Description

Transmontaigne Partners L.P. (“TLP”)

I recommend a short position in TransMontaigne Partners L.P. (“TLP”) common LP units (ticker – TLP). TLP is a Master Limited Partnership with operations in terminaling, storage, transportation and related services for customers engaged in the distribution and marketing of predominantly refined petroleum products. TLP has minimal direct commodity price exposure and earns the vast majority of its revenues from fee based contracts. Its assets consist mainly of strategically located refined products storage terminals. Operations are organized geographically under six segments: Gulf Coast, Midwest, Brownsville, River, Southeast, and BOSTCO. The BOSTCO segment is a 42.5% interest in a JV with Kinder Morgan that is developing a products export terminal in Houston. TLP’s 10-K  has a detailed list of its storage terminals and capacities. TLP’s General Partner interest, Incentive Distribution Rights, and ~20% of TLP’s common LP units are owned by Morgan Stanley (“MS”). MS is also the largest customer of the partnership generating 62% of the 2013 revenues. (MS owns its interests in TLP and does business with TLP through multiple different subsidiaries. In the interest of simplicity I will simply refer to MS).

MS’s status as a financial holding company subjects it to significant regulatory uncertainty regarding its commodity businesses. Although internal reviews at MS have so far determined all of its current activities to be permissible, it is unclear how future interpretations of the BHC Act, the Dodd-Frank Act, and sundry other legislation may evolve. This uncertainty has prompted MS, as well as other financial institutions, to begin to scale back and divest their commodity businesses. Unsurprisingly, in December 2013 MS announced that it was exploring strategic options for its interests in TLP. An update came on May 23, 2014 when the WSJ reported that MS is making progress towards finding a buyer and has identified a short list of bidders including NGL Energy Partners and Buckeye Partners. In isolation, the sales process of MS’s TLP interests could justify a bull case for TLP LP units. A new owner of TLP’s GP would undoubtedly plan to ramp up capital expenditures to spur growth and take advantage of the current North American production bonanza. The market seems to be buying the bull case. Since MS announced the sales process in December 2013, TLP’s LP unit price has appreciated ~25% to date.

The bear case for TLP is significantly more compelling for two reasons. First, MS’s retreat from commodities has irreparably damaged TLP’s organic growth prospects. And second, as by far TLP’s largest customer, MS’s continued withdrawal from physical commodity trading creates significant uncertainty around TLP’s existing revenue streams. Neither of these issues has yet to be reflected in TLP’s valuation, which at 19.9x EV / 2013(A) unlevered DCF and 15x EV / 2015(P) unlevered DCF is roughly in line with its higher growth, lower risk peers.

Organic Growth Prospects

The North American crude oil renaissance did not distribute its benefits evenly across spectrum of midstream companies. Crude oil and wet gas / NGL focused companies saw increased utilizations of existing assets as well as an abundance of growth opportunities as both old and new supply basins’ production increased rapidly. To a lesser extent, refined products businesses have benefited as well. The key difference is that the major refined products supply and demand centers have neither changed nor grown enough to warrant significant new midstream infrastructure. As such, while refined product infrastructure has certainly seen utilizations increase concomitantly with refinery utilizations, new growth projects have been comparatively limited, a few new export terminals notwithstanding. To compensate for this disparity in growth prospects, many refined products focused companies such as MMP, NS, and BPL, established themselves in the crude oil space over the past few years when greenfield projects were plentiful. The growth these companies are now experiencing, as well as the majority of their growth projected over the next several years, is being generated predominantly by their crude oil projects. 

In October 2011, while TLP’s competitors were positioning themselves in the high growth crude oil space, MS informed TLP that it would not expect to approve any “significant” acquisition or investment, effectively handcuffing TLP during the most strategically important time period in the petroleum industry in decades. The only significant project approved by MS from that date to present day was the BOSTCO JV, which today is unsurprisingly TLP’s only apparent source of meaningful growth. As greenfield crude oil / wet gas projects have become increasingly rare, the only companies with roadmaps to sustained growth are those with established asset bases on which to build. Because TLP has failed to establish a presence outside of its refined products core, future growth will be anemic. TLP will be forced either to (over)reach for growth in the already exorbitantly priced midstream M&A market or content itself with low to no growth (the likely outcome of the M&A route as well). Confirmation of the above analysis came on TLP’s 1Q14 conference call when management referred to $150mm of identified growth projects for the next couple of years. Sounds impressive; however, $122mm of the $150mm is BOSTCO Phase 2, leaving a paltry $28mm of other identified growth projects to be put in service over the next two years. Post BOSTCO, TLP will struggle to justify a premium valuation.

