Description

Tidewater Midstream and Infrastructure Ltd. is a vulture investor assembling and optimizing a portfolio of midstream assets in the severely depressed NGL market of Western Canada.  The company is run by a guy who has done very well for shareholders in another Canadian midstream company (Predator Midstream).  They’re trading at roughly half the multiple of comps despite having far less debt.  Tidewater ranks below comps on contract coverage and overall size, but those metrics are moving in the right direction quickly.

All amounts in CAD. 

Canadian NGL market

In Canada, over 90% of natural gas liquids (NGLs) are derived from the processing of natural gas.  Drilling activity for NGL-rich targets is high and takeaway options are lousy.  Propane is the main product derived from these NGLs.  The Cochin pipeline was reversed mid 2014 by Kinder Morgan to flow condensate north for oil sands diluent, resulting in a loss of ~50,000 bbls/d of swing propane export capacity.  Cochin was the only export line from Canada dedicated to propane and had been in operation for over 35 years.  As a result, propane prices actually went negative for much of 2015.  Currently, Canadian producers are earning ~$12/bbl vs a global price of $42/bbl – the largest discount in the world.

Management

CEO Joel MacLeod started out as an accountant and eventually became CFO of SkyWest Energy Corp.  Some years ago he formed a holding company that accumulated and sold off early land positions in the Duvernay, Cardium, Slave Point, Beaverhill Lake, and Belly River plays.  Later he saw an opportunity to improve access to market for heavy crude and formed a crude-by-rail company called Predator Midstream in early 2012, with an IPO that raised just $3.0M.  MacLeod sold that company to Secure Energy Services (TSX: SES) in August 2014 for $107M. 

(Note that Tidewater’s website claims that MacLeod has delivered at least 10x returns to shareholders in each of the 3 oil & gas companies that he founded over the past 6 years.  One of these is obviously Predator Midstream.  I assume the above-mentioned holding company was another.  Not sure about the third.  The latter two were private companies and thus I haven’t yet been able to fully verify this claim.)

MacLeod takes no salary and is owns ~3% of the shares.  Senior management are compensated primarily in RSUs, and despite this have been frequent buyers of the shares on the open market.  Overall, these guys have thus far gotten things done on time and on budget or better, and have paid very reasonable (or better) prices for acquisitions.

The Game Plan

Tidewater’s focus in on the Deep Basin, Montney, and Edmonton areas of Alberta.  They look for profitable arbitrage opportunities and pass some of the savings on to producers in exchange for long-term commitments to use Tidewater’s services. 

The ultimate home-run would be securing an LPG export terminal in British Columbia or the NW U.S., but there should be plenty of upside even if that doesn’t pan out.  Note that such a terminal is less expensive and easier to permit than an NGL terminal.  Propane volumes can be shipped by rail, which eliminates the need for a pipeline, which has been a major hurdle for current LNG proposals. Unlike natural gas, propane can be shipped in its current form so there is not the same capital requirement of major LNG facilities.  Predator Midstream actually succeeded in permitting an export terminal for its heavy crude.)s

Management has done 14 acquisitions since the IPO - all at low multiples of EBITDA (5-6x) while Canadian midstream comps trade at double-digit multiples.  The company claims a replacement cost on these assets of $2B, which implies an average purchase price of ~25% of that cost.

At the same time, Tidewater is optimizing these assets through a variety of capital projects to connect acquired assets to each other and to major pipelines, lower opex, and add new capabilities. The capital projects to date have ranged in cost from $2-26mn with most being less than $10mn, with going-in EBITDA multiples of 1.5-4.5x (i.e. great IRRs).

Proforma for the latest acquisitions, Tidewater will have $120M drawn on a $180M credit facility (which I expect to be upsized before too long).  This will put leverage at 1.4x 2018E EBITDA.  Management targets ratios of 1.5-2.5x – still far less than comps at ~4.8x.

The end-game here is probably to grow this thing to a critical mass that would warrant the attention of potential acquirers (perhaps $100M EBITDA or so, which management expects could be reached in the next 18-24 months).  Keyera would seem to be the most logical buyer IMO. 

Valuation

Current runrate EBITDA is ~$60M and management expects this to be at a runrate of $80M at YE17.  Consensus 2018E EBITDA is $85.3M.  (Proforma for all announced and funded acquisitions and capital projects, the runrate EBITDA will be higher still as some projects are scheduled to go online around mid-year.)  But the more relevant metric is field-level EBITDA, which for 2018E would be around $91M, as a strategic acquirer should be able to eliminate at least $6M of corporate overhead.    Proforma net debt will be $120M, yielding an EV/field-level EBITDA of 6.3x. 

Comps include AltaGas, Enbridge Income Fund, Keyera, Inter Pipeline, Pembina Pipeline, and Veresen.  These are trading around 11x 2018E EBITDA.  At the same multiple, Tidewater would be worth $2.72 per share just based on the field-level EBITDA mentioned above.  Even at a 10% FCF yield, shares would be worth $2.21 (assuming corporate overhead of $8M, maintenance capex of $8M, and interest expense of $4.5M on $120M of debt).

And of course, those EBITDA estimates are likely to trend up over time as new deals/projects are announced.

Why it’s cheap

• Still pretty new/undiscovered – IPO on 4/15/15.  Started from scratch. 
• Screens poorly:  the steady stream of acquisitions means trailing income statement numbers are always lower than run-rate and prospective numbers based on completed acquisitions and fully-funded capital projects. 
• Small current yield (2.9%) due to payout ratio of ~30% vs peers at ~70% as well as the startup nature of many of its assets.  It’s a stupid reason, but let’s face it: some people invest that way.
• Contract coverage not as good as comps in terms of % of EBITDA covered or average contract length.  Management is aware of this concern and has been rapidly narrowing the gap with deals that now cover over 50 producers.  Take-or-pay now accounts for ~50% of current EBITDA (comps at 50-70%), with reserve dedication and fee-for-service deals covering an additional 25%.  Take-or-pay contract lengths are generally in the 1-5 year range vs peers in the 10+ range, but note that management might soon close a large 10-year deal.  In some cases, the company is selling acreage that they acquired in connection with certain acquisitions to producers in exchange for drilling commitments, reserve dedications and throughput volumes.
• Has been a serial issuer of equity (prices ranging from $1.00 to $1.56).  As a grumpy value guy, this one is a tough psychological hurdle, as are the generally bullish sellside reports.  But they really do seem to be buying at low prices and getting good IRRs on the capital projects.  Financing is coming from debt now, but they had to build up some EBITDA before that became available.

Basically, the contract coverage issue is the only item in the list above that I think ought to be factored into one’s fair valuation.  One should also consider the fact that some of the deals have involved related parties.  Thus far I’m ok with this as the multiples paid have been in-line with the other acquisitions (i.e. low multiples).  The selling parties are all companies that pre-date Tidewater.

Catalyst

Sale of company in next ~2-3 years.