Description

Macquarie Infrastructure (MIC) is a seemingly forgotten former hedge fund hotel that just announced it is exploring strategic alternatives, including a sale of the company.  We believe there are plentiful buyers of MIC’s assets and that the stock should be worth between $52-66 in a sale. Worst case, if a sale is not consummated (which we think is likely if proceeds aren’t at least ~$44 a share), we own a collection of high-quality infrastructure assets at a good price.  While we wait for a transaction to occur (or not), we expect the company to continue to pay its $1/share quarterly dividend (~9.5% yield) and expect material improvement in its much maligned IMTT segment in 2020.   In addition to having a timely “event path”, this position is easily hedged by shorting a combination of MLPs and/or BBA Aviation. 

At yesterday’s closing price of ~$43/share and assuming 3 quarters of dividends, we see upside of 25%-60% in the next year.  We view this situation as particularly timely given that many of the funds that would theoretically be interested in this situation have been burned on MIC in the past.  The time sensitivity of this situation and most folks general familiarity with the business, we will be brief but are happy to answer detailed questions in Q&A.

Why the Opportunity exists – Incentives

Macquarie is a C-Corp with an external manager that is entitled to both management fees and incentive fees based on the performance of Macquarie’s stock.  The annual management fee is roughly 1% of the market cap less cash balance at the holdco. Macquarie can also earn an incentive fee of 20% if its return exceeds the return of a US Utilities index.  MIC operated like a traditional externally managed MLP or REIT, with clear incentives to grow its asset base and a kicker via substantial incentive payments if the stock performed well. This resulted in handsome incentive fee payments during the go-go days for the stock, but ultimately resulted in angry shareholder letters when IMTT weakened, the dividend was cut, and the stock cratered.

Flash forward to today, and incentives are much different.  MIC only receives incentive payments to the degree their cumulative performance since IPO is in excess of the cumulative performance of the Utilities index since IPO.  We believe MIC’s stock would need to go to $100+ for them to ever earn an incentive fee again.

Post the implosion of the stock, management took some surprisingly shareholder-friendly actions.  They divested a collection of assets at attractive prices, which accrued value to the equity at the expense of the external manager (which was paid on EV).  The company used proceeds to de-lever and is now at 3.6x net debt/ebitda. In November, MIC voluntarily reduced management fees from being calculated on 1% of EV to 1% of market cap net holdco cash.  This effectively reduced the management fee ~$25M. The manager also purchased $145M worth of stock at an average of $44.50 per share in Q3 2018, further aligning incentives with equity holders.

Today, the external manager owns roughly 13M shares of stock worth over $550M.  These holdings pay out $52M in dividends per year. Further, the manager gets $35-40M a year of management fees, which it takes in stock, further increasing its ownership of the company.  We believe the manager has no hope of earning incentive fees in the future. Their primary interest is now to maximize the value of the company (and their remaining fees) which we believe is consistent with the strategic alternatives announcement the company just made.  More on this later, but we think our incentives at this point are well aligned with management’s.

Business Overview and what people are missing

Macquarie has 3 primary businesses: IMTT (liquid terminal assets), Atlantic Aviation (private airport concessions), and MIC Hawaii (regulated utility & propane distribution business in Hawaii).  MIC Hawaii is small and not the focus of this write-up. Atlantic Aviation is a high quality asset, albeit with some cyclicality. Our understanding is most investors generally like the business itself but are worried about the cyclicality.  Their primary competitor, Signature, is publicly traded in London as BBA Aviation and trades at about 10x EBITDA. We think this is an attractive asset that investors generally understand and appreciate, though we believe people also overestimate the cyclicality of the business.

The real reason this opportunity exists is because most investors do not understand IMTT, its storage assets, cyclicality, and value.  This is the primary business where we think our view differs with other investors and where we can add value in sharing our perspective.

