ATCO - Atlas Corp

[petec]

Agreed. And it won’t just be the Washingtons. There’s another big shareholder that needs cash flow, as discussed extensively on this board.

 

But also: while the hypothetical ROEs look great, I did point out that we don’t know the real IRR because we don’t know the lease terms (nor, indeed, the rates the ships will earn when the leases end). Also, these assets have *relatively* short-lives, and an x% ROE on a short lived asset is much less valuable than the same ROE on a long-lived one. Treat my maths as a paper exercise only.

 

I think the bolded part is key. Wouldn't returns be significantly lower once you account for required debt payments? The company has been trying to reduce the scheduled principal payments (which is fine by me and makes sense...to an extent), but these ships ultimately have a ~25y useful life.

 

So if you assume the required debt payments on these vessels are amortized over say 15y, IRRs on these recent deals look weak.

 

When Sokol joined Seaspan as Chairman, he berated the previous management team for levering up to build new ships, and then when the downturn hit, their balance sheet didn't allow them to buy (almost) new ships at less than 50% of cost (ie, the Sam Zell strategy - your competitive advantage is your opportunistic buying which gives you an asset cost base that is >50% lower than everyone else).

 

Newbuild ship costs haven't dropped by that much, and with charter rates not looking that different from ~2015 (I think) it seems like they're just doing what the previous management did. How is this point of view incorrect?

 

Depends on the timing of debt repayments but assuming they’re back end loaded IRRs could be quite high.

 

What’s your source on new build costs? Not that it matters much since the vast majority of capital deployed has been in acquisitions.

 

 

[Nelg]

Agreed. And it won’t just be the Washingtons. There’s another big shareholder that needs cash flow, as discussed extensively on this board.

 

But also: while the hypothetical ROEs look great, I did point out that we don’t know the real IRR because we don’t know the lease terms (nor, indeed, the rates the ships will earn when the leases end). Also, these assets have *relatively* short-lives, and an x% ROE on a short lived asset is much less valuable than the same ROE on a long-lived one. Treat my maths as a paper exercise only.

 

I think the bolded part is key. Wouldn't returns be significantly lower once you account for required debt payments? The company has been trying to reduce the scheduled principal payments (which is fine by me and makes sense...to an extent), but these ships ultimately have a ~25y useful life.

 

So if you assume the required debt payments on these vessels are amortized over say 15y, IRRs on these recent deals look weak.

 

When Sokol joined Seaspan as Chairman, he berated the previous management team for levering up to build new ships, and then when the downturn hit, their balance sheet didn't allow them to buy (almost) new ships at less than 50% of cost (ie, the Sam Zell strategy - your competitive advantage is your opportunistic buying which gives you an asset cost base that is >50% lower than everyone else).

 

Newbuild ship costs haven't dropped by that much, and with charter rates not looking that different from ~2015 (I think) it seems like they're just doing what the previous management did. How is this point of view incorrect?

 

Depends on the timing of debt repayments but assuming they’re back end loaded IRRs could be quite high.

 

What’s your source on new build costs? Not that it matters much since the vast majority of capital deployed has been in acquisitions.

 

I agree the economics look good if debt repayments are back-end loaded but then the risk just gets transferred to lenders, and I believe most of the debt is recourse. I understand the "but this time the industry is an oligopoly" argument though, which might/should result in vessels not being scrapped before their useful lives (ie, like what happened during the last downturn).

 

Maybe I'm just a grumpy old credit guy, but creditors should want their principal back well before the useful life for the above reason, plus most customer credit ratings aren't that strong either. IMO the prices Atlas is paying for these vessels does not provide much margin of safety if there's a repeat of a ~2016-type downturn.

 

Newbuild cost is from a Jefferies report which sources from Clarksons, which is the same industry publication usually quoted in Seaspan's presentations. I don't know how to post pictures on here, but here's the data (I'm eyeballing it from graphs - I don't have the exact numbers):

- 8.5-9.1k TEU 5-year ranges:

NB costs: ~$82-90m, vs currently ~$87m

5y old vessels: $25-$70m, vs currently ~$50m.

 

- 13-14k TEU 5-year ranges:

NB costs: ~$105-115m, vs currently ~$105m.

