared here

 

Thanks, Chris. Actually, it was the original discussion by BG, Packer, and later Seth, that helped me to understand and became really interested in this investment.

 

I welcome feedback by other board members on my thoughts shared above. E.g. I assumed that the $366MM + $85MM secured debt payment can be simply refinanced. If that assumption is not true, then TOO can run in to liquidity trouble.  On the other hand, they issued 700MM @ 8.5% unsecured debt last year, and used it to take out the 200MM @ 10% debt BBU bought from TK, that is due in 2022. This tells me that they don't foresee any trouble of liquidity in 2019, otherwise they would have kept that 200MM debt because it not due for 4 years. Does that make sense?

 

 

[Deepdive]

heth,

 

That's nice of you to call out BG, Packer and Seth.  It is very un-Wall Street of you. 

[heth247]

heth,

 

That's nice of you to call out BG, Packer and Seth.  It is very un-Wall Street of you.

 

Hehe, I am indeed very "un-wall street", because I don't work in financial industry. I am a software engineer who is still learning value investing. I will try my best to contribute meaningfully to the discussion, and hope can learn from others here. thanks.

[walkie518]

Heth, I appreciate the work you have shared here

 

Thanks, Chris. Actually, it was the original discussion by BG, Packer, and later Seth, that helped me to understand and became really interested in this investment.

 

I welcome feedback by other board members on my thoughts shared above. E.g. I assumed that the $366MM + $85MM secured debt payment can be simply refinanced. If that assumption is not true, then TOO can run in to liquidity trouble.  On the other hand, they issued 700MM @ 8.5% unsecured debt last year, and used it to take out the 200MM @ 10% debt BBU bought from TK, that is due in 2022. This tells me that they don't foresee any trouble of liquidity in 2019, otherwise they would have kept that 200MM debt because it not due for 4 years. Does that make sense?

Unless Brookfield has other plans, I would think that buying into a firm to drive it into bankruptcy is not the goal.

 

My assumption is that Brookfield likely backs the business or finds a way to leverage its balance sheet to put financing in place at attractive rates that the business could not otherwise afford. 

 

There is also a lot of money that could be made on loans with high IRR and low absolute interest rates...likely a way to juice returns for some Brookfield funds should the market dry up?  Too incestuous?

[heth247]

Does any body have access to the MS analyst's recent report on TOO, in which he set the target price to $1? I wonder how he models the normalized cash flow and arrive that kind of valuation. Thanks.

[bjakes00]

I do but can't share. The analyst basically has an "MS estimate" of the value of the fleet of $4.1bn ($1.9bn for the shuttle tankers, $0.4bn for the FSO, $1.4bn for the FPSOs, $0.3bn for the Towage segment and $0.1bn for the UMS segment) and then nets off the debt and the preferreds to get to a common stock equity value of -$0.3. He then applies a 15% appreciation on the shuttle tankers and FPSO/FSOs to get to $1 for common equity...a magical approach.

 

I think a far better way is a cash flow based approach but the key question is whether that debt can be refinanced (which it seems like it can be from some explanations further up in the thread, especially from JDCap).

 

My other question is if there are no returns in this business to be had, why are they choosing to invest into new tankers? Surely there is someone with some capital allocation prowess on the board who can see the returns and is making that decision.

 

Either way, this is a really low return on capital business and I'm hoping a bit here that they can scrape this turnaround through. From what I gather, hope is not a great investment thesis but keen to be proven wrong here.

[heth247]

I do but can't share. The analyst basically has an "MS estimate" of the value of the fleet of $4.1bn ($1.9bn for the shuttle tankers, $0.4bn for the FSO, $1.4bn for the FPSOs, $0.3bn for the Towage segment and $0.1bn for the UMS segment) and then nets off the debt and the preferreds to get to a common stock equity value of -$0.3. He then applies a 15% appreciation on the shuttle tankers and FPSO/FSOs to get to $1 for common equity...a magical approach.

 

I think a far better way is a cash flow based approach but the key question is whether that debt can be refinanced (which it seems like it can be from some explanations further up in the thread, especially from JDCap).

 

My other question is if there are no returns in this business to be had, why are they choosing to invest into new tankers? Surely there is someone with some capital allocation prowess on the board who can see the returns and is making that decision.

 

Either way, this is a really low return on capital business and I'm hoping a bit here that they can scrape this turnaround through. From what I gather, hope is not a great investment thesis but keen to be proven wrong here.

 

Thanks, that's about the same as what I heard from other sources. I agree that it makes more sense to valuate it based on cash flow. But since TOO's cash flow contains so many noises I wonder if the MS analyst at least make any effort to estimate the normalized FCF. Sounds like he didn't.

 

Why do you think this is a "low return on capital business"? The ebitda margin has been consistently > 35%.

[bjakes00]

I’m referring to the sheer amount of capital it takes to generate that EBITDA (never mind the ongoing capex it requires).

 

When you look at the interest bearing debt and the full equity stack (incl. the preferreds) and compare that to the EBIT it generates, I start to get a bit worried.