Storage Assets

Once upon a time there was a concept of a yield vehicle called an MLP that you could lever and that would have consistent enough financial performance to pay a safe, steady dividend to yield seeking investors. Furthermore you could trade on yield and buy assets at a discount to your trading multiple, hence financial alchemy.  As time went on many MLPS diluted the quality of their assets in the name of growth, stretched dividends to unsustained levels, and when energy markets weakened the fairytale ended. Within this world there were 3 publicly traded, pureplay storage MLPs in the US – Transmontaigne, World Point Terminals, and Buckeye. Transmontaigne (TLP) and World Point (WPT) mostly operated distribution based refined product assets with very steady cashflows.  In the great MLP collapse, TLP & WPT performed the way an MLP should – utilization did not dip and the cash kept coming. Both companies eventually were taken out by their sponsors at 10-11x EBITDA.  Buckeye, on the other hand, had a part of their business with very ratable assets, but expanded into other areas, namely a marine terminal in the Caribbean, that were subject to the gyrations of trade flows and contango / backwardation.  When the fuel oil markets in particular flipped from contango to backwardation, IMO 2020 concerns called into question the future of high sulfur fuel oil, and various trade flows changed, utilization in this part of their business collapsed.  Despite these issues, the stock was taken out by private equity earlier this year at ~13x EBITDA.

Today, we believe there are only two publicly traded companies in the developed world with storage assets as either all or the bulk of their business – IMTT (within MIC) and Vopak, neither of which are MLPs. These assets are not well understood by investors or well followed by analysts.  Even with exceptional efforts of diligence, it can still be tough to determine the occupancy and rent on these assets. We believe investors in MIC were lulled into 14+ years of 90%+ utilization and convinced themselves that these assets were solid and would never see utilization dip. While we believe these are very good assets, there are cyclical and structural factors (akin to real estate) that can affect occupancy and rates.  Infrastructure and private equity investors understand this, resulting historically in an ample number of buyers for storage assets whenever they hit the market.

IMTT and IMO 2020

IMO 2020 has become a buzzword and topic de jour.  There are lots of interesting things about IMO 2020 and we could talk for a long time on the topic.  We believe storage assets are structural beneficiaries of IMO and also one of the most sustained beneficiaries. Further, many of these benefits should be long lived, especially in bunkering locations (big ports where ships refuel). 

IMO 2020 is an international standard that requires all non-scrubbed ships to use fuel oil with sulfur content below 0.5% (low sulfur fuel oil, or LSFO) starting Jan 1 2020.  Currently, ships predominantly use 3.5% sulfur fuel oil (high sulfur fuel oil, or HSFO). We believe this change is in the process of wreaking havoc on fuel supply chains and trade flows for months (if not years).  While this process has started to happen, we think it is going to get worse as the law takes effect next year, and will create incremental opportunities for storage over and above what already has come to fruition.

This regulation has two primary effects on storage operators: 

1. The clearest impact of IMO 2020 is the need for more storage in bunkering locations.  Overnight we will be transitioning from a world with 3 primary fuel grades (2 grades of HSFO and marine gasoil (MGO)) to a world with many more fuel types – still HSFO and MGO, but also a slew of LSFO blends. Due to chemical properties of these fuels, different LSFO blends are incompatible with each other. Shell LSFO for example cannot be mixed with BP LSFO, and BP LSFO in New York Harbor potentially can’t be mixed with BP LFSO in Singapore.  We believe every bunker supplier selling LSFO will need their own segregated storage. Further, shipowners who want to ensure consistent supply of fuel (e.g. Maersk) may take out their own storage to ensure compatible fuel is available in all their major locations. The result is higher demand for a finite amount of fuel oil storage tanks.

2. Post Jan 1 2020, the IMO transition could potentially leave HSFO in a deep contango, some of which has already started to happen.  We believe this will create even more demand for fuel oil tanks and, more importantly in our view, increase rates to a level supported by the arb that develops. We can discuss the reasons for this in detail in q&a. 