5y old vessels (data only for 13k TEU): ~$85-$110m, vs currently ~$90m.

 

They seem to be buying stuff mostly in the ~11-12k TEU range (the last 2 acquired 12k TEU vessels were 2y old and $88m each), and I'm guessing the 5 12.2k TEU newbuilds they just ordered cost ~$500m, so [assuming similar charter rates] it seems like the economics between their acquisitions and newbuilds is similar.

 

Btw I own Atlas shares.

[ourkid8]

Are charter rates really not looking that different than 2015? I do not think rates have been this high since ~2008! Please see the below link.  When purchasing 5 new builds that are already backed by 18 charters at the current elevated rates...Maybe they are not following the same path as the previous management. 

 

https://harpex.harperpetersen.com/harpexRH.csv

 

Newbuild ship costs haven't dropped by that much, and with charter rates not looking that different from ~2015 (I think) it seems like they're just doing what the previous management did. How is this point of view incorrect?

[Nelg]

Yeah sorry, I meant the contracted rates of the stuff they've been buying (not spot rates which as you noted are extremely strong right now). They said the ships they're building/recently acquired are generating EBITDA of ~$10m/year, so assuming ~65% EBITDA margins, the revenues seem to be similar to the 15 vessels delivered to Yang Ming in 2015-16 (which are generating revenues of ~$16.5m/year).

 

But anyway you're right, the 18y newbuild contracts at those rates are far better vs say the YM ships which were only on 10y contracts.

 

Edit: Should note the YM vessels were 14k TEU, so the recently-announced newbuilds likely have slightly lower newbuild costs than the YM ones. So yeah the economics may very well be good on those, assuming no MSC (or whoever the liner was) credit issues.

[gfp]

An update on how these notes priced, conversion prices, etc  -

 

https://www.sec.gov/Archives/edgar/data/1794846/000119312520319538/d63418dex991.htm

[NBL0303]

An update on how these notes priced, conversion prices, etc  -

 

https://www.sec.gov/Archives/edgar/data/1794846/000119312520319538/d63418dex991.htm

 

I must confess I'm not sure I understand the net effect of the capped call transactions, i.e. why they are choosing this structure. Anyone have any insight on that?

[gfp]

Not sure if this helps but this is how I understood it -

 

[NBL0303]

Thank you gfp - I guess my question is more like, why did Atlas choose this structure for this offering? What's in it for them now versus other types offerings?

[petec]

Sokol grew Mid-American at a 23% ROE for about 20 years.  His strength is capital-intensive businesses and making them very efficient.  Bing is no slouch either!  Cheers!

 

Yes. I’ve never really trusted that number because my source is Prem and I think he can be a bit sloppy with figures. But Sokol is definitely one of my big reasons for owning Atlas.

 

Actually, all you have to do is look at what Mid-American was earning when Berkshire acquired it in 1999 ($104M) and what it was making in 2010, shortly before Sokol left...$1,131M.  That's about 26% annualized over 10 years in earnings growth.  He essentially did the same thing 10 years earlier growing earnings from $10M to $104M.  Cheers!

 

Well, no. You also have to look at whether Berkshire contributed capital during that time. I’m sure you and others know the answer, but I don’t, which is why I take the CAGR as unproven!

 

Yes, BRK invested about $5b of additional equity capital after the acquisition (and another $1b of equity capital after Sokol left to fund the NV Energy acquisition).

 

If anyone's wondering, this is the history on CalEnergy/MidAmerican (I have gone through all their 10-Ks, though not in great detail - so I think the below is mostly correct:

- Sokol took over in Feb 1991.

- FY 1991 results:

NI $26.6m (vs 1990 NI $12m)

FFO $47.6m (don't have the 1990 number)

FD shares 36.5m (don't have 1990 FD shares outstanding)

= EPS $0.73/share & FFO $1.31/share

 

I don't have 1991 balance sheet numbers, but the below are 1992 numbers:

Recourse Net Debt/ FFO: -0.3x (ie, net positive unrestricted cash)

Total Net Debt/ FFO: 2.8x

 

- BRK acquisition of MidAmerican closed sometime in 2000.

