ATCO - Atlas Corp

[ERICOPOLY]

I agree but it just doesnt jive with my thesis. I was expecting a ramp up in dividend payouts. I bought at $9 or $10 and held for about 1.5 years. Then sold to raise capital, then bought options as a trade, now looking for an exit on the remaining portion of those. I think Wang is doing whats right, but I dont like the shipping business. It seems like a feast or famine deal. When its good its really good, and when not good its damn right brutal.

 

I want my feast, because I fear another famine.  Plus at my age I prefer capital gains. Without rises in the dividend we wont see many capital gains inmo. I think they are doing whats right, it just doesnt fit the original thesis.

Myth, I won't argue with your thesis or your position on cap gains vs. your age, but I do want to look at the cap gains numbers.  Assuming the 5% yield sticks and the $1.50 is right, then in 2013 we're looking at $31.50/share incl. dividends.  Which is 85% in less than two years - about 36% per year.  Maybe I'm dead wrong on the div and the gain, but I think I'm in the 80% right zone, which still puts me at 28% per annum.  Maybe that's below the expected return in this market, but I'll take what I can reasonably assess as probable.

 

I'll note that during feast and famine, Seaspan's operations and customers have performed exactly as expected.  Their financing got screwed, though, so they're not impervious to flaw :D

 

PS. This is one of the things that keeps me from investing in a company like MSFT..  85% value creation for them means that they need to create about $160bn in present value gains.  It just seems like such an improbably large number.  Maybe I need more imagination or something, but I see SSW creating $1bn more quickly than MSFT creating $160bn.

 

 

There's somewhat of a difference here.  SSW gets it's earnings by borrowing money to buy assets.  I'm not sure you can value it strictly on cash flows.  I think it needs to be valued on it's assets to some degree + some premium for the additional cash flows they get for providing crews and management services.  

 

I bring this up because I struggled to justify to myself whether or not the price is being influenced by rational people right now, and whether I would be correct in my assumption that a higher payout would lead to the $25+ price I was expecting.

 

In other words... if a commercial REIT buys up a lot of properties at 14% yields, using 6% interest loans and 25% down.  How much of a premium to book value should it trade at?  Similarly, another REIT buys up properties at 14% yields and uses cash only.  The former has more intrinsic value than the latter, assuming all ends well.  Do they both trade at intrinsic value?  Should they both trade at the same multiple to liquidation value, with the former generating better returns?

 

Do these things get valued only on cash flow, or is risk-adjustment important?

 

I think at the expectations for SSW share prices in the high $20s for example, that's roughly 10x distributable 2012 cash flow.  Couldn't you get the same return by investing in ships WITHOUT using any leverage?  So in what way is that a rational means of valuing SSW?  Who here thinks a highly leveraged company should trade on the same multiple to distributable cash flow as a completely debt free version of the same assets?

 

 

 

 

[Guest VAL9000]

There's somewhat of a difference here.  SSW gets it's earnings by borrowing money to buy assets.  I'm not sure you can value it strictly on cash flows.  I think it needs to be valued on it's assets to some degree + some premium for the additional cash flows they get for providing crews and management services.  

I'm not sure which part of my post you're referring to here - the comparison with MSFT ?

 

In other words... if a commercial REIT buys up a lot of properties at 14% yields, using 6% interest loans and 25% down.  How much of a premium to book value should it trade at?  Similarly, another REIT buys up properties at 14% yields and uses cash only.  The former has more intrinsic value than the latter, assuming all ends well.  Do they both trade at intrinsic value?  Should they both trade at the same multiple to liquidation value, with the former generating better returns?

 

Do these things get valued only on cash flow, or is risk-adjustment important?

 

I think at the expectations for SSW share prices in the high $20s for example, that's roughly 10x distributable 2012 cash flow.  Couldn't you get the same return by investing in ships WITHOUT using any leverage?  So in what way is that a rational means of valuing SSW?  Who here thinks a highly leveraged company should trade on the same multiple to distributable cash flow as a completely debt free version of the same assets?

I'm not sure about REITs.  It's not my specialty, which is why I don't participate on those threads.  I see the analogy, but I think commenting will only lead to confusion.

