Description

Teekay Corporation (TK) is the parent company and general partner for two MLP’s, Teekay Offshore (TOO), and Teekay LNG Partners LP (TGP), in addition to being the parent company of Teekay Tankers Ltd. (TNK). The company has been written up previously on VIC at prices considerably higher than today. At the time, I believed TK represented a compelling value, so this writeup belongs in the “if you liked it at $45, you’ve got to love it at $18” category. The previous writeups are very valuable for background.

I just submitted a writeup on TOO, which is one of TK’s “daughter” MLP’s, and the background for TGP is similar to TOO. Both MLP’s work with long term fixed-rate charters, and have high quality counterparties. They are a key segment of the logistical chain for their client companies.

TK has suffered because of the weakening of the equity funding markets. The growth story for their MLP’s has taken a hit due to the current environment. Ironically, at the current market prices of the MLP’s, it’d probably be rather straightforward to raise equity. That is, if anyone had any dry powder or appetite to invest! 

The current yields and dividend growth of TK’s daughter companies are:

TK is typically analyzed on a sum-of-the-parts basis, given its ownership stake in the MLP’s it manages. The difficulty with sotp analysis is that often the individual parts are not cheap in and of themselves. TK now represents the other end of that spectrum. I believe the MLP’s are very cheap, and one can participate in the TK story either by purchasing the MLP’s or by owning the parent company. In the long-run, the value to TK of its general partner incentive distribution rights (IDR’s), makes TK a very compelling situation.

Both the MLP’s and the TK parent are valued as if the drop-down growth story is completely broken. While the dynamics of raising equity, leveraging it with financing, and arbitraging private company valuations against public company premiums might sound familiar—and discredited! I believe that the parallels are not as obvious as the discredited (for now) LBO model.

In fact, because TK consolidated has a favorable debt profile, and the nature of the MLP growth has been primarily via drop-downs, I’d argue that the daughter company growth can continue without significant disruption. Rather, the price levels have all just been repriced—which arguably makes the dynamics even more compelling. Raising equity at 16% cost-of-capital, in theory, should attract more buyers than raising it at 8%. In theory! Obviously, the caveat has to do with the sustainability of the business model and the long-term performance of its assets.

Teekay has successfully executed drop-downs to all three companies this year. While the current markets are frozen, there remains the possibility that they will thaw again in our lifetime, and TK can resume the path to higher dividend distributions, and becoming an increasingly asset-light general partner.

An obvious concern in the current environment is how much of an impact have the stresses in the global economy impacted TK? TK provided guidance two weeks ago that implied 4^th quarter EPS of approximately $1.00/share. In addition, they provided charter statistics that imply approximately $1.45/share for Q3.

In October, Teekay authorized a new $200 million share-repurchase program. The company has a history of buying back shares, and if fully implemented at current prices, this buyback authorization would decrease the share count by 14.9%. However, management also understands that addressing balance sheet concerns is also a compelling use of liquidity in this environment. Either use argues for support near current valuations.

Teekay has fully financed all future capex. Teekay arranged financing at the time newbuild orders were placed, with all the capex funding provided by major banks and Export Credit Agencies.

As of June 30, 2008, TK had cash of $499 million, plus undrawn revolving facilities of $1,253 million, for $1,752 million in current liquidity. Against that, it had $1,328m of total capex, with only $169m remaining to be funded. TK has a favorable debt profile, with the current liquidity nearly ten times sufficient to repay all facilities coming due through 2010. It has no near-term need to access capital markets.

The company also has no covenant concerns at the Teekay standalone level, nor at its daughter companies. TK has only 3 facilities, representing $346m, tied to hull values, with 11/25/08 coverage of 175-480%. As a result, a 50% drop in vessel value would lose debt capacity of $25m. (Note, the fair market value (FMV) in the companies latest presentation represents values as of that date, according to the conference call—“Q: The starting point for that calculation is that from the 10/3^rd value? A: That’s based on today’s market value.”)

Over 70% of TK’s invested capital operates under long-term, fixed-rate contracts. Total forward fixed-rate revenues exceed $12.2 billion.

Does Teekay’s fixed rate business support the debt servicing of the entire fleet? Currently, it does. TK’s annualized fixed-rate cash flow from vessel operations (CFVO) alone is $467m. TK’s total principal and interest expenses are $401m, leaving $61m excess cash flow just from the fixed-rate vessel operations alone. With 72 million shares outstanding, that is nearly one dollar per share. In addition, the cash flow from vessel operations from the spot fleet was $223 million for the twelve months ending 6/30^th.

This represents a consolidated picture. Drilling down through the debt, 80% of the consolidated total debt is at the subsidiary level and is non-recourse to TK.

Teekay disaggregated debt and statistics:

TK’s investment thesis is straightforward. While the price of oil swings wildly, the company has been relatively insulated from the volatility due to the long-term, fixed-rate nature of its contracts. Arguably, the MLP drop-down growth story has not been broken, as is the case with the LBO model, rather, it has been repriced. Since the debt follows these drop-downs, it’s up to TK and its daughter companies to decide what trade-offs they require as each seeks its mission. TK’s mission to become an asset-lite general partner, and the daughter companies role as the growth vehicles, are completely compatible with each other.

Catalyst