- FY 2000 results:

NI $133m

FFO $597m

FD shares 43.8m

= EPS $3/share & FFO $14/share

 

Recourse Net Debt/ FFO: 3.6x

Total Net Debt/ FFO: 9.8x

 

Leverage was clearly higher, but when BRK acquired MidAmerican, they owned 2 regulated utilities in the UK and US and had a larger independent power plant portfolio...ie, the business quality was superior vs the small geothermal portfolio they owned when Sokol took over.

 

- IMO the "Sokol era" ended around 2009. He sold most of his MidAmerican shares (ie, to BRK) in 2009 for a cool $123m, and started the NetJets restructuring around this time.

- FY 2009 results:

NI $1.16b

FFO 3.3b

FD shares 75m

= EPS $15/share & FFO $44/share

 

Recourse Net Debt/ FFO: 1.6x

Total Net Debt/ FFO: 5.2x

 

There were huge one-time gains from their "failed" acquisition attempt of Constellation Energy Group in 2008 - they made a ton of money from termination fees and their financial restructuring there. And of course, Sokol was credited for the BYD investment which was made in 2008 and I believe is still held within the MidAmerican/BH Energy entity.

 

Thanks, this is useful. So 15/0.73=20x eps in 18 years for a CAGR of 18%, partly driven by an increase in leverage? That seem fair?

[petec]

Agreed. And it won’t just be the Washingtons. There’s another big shareholder that needs cash flow, as discussed extensively on this board.

 

But also: while the hypothetical ROEs look great, I did point out that we don’t know the real IRR because we don’t know the lease terms (nor, indeed, the rates the ships will earn when the leases end). Also, these assets have *relatively* short-lives, and an x% ROE on a short lived asset is much less valuable than the same ROE on a long-lived one. Treat my maths as a paper exercise only.

 

I think the bolded part is key. Wouldn't returns be significantly lower once you account for required debt payments? The company has been trying to reduce the scheduled principal payments (which is fine by me and makes sense...to an extent), but these ships ultimately have a ~25y useful life.

 

So if you assume the required debt payments on these vessels are amortized over say 15y, IRRs on these recent deals look weak.

 

When Sokol joined Seaspan as Chairman, he berated the previous management team for levering up to build new ships, and then when the downturn hit, their balance sheet didn't allow them to buy (almost) new ships at less than 50% of cost (ie, the Sam Zell strategy - your competitive advantage is your opportunistic buying which gives you an asset cost base that is >50% lower than everyone else).

 

Newbuild ship costs haven't dropped by that much, and with charter rates not looking that different from ~2015 (I think) it seems like they're just doing what the previous management did. How is this point of view incorrect?

 

Depends on the timing of debt repayments but assuming they’re back end loaded IRRs could be quite high.

 

What’s your source on new build costs? Not that it matters much since the vast majority of capital deployed has been in acquisitions.

 

I agree the economics look good if debt repayments are back-end loaded but then the risk just gets transferred to lenders, and I believe most of the debt is recourse. I understand the "but this time the industry is an oligopoly" argument though, which might/should result in vessels not being scrapped before their useful lives (ie, like what happened during the last downturn).

 

Maybe I'm just a grumpy old credit guy, but creditors should want their principal back well before the useful life for the above reason, plus most customer credit ratings aren't that strong either. IMO the prices Atlas is paying for these vessels does not provide much margin of safety if there's a repeat of a ~2016-type downturn.

 

Newbuild cost is from a Jefferies report which sources from Clarksons, which is the same industry publication usually quoted in Seaspan's presentations. I don't know how to post pictures on here, but here's the data (I'm eyeballing it from graphs - I don't have the exact numbers):

- 8.5-9.1k TEU 5-year ranges:

NB costs: ~$82-90m, vs currently ~$87m

5y old vessels: $25-$70m, vs currently ~$50m.

 

- 13-14k TEU 5-year ranges:

NB costs: ~$105-115m, vs currently ~$105m.

5y old vessels (data only for 13k TEU): ~$85-$110m, vs currently ~$90m.

 

They seem to be buying stuff mostly in the ~11-12k TEU range (the last 2 acquired 12k TEU vessels were 2y old and $88m each), and I'm guessing the 5 12.2k TEU newbuilds they just ordered cost ~$500m, so [assuming similar charter rates] it seems like the economics between their acquisitions and newbuilds is similar.

