Description

This was my VIC application idea and the stock has appreciated, yet still warrants submission given the meaningful upside potential. 

Golar LNG, a liquefied natural gas (LNG) shipping company which also has interests in non-shipping LNG projects around the world, announced a significant restructuring on August 4th, 2009.  This restructuring into Golar LNG Limited (parent) and Golar LNG Energy (subsidiary) creates a unique opportunity to unlock shareholder value.  The split separates the steady cash flows derived from the company's ships on long term contracts from the higher growth, riskier investments in mid-stream LNG projects.

The parent Golar LNG is comprised of 2 LNG carriers and 3 Floating Storage and Regasification Units (FSRUs) on long term charters (average 10 years) to high quality counterparties such as Petrobras and British Gas.  Contracted EBITDA from these ships is expected to be roughly $150m annually, with limited capital expenditures required.   Free cash flow is expected to be roughly $70m per year or $1/share, this is cash flow that is distributable to equity holders after all interest expense and debt principal payments have been accounted for at Golar LNG. 

The subsidiary Golar Energy is comprised of 4 recently built LNG carriers which currently operate in the spot market, 3.5 1970's built LNG carriers (these are ideal candidates for FSRU conversion), a joint venture with LNG Ltd and Arrow Energy developing a land-based liquefaction project in Gladstone, Australia, and a joint venture with Thailand's PTTEP ("PTT") developing floating LNG production off the coast of western Australia. 

The core management team from Golar LNG will also run Golar Energy. 

The assets being transferred into Golar Energy have been "moved" at conservative net asset values, with upside potential coming from the company's ability to sign further FSRU contracts for these ships which could add a minimum of $1/share in value for every new contract signed.  In addition, the new liquefaction projects such as Gladstone and the PTT joint venture will be significant value creators, and we are not currently paying anything for them. 

In short order, Golar LNG will be able to commence paying a meaningful dividend.  In a normalized equity environment, a yield of 10% would be considered satisfactory and justify a share price of $10/share for the parent company alone, assuming the company pays out $1/share in dividends.   Examples of comparable shipping companies with long term contracted cash flows trading on a dividend yield basis are TGP (Teekay LNG Partners, 9% yield), TOO (Teekay Offshore Partners, 10% yield), SFL (Ship Finance International, 10% yield).  Over time, the company's dividend paying capacity will increase as the company reduces its debt balance.  We consider this a base case scenario. 

In addition, since Golar LNG owns 75% of Golar Energy, valuing Golar Energy at the IPO and current market price of $2 per share (it trades on the Oslo stock exchange under the ticker GOLE.NO) would add roughly $5/share to Golar LNG.  This implies a base case sum-of-the-parts value of $15 for Golar LNG, a 17% premium to the current market price of $12.80.  It is important to reiterate that the company represents that the $2/share IPO price for Golar Energy did not assign any value to the potential for further FSRU contracts or upside from the Gladstone and PTT liquefaction projects, and was instead based upon liquidation values for the ships as is. 

We also put forth a conservative discounted cash flow analysis, in which we've discounted the earnings from ships both on long term contracts as well as the ships trading in the spot market.  Using what we deem to be a conservative 10% discount rate, we obtain a value of $9.55/share for the parent Golar LNG and a $1.88/share valuation for Golar Energy (GLNG owns 2.5 shares of Golar Energy for each share of GLNG.  $1.88 x 2.5 = $4.69/share of Golar LNG).  Thus our downside sum-of-the-parts valuation is $14.24 for Golar LNG, still an 11% return on our investment.  We take comfort in the fact that our DCF analysis arrives at a valuation very similar to our base case scenario.

Neither our base case nor our conservative case scenarios ascribe any value to the growth potential of Golar Energy, which is significant given the meaningful ways we do in fact expect Golar Energy to grow in the next 5 years. 

Thus, our upside case obviously comes from these growth opportunities in Golar Energy.  Specifically, we believe the company will sign more FSRU deals in the coming years.  By way of background, Golar was the first company in the world to provide an FSRU (went on hire in January 2009), previously all regasification of LNG was done on land-based plants.  There are several potential LNG import projects around the world that could utilize an FSRU, for example areas that are concerned about energy security and are looking to increase supply diversity.  FSRUs are a fast (ship delivery can be done in 6 months) and relatively inexpensive solution.  They also solve the "NIMBY" not-in-my-backyard problem. 

