Description

Preferred units of Hoegh LNG Partners (“HMLP”) present an opportunity to benefit from forced selling while earning a well-covered, tax-advantaged 16.8% perpetual yield.

HMLP is an MLP that owns floating storage and regasification units (FSRUs). The company wholly-owns three FSRUs (Gallant, Grace, and the Lampung) and has a 50% joint venture interest in two smaller, older boats (Cape Ann and Neptune). The FSRU industry typically operates under long-term contracts in which a daily “capex” rate is paid in addition to pre-negotiated operating expense and tax reimbursement. Each of HMLP’s FSRUs are contracted through at least 2026, and most of the company’s contracts extend past the end of the decade. Four of the FSRUs have options to further extend their charters for an extra ten years. Recent charter contract rates exceed the levels of HMLP’s in-place contracts, and the market has been tight since the start of the war in Ukraine. As a result, HMLP’s fleet benefits from high cash flow visibility.

The common units of HMLP were listed on the NYSE until September 2022, when the partnership was acquired by parent Hoegh LNG Holdings. Hoegh LNG Holdings is one of the largest FSRU owners globally and is a 50 / 50 joint venture between Morgan Stanley Infrastructure Partners and Leif Höegh & Co.

During December 2022, HMLP announced that it would voluntarily delist and deregister its preferred units to reduce reporting and compliance costs. I recently confirmed this statement with the CFO, who mentioned annual cost savings of $6-7 million. The delisting triggered forced selling from investors unable to hold OTC / unregistered securities. Moreover, the deregistration resulted in the units being classified as “Expert Market” securities. This classification has limited the universe of purchasers given the challenges associated with trading Expert Market securities. The price of the units fell precipitously on the delisting news from $20.95 (a 10.4% perpetual yield) to $13.00 (a 16.8% perpetual yield).

As a result of this technical dislocation, I believe that the preferred units are undervalued and offer an attractive, well-covered distribution yield. The JV FSRUs are currently limited in their ability to upstream cash due to debt covenants, but the wholly owned FSRUs should generate ~$110-120 million of EBITDA in 2023. After interest, debt amortization, and taxes, I estimate cash available for distribution of ~$45-50 million versus $15.5 million of annual preferred distributions.

The company is currently restricted in its ability to upstream cash from the Lampung (which has a separate credit silo from Gallant and Grace) due to ongoing arbitration with the Indonesian government. The arbitration relates to a 2021 effort by the government to terminate what it perceived as an above-market contract. While the company and its legal advisors believe that the case has no merits (and FSRU market conditions have changed dramatically since 2021), the company agreed as part of a debt refinancing to cease shareholder loans / dividends until the arbitration is complete. Importantly, the Indonesian government continues to make regular lease payments, and the company should generate $35-40 million of cash available for distribution excluding the Lampung in 2023 (for a preferred distribution coverage ratio >2x). Net leverage at the Lampung is ~0.4x EBITDA, suggesting ample room to re-lever once the arbitration is complete.

As part of the go-private process, HMLP’s Conflicts Committee hired Fearnleys and Braemar to conduct an appraisal of the fleet. The fleet was appraised at a charter-free value of $1.07 billion, whereas the enterprise value through the preferred units stands at $539 million. As a second point of reference, I built my own DCF for each FSRU based on the in-placed contracts and assumed a significant reduction in rental rates from the end of each minimum contract term through the end of each boat’s useful life. I assumed $55-70K / day for the larger boats and $35K for the JV boats, whereas charter rates for larger boats are currently $150K+. At a 10% discount rate, I estimate a conservative NAV of ~$925MM, with considerable upside should charter rates stay high and / or if extension options are exercised.

The preferred units are cumulative, and Hoegh LNG Holdings cannot take any common distribution while preferred distributions are in arrears. Hoegh LNG Holdings has holding company debt and is also acquisitive, so there is an incentive for HMLP to continue making preferred distributions so that its parent can upstream cash. On August 15, the partnership paid the first common distribution since going private, which may indicate a continued interest in further common distributions. As an infrastructure-focused investor, Morgan Stanley Infrastructure Partners likely desires a recurring common dividend from Hoegh LNG Holdings, providing further incentive to continue upstreaming cash and thereby making required preferred distributions. If the preferred distribution is not paid, the partnership agreement provides preferred unitholders with the right to appoint a director to the board once six distributions are in arrears.

At current prices, the preferred units offer a well-covered yield at a relatively low value-attachment point. Most maritime preferreds trade at a current yield between 8% and 9.5%. I expect HMLP to trade at a discount due to illiquidity. At a 10% current yield, units would be worth ~$21.88 / share, which is not far from the pre-delisting level. Should a steep trading discount persist, it may be accretive for Hoegh LNG Holdings to make a tender offer. As a final kicker for those managing taxable accounts, the last two distributions of 2022 received non-dividend return of capital tax treatment. This could change in the future, but it makes the yield even more attractive on a tax-adjusted basis.

Catalyst

Attractive ongoing yield. An eventual exit for Morgan Stanley Infrastructure. Potential issuer tender offer.