 

Btw I own Atlas shares.

 

I actually think the opposite argument might apply regarding cash flow timing and IRRs. Seaspan have been moving away from asset-level debt, most notably with their big secured lending facility. I don't think there are any principal repayments associated with that facility - from memory it has a bullet maturity, and is effectively a huge revolver. When investments are funded out of this facility (or indeed any other corporate-level bullet debt), 100% of early-year cash flows accrue to equity and the debt can be paid off with later cash flows. Obviously this comes with a risk, which is that they might have trouble extending the revolver, but if you are prepared to take that risk the IRRs could be very attractive.

 

BTW I disagree that the cost difference of $88m vs $100m suggests similar economics. Assuming similar cash flows and therefore similar debt, a 12% difference in total cost represents anything up to about a 50% difference in equity requirement. It's potentially transformative, and my guess is that the IRRs on the acquisitions are significantly higher than the IRRs on the newbuilds. For the newbuilds, Seaspan is effectively just a capital provider clipping a spread until the lessor buys the ships in 18 years. This reduces the risk (not to zero, but it reduces it) so it is reasonable to assume the IRRs are lower or the leverage to achieve the same IRR is higher.

 

Re scrapping of vessels, I had a very interesting chat with a shipper recently who pointed out that the widening of the Panama canal had a significant one-off effect on obsolescence. Essentially a lot of ships built for the old canal (Panamax) became obsolete overnight as larger, more efficient ships came into play. Today, the limits on ship size are imposed by port capacity and journey length (you can't use huge ships on short journeys because the dwell time in ports is too long). To achieve another step-change would require hundreds of little projects - dredging ports, extending docks, etc., across dozens of jurisdictions - and these will not happen in a coordinated fashion. This means the last 15 years have seen a one-off supply shock in the shipping industry. That is part of what caused owners to scrap vessels before their useful lives ended.

 

Add the fact that the industry has been working off the 2008 newbuild excess for over a decade, and there is very little spare capacity and virtually no order book, and I don't worry about early scrapping. The only thing that concerns me on the supply side is the belt-and-road initiatives which are increasing the capacity to move containers across Asia by rail.

[petec]

An update on how these notes priced, conversion prices, etc  -

 

https://www.sec.gov/Archives/edgar/data/1794846/000119312520319538/d63418dex991.htm

 

I must confess I'm not sure I understand the net effect of the capped call transactions, i.e. why they are choosing this structure. Anyone have any insight on that?

 

It makes my brain hurt frankly. gfp's post is useful but I don't fully understand the benefit of synthetically increasing the conversion price, rather than just increasing it. I assume it is to do with tax or accounting.

 

Anyway the net effect seems to be that they have raised 5-year debt at a total cost of 5.5% which could convert into shares at $17.85.

 

The bit that really confuses me is that Seaspan has the right to redeem the notes at par if the shares are over 130% of the unadjusted conversion price, which is $13. Doesn't that hugely reduce the value of the convertibility feature to the buyer?

[gfp]

I'm not an expert on these financings but what I understand is that the lenders (bond buyers) get a convertible with a 13 conversion price and ATCO spends some money (accounted for like original issue discount I believe) to synthetically bump that number into the 17's as far as the cash-for-dilution goes.  There was probably not an attractive market for converts that had a strike in the 17's.  Why they chose this structure - who knows - it was likely the most compelling option the bankers presented to them.  It doesn't sound uncommon but I'm sure it will create a little accounting noise around share price movement since Atlas holds the call spread if I am understanding it correctly.

 

For me, what was/is important was that the derivative trades and the convertible issuance caused the market price of ATCO to decline for no reason other than hedging to facilitate those derivative trades.  And that was/is an opportunity if you want more Atlas around 10.

[Nelg]

Thanks for your thoughts petec, especially re the Panama canal. I have heard Atlas allude to this in calls but not explain it in that detail (or I didn't pick up on it). Are there any other sources/data you can share for this - particularly on your comment "the limits on ship size are imposed by port capacity and journey length (you can't use huge ships on short journeys because the dwell time in ports is too long)"

 

Their corporate debt is basically split ~20% revolver, ~60% TL, and the rest FFH notes, and scheduled repayments are a few hundred m/year. But I take your points and think you're putting out better ones than me.

