Description

AS Tallinna Sadam (“Port of Tallinn” or “Tallinna”) is a majority state-owned Estonian port owner. The company recently IPO’d on the Estonian stock exchange. The company operates four business segments: (1) Passenger port; (2) Cargo ports; (3) Domestic ferry; and (4) “Other”, which is comprised of an ice-breaking vessel and port waste management JV. In its two core port businesses, Tallinna owns the fourth-largest passenger port in Northern Europe (Old City) and two of the largest non-Russian cargo ports in the Baltic Sea (Muuga and Paldiski South). As a landlord port operator, Tallinna maintains and develops quays and sea approaches, leases land to private operators, organizes the traffic of vessels in the harbor basin, and ensures safe navigation in harbor waters. Tallinna effectively serves as the landlord to various port operators. At the current share price, you are buying a “triple-net” port landlord at 12x free cash flow and a 5.8% dividend yield. Additionally, there is €0.40 per share of excess real estate value and incremental upside opportunity from Tallinna’s ice-breaking vessel winning new summer chartering contracts.

Estonia’s economy is among the fastest-growing in the European Union, rising +3.5-4% annually. Despite being a former Soviet Union member, Estonia ranks well in various government transparency metrics such as ease of doing business and corruption perception, ranking ahead of even the US, Canada, and Australia in certain instances. Estonia is also fiscally disciplined with a government debt-to-GDP ratio of 9% according to Eurostat and a budget deficit below 0.5%.

After Estonia left the Soviet Union and gained its independence in 1990, the Estonian government quickly divested more than 90% of its state-owned industrial and manufacturing businesses over just a few years. The government’s primary goal was to find “real owners” capable of running the assets efficiently. Today, the government is left with a few remaining assets to be privatized, including Tallinna. I think the Estonian government was incentivized to price Tallinna at an attractive valuation given its plans to divest some of those remaining assets in the coming years and given its desire to attract more attention to the Estonian stock market.

Tallinna is essentially comparable to a triple-net REIT with the added benefit of scarce waterfront real estate, land ownership, and inflation protection.

• Cargo: As the landlord of the port, Tallinna does not perform any cargo handling, which makes it capital-light. Cargo port operators’ significant investments create high switching costs and enable Tallinna to increase port dues in excess of inflation (+3-4% annually). Tallinna’s cargo port activity is largely driven by Baltic Sea region GDP, which is expected to grow at +3-4% versus average GDP growth in the EU of ~+2%.

• Passenger: Passenger volumes and import/export volumes have typically grown in-line with GDP. Tallinna’s passenger port primarily serves three-hour ferries between Helsinki and Tallinn, benefiting from strong traffic generated by healthcare visits, tourism, and work commutes between the two cities. The only alternative to the Helsinki-Tallinn ferries is a roundabout 9-hour drive through St. Petersburg.

In addition to owning the land at each port, Tallinna also owns empty plots adjacent to the Muuga and Old City ports. Tallinna’s Old City passenger port is at the heart of Estonia’s capital Tallinn next to Vanallin, which is the country’s top tourist area. The company plans to form JVs to develop Old City’s 16.2 hectares of excess land into a waterfront commercial and residential complex. Tallinna does not plan to invest much capital in the development but will remain as the landlord. The complex is still in the planning stages and is expected to be completed by 2030. Based on undeveloped land prices in the Old City of €150 / square meter, the land could be worth as much as ~€70 million once developed. At Muuga and the Pladiski South cargo port, Tallinna owns ~200 hectares of excess land worth €80 million at €40 / square meter.

Tallinna plans to pay out at least 70% of its net income (~€30 million) in dividends for a 5.8% yield at today’s share price. The Minister of Economic Affairs is pushing the company to pay €35 million annually, which would translate to 6.8% yield.

The primary risk for this investment relates to income generated from cargo bound for Russia. Tallinna’s cargo volume over the last few years has declined significantly, driven by a slowdown in Russia-based activity, but there is still some remaining volume that they handle. The most significant remaining exposure is to Russian fertilizer, of which Tallinna handles ~2 million tons. After the Russian government ordered exports of liquid bulk to be directed through Russian ports several years ago, some industry analysts now believe Russia could similarly direct Russian fertilizer exports through its own ports. Today, however, Russia does not have enough suitable port capacity to handle this export activity. In addition to the fertilizer volumes, Tallinna also has some remaining fuel oil exposure. Fuel oil volumes in Muuga and Pladiski South have declined from ~21 million tons in 2011 to ~2.5 million tons in 2017. Most of the remaining fuel oil is Belarussian transit volume, however, which has to date actually been quite steady. Aside from that, the remaining liquids volume is from refined product imports which should be sticky.

Additional Upside

• Botnica Summer Contracts: Tallinna bought the multi-purpose offshore vessel Botnica in 2012 for €50 million after winning a 10-year ice-breaking contract from the government. The ship initially earned ~€8-9 million of EBITDA annually from the contract and the summer charter. In 2015, however, sanctions imposed on Russia and a weak oil market resulted in early termination of the summer charter and reduced EBITDA by ~€6 million to €2-3 million.

• China & EU Infrastructure Investments: The EU is planning to build a new freight and passenger railway to link several Eastern and Northern European countries including Estonia. The freight intermodal logistics center in Estonia starts at Muuga, adjacent to or possibly even within Tallinna’s cargo port complex. Additionally, Tallina’s passenger port would be connected to the railway’s Tallinn station by a new tramline. The project is fully funded by the EU and the respective beneficiary countries without any contribution from Tallinna.

Valuation

I value Tallinna based on a SOTP with the core ports businesses (Passengers and Cargo) valued at 12.0x EBITDA based on comparable Nordic port operators and the lower-quality ice-breaking and ferry businesses at 7.0x and 8.7x EBITDA, respectively. Tallinna bought the four ferries which they are operating today in 2016 for €120 million; I value them at €100 million. I value the company’s excess land at a 20-50% discount to comparable land prices in the region, which adds €0.40 per share to the NAV. Note that I also assume flat passenger EBITDA, zero fuel oil and fertilizer volumes, and non-renewal of the ice breaking contract post-expiration. Altogether, these assumptions yield a Tallinna SOTP of €2.50 / share.

Additional Risks

FinEst Link Tunnel: The Finnish and Estonian governments are assessing the feasibility of a 100km tunnel to connect Tallinn and Helsinki. This would be the longest underwater tunnel ever built. The tunnel would adversely affect Helsinki-Tallinn ferry traffic and thus Tallinna’s passenger port activity. According to the government’s technical and feasibility study, however, the tunnel is not expected to be completed before 2050. Moreover, the tunnel would cost €13-20 billion euros and would be NPV-negative even assuming 40% financing from EU grants, aggressive debt financing (99% debt-funded at a 1.5% interest rate), and a 3.5% discount rate.

Decline in Finnish Tourists to Estonia: Almost half of the ferry passengers to Old City are Finns visiting Estonia and the majority of them are tourists who come to Estonia for its cheap beer, food, healthcare services, and spas. The Estonian government increased the excise tax on beer by 70% and local media claims the government is planning to hike it by an additional 10% annually. I do not think these changes will have a material effect on port and tourism activity, however, as the excise tax post-hike represents just 10-15% of total retail cost and beer in Helsinki is almost twice as expensive as beer in Tallinn.

Catalyst