 

I need to read all that stuff that JDCap linked around the financing of these assets, if you have long life asset level finance you might be able to focus less on ROCE/RONOA and focus more on ROE.

 

Also a bit concerned that Brookfield will transfer equity value to the debt holders here (of which it is both) and stuff the minorities.

 

That being said I’m along for the ride and it’s a small enough position that I’m not too concerned.

[heth247]

I’m referring to the sheer amount of capital it takes to generate that EBITDA (never mind the ongoing capex it requires).

 

When you look at the interest bearing debt and the full equity stack (incl. the preferreds) and compare that to the EBIT it generates, I start to get a bit worried.

 

I need to read all that stuff that JDCap linked around the financing of these assets, if you have long life asset level finance you might be able to focus less on ROCE/RONOA and focus more on ROE.

 

Also a bit concerned that Brookfield will transfer equity value to the debt holders here (of which it is both) and stuff the minorities.

 

That being said I’m along for the ride and it’s a small enough position that I’m not too concerned.

 

I see. I guess the low ROIC so far is a result of management's past mistakes on bad capital allocation, and that is what BBU comes in as the fix. But the business itself is a good business that earns high margin.

[petec]

Why do you think this is a "low return on capital business"? The ebitda margin has been consistently > 35%.

 

EBITDA margins don’t necessarily have anything to do with ROIC. Partly because D&A can be high; and partly because the margin can be very high but revenue/capital employed can be low. For example if you rent your house (at least where I live) the margin may be 80-90% but the ROIC is about 4%.

 

As I’ve argued above here, I don’t see any hard evidence that this is a much better business than any other capital intensive, buy-the-asset-and-collect-the-rent business.

[heth247]

Why do you think this is a "low return on capital business"? The ebitda margin has been consistently > 35%.

 

EBITDA margins don’t necessarily have anything to do with ROIC. Partly because D&A can be high; and partly because the margin can be very high but revenue/capital employed can be low. For example if you rent your house (at least where I live) the margin may be 80-90% but the ROIC is about 4%.

 

As I’ve argued above here, I don’t see any hard evidence that this is a much better business than any other capital intensive, buy-the-asset-and-collect-the-rent business.

 

Yes, you are right, ebitda margin is not the right metric to use here, should look at ROA. Actually, TOO's ebitda margin is kind of poor when compared to KNOP, which is close to 80%. But I guess that's because KNOP is a pure shuttle tanker play and their ships are all pretty new. TOO's shuttle tankers are mostly old, and under invested.

[heth247]

As I’ve argued above here, I don’t see any hard evidence that this is a much better business than any other capital intensive, buy-the-asset-and-collect-the-rent business.

 

Petec, just curious, isn't SSW in a similar business model? Why do you prefer SSW over TOO?  Is it because they are more ahead in a stage where they are done with capex for new ships? 

[petec]

As I’ve argued above here, I don’t see any hard evidence that this is a much better business than any other capital intensive, buy-the-asset-and-collect-the-rent business.

 

Petec, just curious, isn't SSW in a similar business model? Why do you prefer SSW over TOO?  Is it because they are more ahead in a stage where they are done with capex for new ships?

 

Yes and yes, basically. I think they are fundamentally similar in that if ROIC ever rises much above WACC capital will come flooding in. And I prefer SSW because it's spewing FCF, and that FCF is in the hands of a very sound capital allocator who is looking outside the core business for high returns.

 

With TOO I gave up on due diligence fairly early because I couldn't easily calculate FCF (I found the accounting difficult at first glance), couldn't get a handle on capital deployment, and didn't like the fact that people seemed to think it had barriers to entry which I couldn't see. In other words, I couldn't immediately get a sense of its value and wasn't comfortable that other investors understood it, which can be a nasty combination.

 

Please note that I did not work deeply on TOO. I'm not saying I don't think the stock has deep value. It may be a far better buy than SSW but I didn't do enough work to determine the value.

[Seth Lowry]

I thought I would chime in on a few things as I have looked like an idiot on this one…

 

Part I)

Here are some notes on the MS downgrade note...

 

Morgan Stanley’s thesis centered a perceived funding gap. Morgan Stanley assumes a “$503M funding gap” that will require an equity raise or debt for equity swap.  Morgan Stanley’s funding gap thesis is wrong for the following reasons:

 

1.      Misunderstands VARG FPSO Contract +$219M

 

MS misses the fact that the VARG FPSO will be financed by Alpha Petroleum upfront, NOT Teekay!  His model and the funding gap above includes $219M that is just simply an error. 

 

Slide 6 from presentation…

https://www.teekay.com/investors/teekay-offshore-partners-l-p/financials-presentations/

 

2.      MS still forecasts a common dividend +$58M

 

Incredibly, not only does Morgan Stanley forget that Teekay Offshore cut its dividend to zero, but he actually forecasts TOO to increase its dividends despite his “funding gap” thesis…this one is really baffling to me

 

3.      Liquidated Damages from Petrobras Settlement +$91M

 

MS does not factor this in

 

4.      Working Capital +$50M

 

Morgan Stanley forecasts a $50M use of working capital for no justifiable reason

 

5.      Aggressively assumes payoff of Arendal Spirit Flotel  +~$40M

 

MS assumes that this facility won’t get extended and that this vessel won’t get chartered for 3 years.  In reality, it is bidding for work in Brazil right now and Petrobras has incentive to charter this asset from the settlement above.  Further, the banking facility is likely secured against the liquidated damages and will be able to be extended without a charter.