 

On your MidAmerican question: "15/0.73=20x eps in 18 years for a CAGR of 18%, partly driven by an increase in leverage? That seem fair?"

 

It's fair to say that though he was likely also responsible for the ~2x increase in earnings from 1990 to 1991 too (he cut 25% of employees in the first few months of 1991, and started a few-year trend of increased load factors on the geothermal plants)...but I don't know if they raised equity in 1991. Anyway, it's a good record however which way you cut it, and it is more anomalous that he did that while also substantially improving the business quality.

[gfp]

As some more color on the "why this structure" question - here are some quotes from Sokol and Chen (and the PR for the upsized, closed offering)

 

"This initial offering by Atlas's subsidiary, Seaspan, within the institutional unsecured credit markets resulted in providing low-cost unsecured capital for future growth and enhanced our balance sheet and capital structure while also providing increased financial strength. The transaction was an important step toward our objective of achieving a corporate investment grade credit rating. The capped call structure also provides protections to holders of our common shares by mitigating future dilution while setting a higher than market exchange price," commented, David Sokol, Chairman of the Board of Directors of Atlas.

 

"We are pleased to access the unsecured institutional credit markets with a structure that provides protections for current equity holders and an effective capital solution for our stakeholders. This offering further demonstrates our prudent decision-making regarding our capital structure, which is based on stringent financial discipline that ensures we are well-positioned to seize opportunities while reducing the Company's overall cost of capital. We believe that the exchangeable notes will offer our institutional investors a great opportunity to participate in our continuing quality growth, while optimizing our capital structure and operating platform for existing investors over the long-term," remarked Bing Chen, President and CEO of Atlas.

 

The notes will be exchangeable under certain circumstances at the option of the holders into Atlas common shares, par value $0.01 per share ("Atlas shares"), cash, or a combination of Atlas shares and cash, at Seaspan's election, unless the notes have been previously repurchased or redeemed by Seaspan. The notes are not guaranteed by Atlas or any of its or Seaspan's respective subsidiaries. The notes will mature on December 15, 2025, unless earlier exchanged, repurchased, or redeemed. The exchange rate will initially equal 76.8935 Atlas shares per $1,000 principal amount of notes (equivalent to an initial exchange price of approximately $13.01 per Atlas share). The exchange rate will be subject to adjustment upon the occurrence of certain events, but will not be adjusted for any accrued and unpaid interest. After giving effect to the cap price established in the capped call transactions, the initial effective exchange price on the notes of $17.85 per Atlas share represents a premium of approximately 75% over the last reported sale price of the Atlas shares of $10.20 per share on the New York Stock Exchange on December 16, 2020.

 

http://newsfile.refinitiv.com/getnewsfile/v1/story?guid=urn:newsml:reuters.com:20201222:nPn1SK3nKa&default-theme=true

[gary17]

this stock is clearly benefiting from the huge increase in freight price....is that understanding correct?

i wonder how sustainable this is and what this means....

[ValuePadawan]

New CFO as well https://ir.atlascorporation.com/2021-01-11-Atlas-Announces-Appointment-of-New-Chief-Financial-Officer?asPDF=1

[bluedevil]

Atlas will see some benefit from the increased rates, as they have a small set of ships that are on shorter term charters (mostly older/smaller boats).  Most contracts are on long term charters, so it won't necessarily benefit Atlas that much, and even when ships come off charter, they often give the liners options to extend for a year or two.

 

Atlas has a large number of ships on big contracts that are coming off charter in 2022 and 2023, but again often with liner options.  The big question in my mind is whether Atlas can use the booming prices that are currently prevailing to try to negotiate some favorable extensions of those contracts while the market is hot.  They don't need to fully capture the prevailing rates, but just use the hot market to secure second charters at good, profitable rates.  If they can do that, the biggest risk facing the company will have been removed and I believe will lead to a re-rating of the stock higher.  Fingers crossed!

[petec]

Interesting to see the contex index (which tracks spot rates for smaller vessels) is at its highest level since before the GFC, and roughly double the average level since then.