 

SSW seems to be valued on a few different metrics - #1 dividend, #2 cash flow, #3 assets - debt.  I break out 3 because book value or intrinsic value don't really describe it.  I think a lot of SSW's high valuation in '07 was due to the replacement cost of their container ships.  Well, they're not as valuable now because the yards are building them more cheaply, so really #1 and #2 are what drive the price today.

 

Yes, I think that if you didn't use leverage you would create the same cash flows, but you wouldn't create the same value for shareholders.  Let's say fair value is 3,000 based on 10x DCF.  If you go the pure equity route, you save on the interest costs - 6% * 2,500 debt = 150, so DCF = 450, but you have to put up more on the equity side.  So instead of 100mm shares we'd have 240mm shares (assumes 40/60 equity/debt split).  Price per share = 4500 / 240 = 18.75.  Same numbers with the current debt equity split is 3,000 / 100 = 30 per share, as you pointed out. [Edit: fixed my math here]

 

The equity picture is actually worse because there's a tax shielding effect associated with debt cost (i.e. when you finance with debt, you don't pay tax for that finance cost.  You will pay tax on the additional profits associated with the 100% equity approach, so DCF is closer to 400 but whatever the point is made.).

 

This is a simple model, but I think it fairly illustrates why debt it used the way that it is.  If I were the Washington family, I'd probably prefer a 100% debt capital structure, but clearly that won't fly because banks won't lend that kinda dough at those rates without having equity participants around to absorb the blow if things go sour.

 

[ERICOPOLY]

There's somewhat of a difference here.  SSW gets it's earnings by borrowing money to buy assets.  I'm not sure you can value it strictly on cash flows.  I think it needs to be valued on it's assets to some degree + some premium for the additional cash flows they get for providing crews and management services.  

I'm not sure which part of my post you're referring to here - the comparison with MSFT ?

 

In other words... if a commercial REIT buys up a lot of properties at 14% yields, using 6% interest loans and 25% down.  How much of a premium to book value should it trade at?  Similarly, another REIT buys up properties at 14% yields and uses cash only.  The former has more intrinsic value than the latter, assuming all ends well.  Do they both trade at intrinsic value?  Should they both trade at the same multiple to liquidation value, with the former generating better returns?

 

Do these things get valued only on cash flow, or is risk-adjustment important?

 

I think at the expectations for SSW share prices in the high $20s for example, that's roughly 10x distributable 2012 cash flow.  Couldn't you get the same return by investing in ships WITHOUT using any leverage?  So in what way is that a rational means of valuing SSW?  Who here thinks a highly leveraged company should trade on the same multiple to distributable cash flow as a completely debt free version of the same assets?

I'm not sure about REITs.  It's not my specialty, which is why I don't participate on those threads.  I see the analogy, but I think commenting will only lead to confusion.

 

SSW seems to be valued on a few different metrics - #1 dividend, #2 cash flow, #3 assets - debt.  I break out 3 because book value or intrinsic value don't really describe it.  I think a lot of SSW's high valuation in '07 was due to the replacement cost of their container ships.  Well, they're not as valuable now because the yards are building them more cheaply, so really #1 and #2 are what drive the price today.

 

Yes, I think that if you didn't use leverage you would create the same cash flows, but you wouldn't create the same value for shareholders.  Let's say fair value is 3,000 based on 10x DCF.  If you go the pure equity route, you save on the interest costs - 6% * 2,500 debt = 150, so DCF = 450, but you have to put up more on the equity side.  So instead of 100mm shares we'd have 240mm shares (assumes 40/60 equity/debt split).  Price per share = 4500 / 240 = 18.75.  Same numbers with the current debt equity split is 300 / 30 = 30 per share, as you pointed out.

 

The equity picture is actually worse because there's a tax shielding effect associated with debt cost (i.e. when you finance with debt, you don't pay tax for that finance cost.  You will pay tax on the additional profits associated with the 100% equity approach, so DCF is closer to 400 but whatever the point is made.).

 

This is a simple model, but I think it fairly illustrates why debt it used the way that it is.  If I were the Washington family, I'd probably prefer a 100% debt capital structure, but clearly that won't fly because banks won't lend that kinda dough at those rates without having equity participants around to absorb the blow if things go sour.