Contango develops when the out month futures price of a commodity are in excess of the near dated months. This dynamic can create arb opportunities for traders and help subsidize storage economics even for purel logistics customers. Traders can buy HSFO in January, store it, and lock in an arb by selling futures contracts on their stored inventory at a higher price. The expected contango in the futures market has blown out in the last three months as this dynamic has increasingly become consensus amongst market participants. 2020 contango has expanded from flat to nearly 70 cents / barrel / month, easily supporting paying storage operators like IMTT 50-60 cents / barrel / month.

IMTT has fuel oil storage in two locations, Bayonne (New York Harbor) and the Lower Mississippi River (LMR). IMTT used to be viewed as a rock solid asset - utilizations stayed steady in the low-mid 90s as the asset churned out cash flow. Charts like this helped enforce the view that these assets were incredibly rock solid and worth 14x+ EBITDA.

Unfortunately, a year ago, this happened (see far right of the graph):

So, which is the real IMTT, the one that consistently had low 90s utilization or the one we see today? We believe the bulk of the drop in utilization relates to concerns about long term storage demand ahead of IMO 2020 and, to a lesser degree, excess clean tankage in Bayonne, and a new fuel oil terminal that opened up next to St. Rose, called Pin Oak (the former CEO of Pin Oak now runs IMTT sales effort).  The bulk of the weakness manifested itself as empty fuel oil tanks in the LMR and dramatically lower fuel oil storage rates. We think of storage assets as similar to real estate -- although these are very high quality assets, a host of other structural market factors can cause temporary peaks and valleys in performance. However, we think given the lack of appreciation of this asset class in the public markets, people are forgetting the 10yrs of exceptional strong utilization rates and only remembering the most recent downturn. This depressed utilization persisted through Q2’19. Given the dynamics described earlier, we believe this headwind is about to reverse and become a tailwind, the beginning of which we saw with Q3 results.

On MIC and Vopak’s most recent earnings calls, both stated they are essentially 100% leased for fuel oil globally for Q4. To be specific, IMO 2020 tailwinds manifest themselves in two ways at IMTT. First, significant LMR fuel oil storage that sat empty in Q2 should fill in Q4, boosting wholeco utilization 5%+ well into the high 80s per management guidance (which we believe is conservative). LMR’s proximity to refining operations makes this a prime place for traders to capitalize on cheap & convenient HSFO and arbitrage the contango. This also makes it a natural location to blend LSFO, which is a more structural reason for sustained storage demand in the region.  The contango, on the other hand, is a more temporary factor that supports rates. Second, we could see material storage rate increases, not only in LMR but also in Bayonne. NYH is the second largest bunkering hub in the US and we believe IMTT Bayonne is the only bunkering terminal of size in the NYH (the competing bunkering terminal owned by Kinder Morgan recently ceased operations and is being converted into condos).

On Bayonne specifically, we believe this is a prized asset given its unique position as the primary bunkering location in NYH and its ample waterfront frontage. Historically Bayonne storage has traded at a premium to other storage in NYH for this reason.  Although utilization and rates are weaker than they have been historically, we believe specific infrastructure improvements should return this asset to being fully utilized and achieving premium rates sometime in the next couple years.

We forecast a more robust fuel oil storage market to add between $38mm to $80mm of EBITDA to IMTT in 2020 (over 2018 EBITDA excluding the 39m shell refinery payment).  We believe the lower end of that range should be sustainable, while the higher end of that range may prove temporary.

Atlantic aviation comp transactions:

We believe bulky FBO precedent transactions indicate Atlantic private market value of at least 11x; potentially much higher.  We note two particular data points to value Atlantic. First, Landmark is the only FBO asset of comparable scale to that changed hands. We see 12.8x and 10.6x as reasonable upper and lower bounds. While 12.8x may be a high multiple given any acquirer of Atlantic will have less synergy potential than BBA, we believe Atlantic should trade at a premium to 10.6x (which likely bakes in lofty unrealized synergies). Second, Signature Aviation (the FBO business of BBA, which will be the whole business once BBA closes two announced divestitures) currently trades in the public market at an implied 10x CY19 EBITDA. We think of this multiple plus a 1-2 turn premium as a floor valuation for any standalone Atlantic deal.