Another historical avenue of growth exploited by TLP was asset drop downs from MS. There is little clarity into the actual cash flows associated with the remaining assets to be dropped; however, it is certain that the vast majority of assets previously owned by MS have been sold to TLP already. Based on the scant description of the remaining assets found in TLP’s investor materials, their combined DCF is not enough to move the needle.

Existing Revenue

A lofty valuation unjustified by growth prospects, while not auspicious, is not typically enough to warrant a short sale. However, concurrently with its decision to sell its ownership interests in TLP, MS seems to be winding down its physical commodity trading activities as well. Although MS has not officially announced its desire to divest and/or wind down this business, actions speak louder than words. In fact, the MS TLP sales process may not be as pertinent to the value of TLP LP units as a sale that MS signed in December 2013. That is when MS sold its crude oil trading and storage business to Rosneft. The Rosneft sale signals that MS is trying to divest not only its physical commodity assets but its commodity trading businesses as well. Further, MS has already allowed some contracts with TLP to roll off and has provided notice to TLP that it will not renew others. MS’s physical commodity trading group accounted for 62% of TLP’s 2013 revenue and 64% of 1Q14 revenue. In aggregate, MS contract roll offs that have already occurred combined with those yet to hit TLP’s results account for ~14% of the revenue that TLP earned from MS in 2013 and 9% of total 2013 TLP revenue. A continuation of MS contract roll offs would do significant damage to TLP’s current earnings power if TLP is unable to recontract the capacity in a timely manner at comparable rates.

Several MS contracts came up for renewal in 2013. Some of these contracts were extended others were not. Those that were renewed were given variable terms that end once MS gives 18 – 24 month notice. The contracts that were not renewed covered the following assets: the Razorback pipeline and terminal system, a few Florida terminals, and the Fisher Island Terminal. The Razorback system and a portion of the Florida capacity have been recontracted with 3^rd parties and will generate comparable revenue going forward. The remainder of the Florida capacity and the Fisher Island terminal remain uncontracted, and management’s comments regarding the outlook for the assets were not very optimistic. Combined the uncontracted capacities represent $6.1mm of annual TLP revenue. $1.8mm of the loss in revenue is already reflected in TLP’s 1Q14 results, and the remainder rolled off 5/31/2014. In the cash flow projections below, the revenue from these assets has been excluded going forward.

Of the contracts that were extended, MS has already provided notice of termination for its capacity at the Collins / Purvis. The annual TLP revenue associated with this contract is ~$9.2mm. TLP management’s commentary on this asset is far more sanguine than that regarding the aforementioned Florida and Fisher Island uncontracted capacity. As such, the cash flow projections below assume that the Collins /Purvis terminal is recontracted immediately at comparable rates, and TLP suffers no loss of revenue.

MS did sign one new small contract in 2013 with TLP for a barge dock in Baton Rouge. The contract is worth $1.2mm annually to TLP and grants MS exclusive rights to the barge dock until 2023. Although this is pure speculation, given the relatively small dollar figure and long term exclusivity stipulation, this seems to be a contract that MS signed to sell vs actually use for the 10 year term.

All in, the net decrease in TLP revenue that will be generated by MS going forward is $14.1mm. As previously mentioned, the cash flow projections below assume that the $9.2mm of revenue at Collins / Purvis recontracts. Therefore the net decrease to TLP revenue due to MS contract roll offs is $4.9mm. However, a portion of this decrease is already reflected in 1Q14 results. As shown in Exhibit A, there is an incremental ~$4.3mm decrease in revenue going forward from 1Q14.