 

 

I'm not criticizing their choice of using debt, which seems to be what you are justifying.  I agree with you it seems like a good risk-adjusted idea.

 

I'm criticizing the analysis that tries to put a multiple on their distributable cash flow without taking into account the level of leverage.  It just doesn't make sense, because one winds up with situations where one is expecting somebody to buy the shares at a price far in excess to liquidation value.  Another version of the company with the same assets but without using leverage is also going to sell for the same multiple to cash flow, yet at 1x liquidation value?  

 

EDIT:  The person buying the highly levered version of the company ought to see outsized returns for the extra risk, but that's not going to happen if he buys it for the same multiple to cash flow as the no leverage version.

 

[Guest VAL9000]

I'm criticizing the analysis that tries to put a multiple on their distributable cash flow without taking into account the level of leverage.  It just doesn't make sense, because one winds up with situations where one is expecting somebody to buy the shares at a price far in excess to liquidation value.  Another version of the company with the same assets but without using leverage is also going to sell for the same multiple to cash flow, yet at 1x liquidation value? 

Most businesses are valued far in excess of liquidation value...  so I'm still confused at that example.  Certainly the leverage is important, but the cost of the leverage is already taking into account in DCF.  The risks associated with leverage is something else entirely.  More highly levered companies have greater exposure to refinancing risk, interest rate risk, covenant breaches, etc.  So, yeah, I'd say a company with higher leverage might be worth 8x DCF vs. a company with lower leverage that might be worth 10x DCF.

 

Ultimately, the market will decide if the number for SSW should be 5x, 8x, or 10x, and that decision will be based on how reliable those cash flows appear to be.  The risk associated with the leverage will be accounted for.  Currently we're at about 5.5x DCF - 1.2bn for ~220 DCF.  That seems kinda low, considering there are about 8-9 years left on average for all charters, with the bigger/better charters being the newer ones.  But there are leverage risks and asset depreciation to consider.  But there's also growth to consider.

 

In a stable state (plateauing at 100 ships for example), probably something like 6-8x DCF seems right, but that's gut feel more than anything.

 

 

[ERICOPOLY]

I'm criticizing the analysis that tries to put a multiple on their distributable cash flow without taking into account the level of leverage.  It just doesn't make sense, because one winds up with situations where one is expecting somebody to buy the shares at a price far in excess to liquidation value.  Another version of the company with the same assets but without using leverage is also going to sell for the same multiple to cash flow, yet at 1x liquidation value? 

Most businesses are valued far in excess of liquidation value...  so I'm still confused at that example. 

 

Alright, suppose I start a holding company that raises cash at 6% to buy SSW preferred stock which is yielding 9%.

 

What multiple to book value should it trade at?

 

To answer your question, most businesses trade at premiums to liquidation value because there is something intangible of value there -- for example, MSFT makes ridiculously high returns on equity without using any debt.  That "something" has value.

 

But the ship and the service of providing crews are the only value -- there is no other intangible.  They merely take that value and lever the crap out of it.

 

 

 

 

[Guest VAL9000]

Alright, suppose I start a holding company that raises cash at 6% to buy SSW preferred stock which is yielding 9%.

 

What multiple to book value should it trade at?

I see what you're saying.  If a ship were its own company with its own charter that made 15%, and Seaspan was just a 40/60 equity/debt vehicle that invested in these ship companies, then why would SSW be worth anything above or below the value of the ship?

 

To answer your question, most businesses trade at premiums to liquidation value because there is something intangible of value there -- for example, MSFT makes ridiculously high returns on equity without using any debt.  That "something" has value.

 

But the ship and the service of providing crews are the only value -- there is no other intangible.  They merely take that value and lever the crap out of it.

This seems to have gotten philosophical..  what is Value?  What is it worth? :D  Zen and the Art of Seafaring Vessel Maintenance

 

Really though, I think you're getting to a question of what a relatively good business is and what a relatively good price is.  I can map out where Seaspan goes from 1.25bn to 2.5bn.  I can't see where MSFT goes from 210bn to 420bn.  But maybe I don't have the imagination required.