Storage transaction multiples:

These are a collection of recent comp transactions that we believe most accurately compare to IMTT.  We’d note that the two MLP takeouts here (WPT & TLP), both had GP value that the sponsors surrendered, and were also non-competitive processes because the acquirer was also the GP.  Adjusting for the implied value of the GP stake in the offer price, we believe these assets traded for closer to 12x EBITDA. We’d also highlight Pin Oak as a direct comp, since they are right next to IMTT’s St. Rose asset in the LMR.   It’s also worth noting that there have been some exceptionally high multiple transactions over time here, namely in “prized” assets like those in Singapore (Universal Terminal), Rotterdam (Koole Terminal), and the Houston ship channel (Houston Fuel oil terminal).  In each case these assets were acquired for mid-teens EBITDA multiples. One could argue that the Bayonne asset of MIC fits this bill, but we are not baking that into our estimates of proceeds. 

Valuation Scenarios

We believe our valuation assumptions are supported by the comp transactions and also generally consistent with multiples paid for businesses with similar characteristics.  For Atlantic aviation, in our base case, we assume midpoint of this year’s ebitda, in our bull case we assume low single digits growth this year, and in our bear case we estimate what a modest recession number might look like.  For IMTT, we have granular assumptions we can share in Q&A, but we assume near full fuel oil utilization and storage pricing between where the market is today (~$.55-$.60 per barrel per month) and where we expect price could end up ($.80/barrel/month) as we move through 2020.  Likewise we assume conditions in clean storage in Bayonne remain weak, and get modestly weaker next year. 

Disposition fees / alignment of interests

In conjunction with exploring a sale, the manager has agreed to cancel the management agreement upon a successful exit based on the net proceeds after debt paydown, taxes, and transaction costs.  We lay out some of the math below in terms of how we would view the attractiveness of a sale if we were the external manager. In order for a sale to be beneficial vs. continuing to run this as a public company, we think MIC would need to fetch mid 40s/share.  Given their equity ownership and management agreement, we think MIC would be highly unlikely to sell at levels below around where the stock currently trades.

Risks

• While we believe these storage assets are very high quality, idiosyncratic structural events can cut either positively or negatively.  Storage is also a very opaque market with conflicting opinions about what is happening. We think we have a good pulse on the market, but it can change quickly.  IMO is a once in a generation structural change and lots of different things can happen. While we believe most of those knock ons will benefit storage and MIC in particular, it’s admittedly an unknown.  

• Through industry checks and analysis we have done the US and abroad, we are aware of some weakness in clean storage products. Although this is difficult to quantify exactly, we do note that clean storage in the NYH is overtanked and high 80s guidance by management seems to imply some incremental weakness in Bayonne. This could be a modest headwind in the near future (although we believe the fuel oil uplift from IMO 2020 will more than offset this headwind and have factored weakness into our forecasts). That said, clean products are often used as blendstocks for LSFO and marine gas oil can be used directly as well. We believe there is some optionality as well for clean storage as we enter 2020 as the shipping industry scrambles for bunkering solutions.

• FBO operators are highly cyclical -- Atlantic revenue dropped >30% in 2009. However, we also point out that a) this was a particularly nasty downturn and b) EBITDA only contracted 22%, showing a degree of operating leverage control. 

• If MIC were to sell its businesses piecemeal, owners of MIC could incur tax leakage associated with all but the final transaction. It is possible that the carrying value of (especially older) businesses are low and tax leakage when selling those assets could be significant. However, we note that management disposition fees are adjusted for tax and, again, that the mgmt co’s economic interest via share ownership far outweighs incremental dollars from mgmt / disposition fees.

Catalyst

**Investors starting to do the math, management going on the road

**Further stregthening of IMTT as we move throughout 2020

**Sale of part or all of the business