Each FSRU contract would add a minimum of $1-$1.50/share in value to GLNG given the high returns on capital these FSRU contracts provide.  For example, on the 3 FSRUs Golar has already contracted, it spent roughly $100m in capex to fund the conversion from a basic LNG carrier to an FSRU, and signed a 10 year contract with 5 year options thereafter providing for EBITDA of $40m/year.  Using conservative discount rates, we obtain a net present value of roughly $150m for the FSRU, 75% of which accrues to GLNG as they own 75% of Golar Energy.  Compare that with a $30m value for a 1970s built basic LNG tanker, and we arrive at our $1-$1.50 of value creation per FSRU contract signed.

Upside in Golar Energy will also come from improved spot market trends in the coming years, which obviously impacts the modern ships trading in the spot market.  We expect to see an uptick in LNG shipping as significant new liquefaction capacity comes online in 2010.  These plants are located in areas like Qatar and Nigeria and will increase the amount of LNG capacity by 30% in one year.  This incremental LNG supply coming primarily from the Mideast is likely to find a home in the US, which will not only increase the demand for LNG tankers, but also the trade route mileage.  The LNG tanker supply orderbook/delivery schedule is not threatening. 

Lastly, upside in Golar Energy will come from the Gladstone liquefaction project and the floating LNG production project with Thailand.  While difficult to quantify at this stage, we are confident in the value creation opportunity of these projects.

The Gladstone project currently has a Heads of Agreement in place which lays out the commercial arrangements from beginning to end - from the purchase of gas by the JV from Arrow Energy through to the sale by the JV of gas to Golar Energy and then on to signed Japanese buyers.  A final investment decision is expected in early 2010, with execution of binding contracts targeted for mid 2010.  All environmental approvals have been received and this project should deliver first gas in early 2013.  The first train constructed by the JV is projected to generate a return on equity in the mid teens, with very attractive expansion opportunities (which because trains 2-4 can piggyback on the infrastructure of train 1 will generate much higher returns).

Management:

Golar's Chairman/President and single largest shareholder is the shipping magnate John Fredriksen, who owns 46% of the company.  Fredriksen typically takes large, minority stakes in his public companies and believes strongly in paying out free cash flow to shareholders.  In other words, he'd much prefer to have the cash in his (and ours, as respective shareholders) pocket than to have it stay within the company. 

Also noteworthy, the Fredriksen management team previously employed this strategy back in 2004 when they split Frontline Ltd (ticker FRO), an oil tanker company, into two separate companies - Frontline Ltd and Ship Finance International Ltd (ticker SFL) with great success.

BASE CASE VALUATION:

Golar LNG Parent:  $1.00/share dividend capitalized at 10% = $10.00

Golar Energy Subsidiary:  2.5 shares of Golar Energy for every share of GLNG trading in the market at $2/share = $5.00

Sum of Parts Value = $15.00

CONSERVATIVE CASE VALUATION:

Golar LNG Parent:  DCF of cash flows at 10% = $9.55

Golar Energy Subsidiary:  DCF of cash flows at 10% = $1.88/share of Golar Energy.  2.5 shares of Golar Energy for every share of GLNG = $4.69

Sum of Parts Value = $14.24

UPSIDE CASE:

Additional minimum of $1/share for every new FSRU contract signed, with the likelihood for 3 new FSRU deals over the next 3 years

Increased value for Golar Energy from an improved spot market

Gladstone liquefaction project

Thailand's PTTEP floating LNG production project

Sum of these could add north of $5/share of incremental value, or a $20.00 sum of parts value

Conservative Case Valuation Support Materials

Catalyst

While in the near term Golar LNG's share price will likely trade at some discount to the sum-of-the-parts value (a "holding company discount"), we anticipate that discount narrowing once the company begins paying a dividend (expected Q2 2010).  Finally, we believe there is a significant likelihood that sometime in 2010 Golar LNG will distribute as a dividend its entire holding of Golar Energy shares, which would result in the elimination of whatever remained of the "holding company discount."