 

Seaspan's value is there, and it's even measurable.  The value of Seaspan is reflected in the value of the charters.  Seaspan's value is this, for each contract:

Value =

  (annual revenue - annual opex) * n years

  + Value of ship in n years

  - Cost of ship finance over n years (all discounted back to today)

 

That's the math for the value that Seaspan adds over and above basic ship finance (which would result in value = 0).  The value comes in many forms, such as high quality operations (99% utilization rate), plug and play solution, discounted ship pricing, scale (ability to do big deals), financing.  The existence of SSW's customers prove that there's value above and beyond just providing a vessel leasing facility..  And you can even measure it with the formula above.

 

It's not Microsoft in terms of bootstrapping amazing value out of thin air, but most companies aren't Microsoft and I don't think that would keep me from investing in them.

 

[ERICOPOLY]

That's the math for the value that Seaspan adds over and above basic ship finance (which would result in value = 0).  The value comes in many forms, such as high quality operations (99% utilization rate), plug and play solution, discounted ship pricing, scale (ability to do big deals), financing.  The existence of SSW's customers prove that there's value above and beyond just providing a vessel leasing facility..  And you can even measure it with the formula above.

 

You are right.  There are some intangibles there which are worth paying a premium for.  However, you'd have that value even if they didn't employ leverage.  Once they leverage it, should "fair price" come at the same multiple to cash flow as the low-risk form of the company?

 

I have yet to see anyone's price target of SSW discuss this.  Perhaps this is because in the real world there is no such thing as risk-adjusted fair value?  Maybe it's all in my head?

[gaf63]

Turns out that this a  timely discussion of debt, SSW  just announced another offering of its pfd C shares ,  no mention of quantity as of yet, 

another 10 mil shs would give them over $400 mil in cash,  wonder what they're up to , big ship purchase , purchase of Mng. sub??

 

 

Also interesting is that the existing C shs. traded heavily all day and were down over 5% at one point, yet SSW hadn't released the info to public , received my email after closing today.

[Guest VAL9000]

You are right.  There are some intangibles there which are worth paying a premium for.  However, you'd have that value even if they didn't employ leverage.  Once they leverage it, should "fair price" come at the same multiple to cash flow as the low-risk form of the company?

 

I have yet to see anyone's price target of SSW discuss this.  Perhaps this is because in the real world there is no such thing as risk-adjusted fair value?  Maybe it's all in my head?

 

Nah I think you're right.  There's the cost of leverage, which is already accounted for.  But the risk associated with leverage is something else entirely - failure to pay, failure to refinance, failure to meet various covenants.  So those are worthwhile considerations and would have an impact on valuation, but I'm not sure how big of an impact it would have.  Failure to refinance and meeting covenants seem remote.  Failure to pay is offset by their high credit customer base and proven chartering model.  So it's a factor, but not a huge one IMO - maybe from 10x to 9x DCF?  Assuming 10x DCF is the right price for the no leverage scenario.

[ERICOPOLY]

You are right.  There are some intangibles there which are worth paying a premium for.  However, you'd have that value even if they didn't employ leverage.  Once they leverage it, should "fair price" come at the same multiple to cash flow as the low-risk form of the company?

 

I have yet to see anyone's price target of SSW discuss this.  Perhaps this is because in the real world there is no such thing as risk-adjusted fair value?  Maybe it's all in my head?

 

Nah I think you're right.  There's the cost of leverage, which is already accounted for.  But the risk associated with leverage is something else entirely - failure to pay, failure to refinance, failure to meet various covenants.  So those are worthwhile considerations and would have an impact on valuation, but I'm not sure how big of an impact it would have.  Failure to refinance and meeting covenants seem remote.  Failure to pay is offset by their high credit customer base and proven chartering model.  So it's a factor, but not a huge one IMO - maybe from 10x to 9x DCF?  Assuming 10x DCF is the right price for the no leverage scenario.

 

It would be interesting if they would start a new unleveraged version of themselves.  Someone could conceptually go long on the new unleveraged one trading at 10x DCF and hedge by shorting the highly leveraged one also trading at 10x DCF.  Whenever on the cusp of financial crisis, this trade should work every time.