 

6.      MS appears to be forgetting about the PetroJarl I contract reversion late this year which adds $30M of pure rate increase

 

7.      Miscalculates preferred interest costs by $8M

 

These six items total $496M or 99% of the $503M in Morgan Stanley’s shortfall is simply attributed to bad analysis

 

In addition to the mis-modeled items listed above, the remainder of the shortfall can be attributed to Morgan Stanley simply lowering his earnings assumptions in shuttle tankers and FPSOs.  It is hard to piece together, but he basically lowered his operating cash flows to only $238M a year.  I have no idea how he got that low, but keep in mind that TOO has $300M/year in D&A and another $20M-$30M or so in Other Amortization. 

 

MS forecasts a significant decline in shuttle tankers, and I find this particularly hard to believe since 1) in 2019 TOO will benefit from the full year of operations from the ECC newbuilds 2) rates are increasing and 3) it will take delivery of 6 newbuilds through 2020. 

So adding the six errors in modeling assumptions above and a normal forecast for FPSOs and Shuttle tankers means there is no funding gap in my view.

 

Therefore, there does not seem to be any funding risk for Teekay Offshore.  Also, there would be huge reputational risk for Brookfield if they screwed up the funding, particularly since they spent half of their equity capital on retiring preferreds in 2017 and last year they called the intercompany loan at full par ($212M) that wasn’t due until 2022.

 

However, shame on BBU and TOO for letting a narrative this bad dominate the market and cause this much confusion.  Lack of communication among the co-sponsors has been extremely disappointing.  It has caused skepticism among investors that they are mis-aligned.  I continue to believe that both of these sponsors have strong reasons not to screw minority common shareholders, and pick short-termism over long-term value investing principles (as they both trumpet) but its not like they are giving us a lot to go on.   

 

Part II)

 

I think the market is really misunderstanding the capital structure maneuvers of BBU/TOO but here is my take…

 

The market is failing to appreciate lending constraints in the shipping capital markets, principally from European banks.  Regulations have punished traditional European shipping bank debt lenders (RBS sold their book at 20c on the dollar).

 

This is why having BBU as sponsor, with significant capital access, positions TOO so much better on a relative basis.  All of the high quality shipping companies are issuing preferreds (albeit high cost) and termed debt (if they can) to supplant a lower level of bank debt and stricter lending standards.  Since BBU’s recap, duration has been pushed out from ~2 years to 5 years.  This is huge and greatly underappreciated.     

 

For details on why BBU and TOO are making capital structure changes look at SSW last quarter’s transcript.  They are running the same playbook.  There is also good info in GasLog’s investor day presentation. 

 

Consider TOO's/SSW's refinancing versus what its peer, KNOP Offshore faces.  KNOP is more leveraged and it is facing significant refinancing risk especially considering it is paying out a large dividend (12%) and it cash flows are being siphoned nearly 50% to its sponsor via IDRs. 

 

Bottom line, TOO’s blended debt capital costs went up ~2% but unlevered returns on its shuttle tankers went from HSD to low/mid-teens (see ECC shuttle tanker analysis in NOK bond deck).  TOO is winning on a relative basis, which can be a powerful dynamic in competition limited markets. 

 

Part III)

Capex on shuttle tankers is required so they can meet their obligations under the MSA with their major oil shuttle tankers.

They have now refreshed nearly 1/3 of their shuttle tankers in their fleet.

 

Secured debt is project finance and amortization is secured against the timecharter contract (not TOO credit profile or cash sweep) so keep that in mind when thinking about sources and uses for capex funding.

 

Part IV)

Be very careful with shipping accounting.  I would encourage everyone here to read the fine print and crack open excel and model in detail (or pay someone to do this).  EBITDA margins are simply not comparable across the space, ROA/ROE as well.  E.g. fee income, amortization of contracts, and even weirder stuff like contra-expense from earned pool revenues (as in the case of GLOP). 

 

For instance, SSW has the same financial profile as TOO, but it does not account for replacement cost…again, it does not account for replacement cost, $0 – look in their investor day presentation for details. And it trades for 10x EBITDA.  I actually like SSW as well, but not for its current financials...it is very interesting to compare SSW to TOO which has at least has OK replacement cost assumptions (I still model >20% replacement cost above TOO mgmt..) but TOO trades at 5x EBITDA. 

 

In my opinion, misunderstandings on shipping capital markets and in shipping accounting, particularly more sophisticated discussions on topics such as return of capital in replacement cost assumptions are burning investors hard i.e. Dynagas. 

 

I wish the shipping sector would clean up their act and report more normalized numbers and accounting treatments.  It would help long-term investment in the space.

 

Hope the above helps.