 

Atlas doesn't have a huge amount of exposure to spot rates but this will help at the margin. It's also suggestive of tight supply and demand conditions, which can't quickly be fixed by increasing supply given the size of the current order book. 2021 will be an interesting year.

[petec]

Thanks for your thoughts petec, especially re the Panama canal. I have heard Atlas allude to this in calls but not explain it in that detail (or I didn't pick up on it). Are there any other sources/data you can share for this - particularly on your comment "the limits on ship size are imposed by port capacity and journey length (you can't use huge ships on short journeys because the dwell time in ports is too long)"

 

Sorry only just seen this. No, I can't give a specific source, but I think Seaspan have mentioned it on conference calls and I have heard it from other sources also. It makes intuitive sense. The longer you're at sea the more you save by cramming more containers onto one ship. But if you're not at sea long, then the time taken to load and offload them offsets the benefits. I believe even the trans-Pacific route is too short for the the really big ships, which are only optimal on Asia-Europe routes. I may have misremembered that specific datapoint but the overall point stands.

[petec]

https://www.bloomberg.com/news/audio/2021-01-17/why-the-cost-of-shipping-goods-from-china-is-soaring-podcast

 

Interesting discussion. I’m not sure I agree on the long term outlook but the points about competitive dynamics and the issues with really big ships are valid in my view.

[Castanza]

https://www.bloomberg.com/news/audio/2021-01-17/why-the-cost-of-shipping-goods-from-china-is-soaring-podcast

 

Interesting discussion. I’m not sure I agree on the long term outlook but the points about competitive dynamics and the issues with really big ships are valid in my view.

 

Great discussion, thanks for posting

[Viking]

https://www.bloomberg.com/news/audio/2021-01-17/why-the-cost-of-shipping-goods-from-china-is-soaring-podcast

 

Interesting discussion. I’m not sure I agree on the long term outlook but the points about competitive dynamics and the issues with really big ships are valid in my view.

 

Great discussion, thanks for posting

 

- 85% of shipping is controlled by three ‘alliances’. Hello oligopoly

- it will be very interesting to see how the current pricing environment affects Seaspan.

- the small amount of their business that is not on long term contract should be doing well given the spike in pricing

- as contracts roll off, if spot pricing remains elevated, it makes sense new contract prices should tick higher

- will much higher spot prices make acquisitions of new vessels more difficult? This could slow growth at Seaspan.

- Seaspan looks to be in the sweet spot size wise (10 - 12,000 TEU vessels).

[no_free_lunch]

If they are stymied from growth they should have other options.  They are running an ffo yield of over 20%.  Couldn't they simply crank the dividend or cannibalize the shares if needed?  Just a question of whether management would be willing to do such. Sokol is good but is he an empire builder or will he stay focused on shareholder returns?

[petec]

I feel fairly confident on that front. Just paying down debt and using the hard market to extent contracts would move the stock, I think.

[Castanza]

https://www.bloomberg.com/news/audio/2021-01-17/why-the-cost-of-shipping-goods-from-china-is-soaring-podcast

 

Interesting discussion. I’m not sure I agree on the long term outlook but the points about competitive dynamics and the issues with really big ships are valid in my view.

 

Great discussion, thanks for posting

 

- 85% of shipping is controlled by three ‘alliances’. Hello oligopoly

- it will be very interesting to see how the current pricing environment affects Seaspan.

- the small amount of their business that is not on long term contract should be doing well given the spike in pricing

- as contracts roll off, if spot pricing remains elevated, it makes sense new contract prices should tick higher

- will much higher spot prices make acquisitions of new vessels more difficult? This could slow growth at Seaspan.

- Seaspan looks to be in the sweet spot size wise (10 - 12,000 TEU vessels).

 

What’s interesting about the shipping industry compared to others is how well you need to predict future demand. For example he was talking about how these shipping companies aren’t building bigger ships to account for the increased demand. Why? Because they recognize it’s likely not permanent. Ships are expensive and take a very long time to build. So you’ve really got to gauge that cash flow appropriately. It’s not like UPS where you can go rent a bunch of U-hauls for the busy season and call it a day.

 

I guess this makes sense why he though the industry might be moving back towards mid sized ships. Large ones are less flexible functionally, efficiently and operationally which carries more negatives than positives.

 

At least, that is what I gathered from his discussion.