 

[Packer16]

The probabilty of default can be estimated from the bind/pfd market.  So you can value the equity based upon distributable cash flows and probability adjsut the equity value by the probabilty of default.  For a B credit like Seaspan the 5-yr cum probability of default is 27.5% and the 10-yr is 36.8%.  So one way to risk adjust the DCF multiple is by reducing it to reflect the probability of default (which in this case would be 30%).  Therefore, a 10x unlevered multiple is equal to 7x B rated leverage multiple.

 

I have found this helpful in my analysis of leveraged firms as it provides me a discount to compare firms with different amounts of leverage.  These cum probilities decline to 3 to 5% at the A- rating so the effects on value for firms with greater than A- rating is very small.

 

Packer

[Guest VAL9000]

Packer, interesting analysis.  How does the amount of debt vs equity factor in?  That is, if SSW had just 10% debt, would a B rating still take 30% off of the DCF multiple?  Or is the thinking that at 10% SSW would achieve an A rating?

 

[Packer16]

The lower debt would result in a higher rating.  Another way to approach probabilty of default is the pricing of debt securities but the rating model (if the firm is rated) is simpler to apply.  This idea is described in detail in "The Little Book of Valuation" by Damadoran, a great read for this and other valuation techniques.

 

Packer

[txlaw]

This is a real interesting discussion because I've had the same sort of debate internally about how ATSG should be valued by the market. 

 

I almost always use a debt-adjusted earnings yield-oriented valuation for going concerns that I think will be around for a while.  However, one sector where I don't really adjust for debt is the financial sector, where the whole point is to establish a company that borrows capital and deploys it in order to earn a spread. 

 

So the question I've been asking myself is whether a leaseco is more like a finance company than other companies.  In a way, with a company like SSW or ATSG, the company is set up primarily to borrow capital, buy assets, and lease the assets such that the leaseco captures the spread between its finance costs + depreciation and the rents it receives.  When I think about it that way, I can sort of see valuing the company by applying a multiple to owner earnings, which you can sort of think of as distributable cash flow, assuming no growth or shrinking of the business.

 

I still use a debt-adjusted valuation method for ATSG.  But I do wonder what the market would do if the company distributed all its owner earnings rather than growing the business.

[Myth465]

Humm I use debt adjusted valuations unless I am almost certain of the cash flows. I also like to see leases matching the life of the asset. SSW and ATSG provide a high level of certainty inmo. For some reason I am very comfortable with ATSG expanding, but not with SSW. There just seems to be more barriers with the freighters inmo.

 

txlaw with regard to ATSG, do you look at cash flow to EV, and how do you feel about the expansion? At some point I hope they distribute all of their earnings, but right now I like the expansion because the demand seems to be there, they avoid paying taxes, and the debt is at an extremely low rate when compared to SSW.

 

How do you guys feel about SSW paying 10% interest.

 

 

[Packer16]

You are right about SSW becauswe its customers are all AAA so the adjustment probably should be adjusted downward.  The current yield of the C preferred is somewhere in the 8%s, so the market thinks there is higher risk than there AAA customer profile would imply.

 

Packer

[Guest VAL9000]

You are right about SSW becauswe its customers are all AAA so the adjustment probably should be adjusted downward.  The current yield of the C preferred is somewhere in the 8%s, so the market thinks there is higher risk than there AAA customer profile would imply.

 

What do you think about the seniority structure's impact on the market implied B rating?  It's something like this:

1. Bank Debt

2. Pref Shares - C (listed)

3. Pref Shares - A & B (unlisted)

4. Common

 

Pref shares are junior to bank debt, which makes up 60% of the asset financing.  Is there an implied discount of the C prefs awarded by the market?  That is, because they are the most senior form of capital, should the bank debt be rated higher than the pref shares?

 

In a way this is indicated by the 6% fixed rate on the debt, but that was then and this is now (for better or worse).

 

[txlaw]

Humm I use debt adjusted valuations unless I am almost certain of the cash flows. I also like to see leases matching the life of the asset. SSW and ATSG provide a high level of certainty inmo. For some reason I am very comfortable with ATSG expanding, but not with SSW. There just seems to be more barriers with the freighters inmo.

 

txlaw with regard to ATSG, do you look at cash flow to EV, and how do you feel about the expansion? At some point I hope they distribute all of their earnings, but right now I like the expansion because the demand seems to be there, they avoid paying taxes, and the debt is at an extremely low rate when compared to SSW.