Cash Flow Projections – See Exhibit A for 2015 and 2016 Cash Flow Build Up

Valuation – See Exhibit B for Enterprise Value Build Up

At 19.9x EV / 2013(A) unlevered DCF and 15x EV / 2015(P) unlevered DCF, current owners of TLP LP units expect a lot to go right. They seem to be focusing hard on TLP’s one to two year growth prospects (i.e. the cash flows show above), which admittedly look pretty good, and completely disregarding the medium to long term outlook of the business. By 2016, TLP’s growth prospects will be nonexistent, and even if management is able to salvage lost MS revenue, TLP will no longer command a premium valuation relative to its peers.

It is difficult to find publicly a publicly traded comp to TLP; however, Buckeye Partner’s (“BPL”)  ~$850mm acquisition of Hess’s refined products terminals in October 2013 provides an excellent analog and exemplifies a more appropriate valuation for a refined products business with low growth prospects. The purchased Hess assets consist of 19 refined product terminals and do not bring along material additional growth projects for BPL. They generate a steady cash flow stream supported by multi-year contracts with one major customer (Hess) who is no longer economically incented to utilize the assets. It would honestly be hard to design a better comparable to TLP. And at what valuation did these assets transact? According to BPL’s press release, management is expecting to achieve less than an 8.0x EBITDA multiple after 12 months. Assuming that maintenance capex is 15% of EBITDA, this translates into a 9.4x unlevered DCF multiple. Applying a similar multiple to TLP’s business in 2016 implies the following decreases in the current LP unit price to fair value under different cash flow sensitivity cases.

The valuations implied above assume investors demand a 10% total return and TLP averages an 8% distribution yield over the time period. Changing one or both of these assumptions does not change the answer materially as we are only dealing with a couple of years. As illustrated above, even assuming no further degradation in revenues generated by MS, TLP’s common units are overvalued by 20% - 57%. In addition, although this thesis does not depend on it, any hiccup in North American crude oil production’s seemingly inexorable path up and to the right would also cause a step change down in TLP’s trading multiples, along with the rest of the nosebleed inducing valuations that can currently be found in the MLP sector.

The main risk to this thesis is that the future buyer of MS’s interests revitalizes the business and propels it to future growth most likely by concurrently stepping into and/or purchasing MS’s TLP contracts. However, for the reasons described above, growth opportunities will not be plentiful no matter who the ultimate buyer is. It is also worth noting that the two most strategically obvious buyers for these interests are unlikely to transact. The first and most advantageous buyer for MS is BPL.  As a refined products focused MLP with an existing marketing business, BPL could purchase MS’s interests and step into its contractual shoes at the same time. However, BPL is already overlevered at 4.5x LTM Debt/EBITDA and is barely covering its distributions. As such it will likely not be able to issue the requisite debt for a cash transaction. In addition, Buckeye’s current equity cost of capital of ~5.6% is too high to make the math work at prevailing GP multiples (25x-35x free cash flow), especially with no coverage cushion. The second strategic buyer, Magellan Midstream Partners (“MMP”), is extraordinarily disciplined with respect to acquisition valuations and would almost certainly balk at paying current market multiples. In addition, MMP does not have a products marketing business. Therefore even if MMP stepped up, MS would still need to find another buyer for its trading business. The other party mentioned in the May 23 WSJ article, NGL Energy Partners (“NGL”), would be entering a completely new business line with this acquisition, and although NGL has been very acquisitive since its IPO a couple years ago, wading into completely uncharted waters at current valuations seems aggressive even for them. Although a temporary pop caused by the announcement of a successful sale of MS’s TLP interests is a near term possibility, risk, defined as the likelihood of a permanent loss of capital, is attenuated by two factors: TLP’s historically high valuation and MS’s retreat from physical commodities trading.

Exhibits

Exhibit A - 2015 and 2016 Cash Flow Build Up

Note: All debt is kept on TLP’s revolver at its 1Q14 interest rate of 2.6%.

Exhibit B – Enterprise Value Build Up

Note: Enterprise Values assume that all growth capex is funded with retained cash flow and debt issuances. GP Equity is valued pari passu with the LP Equity (DCF Yield of 6.6%). As GP’s invariably trade at a significant premium to the LP, this is a very conservative assumption. TLP LP unit price as of 6/4/14.

Catalyst