 

How do you guys feel about SSW paying 10% interest.

 

 

That's pretty much what I mean when I say debt-adjusted, looking at OE and EV.  If I were just buying the whole thing, assuming pay off of debt, what would I pay?  And what would that number look like given the passage of time?

 

But then there is the question of whether a leaseco is similar to a finance co.  We never talk about adjusting for debt when discussing banks or insurance companies, right?  It's always about ROE.

 

And are leasecos similar to REITs?

 

Also, utilities that the market likes seem to trade on ROE metrics.  Imagine if Sprint traded on OE with the same multiple as AT&T!

 

I like ATSG's expansion plans given their projected unlevered ROIC on the new planes, but I do wonder what Mr. Market would do if ATSG were allowed to pay a dividend.

 

I wish I had looked at SSW when all you guys were talking about it a while back.

[txlaw]

I like ATSG's expansion plans given their projected unlevered ROIC on the new planes, but I do wonder what Mr. Market would do if ATSG were allowed to pay a dividend.

 

The one caveat to the unlevered ROIC comment is that ATSG seems to use EBIT over capital invested, but those newly purchased planes, though durable goods, are depreciating assets. 

 

So the unlevered ROIC measure overstates economic return on capital invested.

[ERICOPOLY]

How do you guys feel about SSW paying 10% interest.

 

I hope they aren't borrowing at 10% to buy assets at 12%.

 

 

[Guest VAL9000]

The one caveat to the unlevered ROIC comment is that ATSG seems to use EBIT over capital invested, but those newly purchased planes, though durable goods, are depreciating assets. 

SSW faces a similar issue with depreciating assets.  It'll take a while to get visibility, but my guess is that SSW will begin to sell off ships at the 18-24 year mark.  Management has made statements about the value of a young fleet, and given their usual charter lengths of 6- or 12- years, these numbers make sense to me.  They own, finance, and manage these vessels, so we should expect that they will take very good care of them since they are the ones who will end up holding the bag.

 

My limited understanding of ATSG indicates that they will be similarly motivated to maintain their fleet.

 

[Guest VAL9000]

I hope they aren't borrowing at 10% to buy assets at 12%.

 

They aren't.  It's a mixed capital structure.  8.5% for preferreds.  6% for bank debt.  ?? for equity / retained earnings.

 

Having more preferred / equity brings the cost of debt down, making for a more efficient capital structure.

 

Where does the 12% come from?

 

[txlaw]

The one caveat to the unlevered ROIC comment is that ATSG seems to use EBIT over capital invested, but those newly purchased planes, though durable goods, are depreciating assets. 

SSW faces a similar issue with depreciating assets.  It'll take a while to get visibility, but my guess is that SSW will begin to sell off ships at the 18-24 year mark.  Management has made statements about the value of a young fleet, and given their usual charter lengths of 6- or 12- years, these numbers make sense to me.  They own, finance, and manage these vessels, so we should expect that they will take very good care of them since they are the ones who will end up holding the bag.

 

My limited understanding of ATSG indicates that they will be similarly motivated to maintain their fleet.

 

 

That's right, ATSG is similarly motivated.  And you can sort of figure out how much depreciation understates economic earnings by relying on management's maintenance capex figures.

 

But I don't think just using EBIT/cost for ROIC is acceptable without explaining that capex will be needed to maintain the assets over time.

 

By the way, what is SSW management's assessment of ROIC on new ships?  It must be high if they're borrowing at such high rates.

[Guest VAL9000]

 

By the way, what is SSW management's assessment of ROIC on new ships?  It must be high if they're borrowing at such high rates.

I've never seen this number published, but I'm going to try to work it out on my own.

[ERICOPOLY]

They aren't.  It's a mixed capital structure.  8.5% for preferreds.  6% for bank debt.  ?? for equity / retained earnings.

 

There you go, that's true.

 

Where does the 12% come from?

 

On one of the conference calls, they claimed that they look for deals were the hurdle rate is 12% (my understanding is that 12% is what they would earn on the deal if no leverage were involved). 

 

ROIC is 21% on such a deal with 40% down payment and 6% interest rates.