Description

Teekay Corporation

ticker: TK                     price: $56.84                mkt cap: $4.3B             date: 7/23/07

 

Most investors view Teekay as a leading long haul tanker company transporting oil around the world with financial results that are subject to the vagaries of the spot market. Teekay is much more than that. Teekay is an asset management company focused on the marine midstream market which has transformed itself from a tanker company to one that both manages and owns approximately $8 billion of assets, the bulk of which are operated under multi-year contracts with a consistent and growing revenue and earnings stream. Its business includes 150 vessels (owned, chartered, or managed) with another 26 vessels on order. It transports approximately 10% of the world’s seaborne oil. TK’s diverse business spans a variety of vessel types (shuttle tankers, floating storage units, crude oil tankers, gas tankers, and product tankers) with a variety of contract lengths (spot to 25 years).

 

Teekay is the parent company with a market cap of $4.3 billion. The company has a unique and complicated ownership structure, which includes three publicly traded entities: 1) Teekay LNG Partners L.P. (TGP); Teekay Offshore Partners L.P. (TOO); PetroJarl ASA (TKPOY).

 

For more description of the company and its valuation, please see glg919’s thorough write-up dated 12/7/06.  This write-up is meant to supplement the previous write-up to highlight changes that have occurred since then, and to show that the company remains misunderstood and significantly undervalued. TK’s fair value is $90, which represents 59% upside from the current price.

 

Ownership Structure

Please see http://www.geocities.com/grady181818/tkfigure.xls for a graphical depiction of TK’s ownership structure.

 

TK Parent Company & Spot business

As shown in the above diagram, one can see that TK, the parent company, owns stakes in two MLPs, TGP and TOO, and 64.5% of PetroJarl. The remaining business in TK, its spot segment, is a provider of international crude oil and petroleum product transportation services through its spot tanker fleet, which includes the world’s largest fleet of Aframax-size oil tankers. The company operates about 100 crude and product tankers in its conventional tanker segment. In 2006, this segment shipped 1 billion barrels of oil through its own fleet and in-charter agreements. Contracts are priced based on the spot-market, which is short-term and prices can fluctuate significantly on a day-to-day basis. Customers include major oil companies.

 

Vessels are designated by cargo capacity, which is measured by deadweight tons or dwt. Deadweight is the displacement at any loaded condition minus the lightship weight. Aframaxes are 75-120k dwt. Other vessel types include Suezmax (120-200k dwt), Panamax (50-75 k dwt), Very Large Crude Carriers (VLCCs, 200-320k dwt), and Ultra Large Crude Carriers (ULCCs, 320k+).  TK’s spot business is composed mainly of Aframaxes and its routes are mainly in the Indo-Pacific and Atlantic Basins.

 

Currently, spot rates are $30,000 to $35,000 per day, and even if rates were to decline, the company could sell its ships for their replacement value. In addition, TK’s fleet is all double-hulled and relatively young. Accordingly, the replacement value is real. The significance of double vs. single-hull are twofold. One, double-hull ships command a premium over single-hull vessels in day rates, and second, international shipping regulation mandates the removal of single-hull vessels by 2010.

 

OMI Assets – Strategic and accretive acquisition.

On April 17, 2007, TK announced a $1.1 billion transaction with OMI to acquire 13 Suezmaxes (seven owned and six in-chartered) and eight product tankers. The transaction translates to approximately 10x EV/Fwd EBITDA (without synergies) and 7.5x (with synergies). The purchase expands TK’s Suezmax portfolio to 33 vessels with 10 more on order. Eighty-one percent of the fleet is fixed with an average length of two years, and 70% of 2008 of cash flow vessel operations is fixed. The transaction is expected to be immediately accretive to earnings and the company expects 10% accretion in 2008. These assets will be included in TK’s carve out of its conventional tanker business later this year.  Please note that any synergies from the OMI acquisition are excluded in the valuation below.  That represents upside to the numbers.

 

Spin-off of TK Conventional Tanker Business – The Catalyst that Should Unlock Significant Value.

One very important catalyst (announced in May 2007) is that TK plans to spin out its spot business by the end of this year. As shown below, the value this business is worth $25 per TK share.

 

The table below shows the main components of the $1.8 billion valuation. The largest component is the fair market value (FMV) of TK’s fleet of $1.6 billion, which is based on second-hand values from Clarkson’s, an industry source that tracks the tanker industry. Net debt of $641 million is a complicated calculation, which nets out TGP, TOO, and Petrojarl’s net debt from TK consolidated. The $168 million value of the in-chartered fleet is management’s estimate. Other items include newbuild installments of $366 million (on TK’s balance sheet), $177 million of “in-the-money” newbuilds (basically the value increase vs. what TK paid on newbuilds), and $221 million from RasGasIII installments to date.

 

FMV of owned "on the water" fleet	1,550
(per Clarkson's)
Less: Net Debt	641
Equity value of owned fleet	909
Equity value of in-chartered fleet	168
(mgt est)
Subtotal of Operating Fleet	1,077
Other Items
"In the money" amount of N/Bs	177
N/B installments to-date	366
RasGas III Installments to date	221
Subtotal of Other Items	764
Total Equity Value	1,841
TK diluted sh	74.55
Equity Value per sh	24.70

 

 

Teekay Offshore Partners L.P. (TOO)

The vessels in its fixed-rate tanker segment are also based on long term contracts, usually between four to ten years.  TOO competes primarily in the offshore loading business. These offshore loading vessels, called “shuttle tankers”, transport oil from offshore production platforms to onshore storage and refinery facilities.  TOO’s shuttle tankers are primarily subject to long-term, fixed-rate time-charter contracts for a specific offshore oil field.

 

TOO’s main asset is a 26% interest in Teekay Offshore Operating LP (OPCO). OPCO’s assets include 36 shuttle tankers, four floating storage & offlake (FSO), and nine conventional tankers. FSO units are oil tankers that have been moored in an oil field and have been modified to store and transfer oil.

 

TOO is a publicly trades MLP. Given TK’s ownership structure, TK’s stake in TOO is worth $34 value per TK share.

 

TOO Share Price	37.45
Shares	19.6
TOO Mkt Cap	734
Offshore Operating	2,824
Mkt Cap of TOO (TK portion)	2,552
TK diluted sh	74.55
Equity Value per TK sh	34.24

 

The current share price of TOO translates to a 13.5x EV/EBITDA multiple on OPCO based on my $280 million 2008 EBITDA estimate. From a dividend yield perspective, one can expect $1.80 in unit distributions in 2008 or a 4.8% yield. Management has indicated that TOO can increase its distribution by 15% y/y for the next several years. Given the many ways TOO can generate growth, management is very comfortable with this growth target.

 

 

Teekay LNG Partners L.P. (TGP)

This segment provides a very stable business with great visibility. In 2005, the initial fleet included four LNG carriers and five Suezmax vessels. In 2006, the company added three Suezmaxes. Its current fleet consists of 7 LNG carriers, 1 LPG carriers, and 8 Suezmaxes.  LNG carriers are chartered to carry LNG for a fixed period of time, usually 20 to 25 years with cost escalation provisions. The charter rate is payable to the owner on a monthly basis. The company’s strategy here is to expand its LNG and LPG fleets on a build-to-suit basis. The company expects LNG shipments are expected to grow at a 7% driven by continued global demand for natural gas. In addition, LPG shipments are also expected to grow 7% due to rapid growth in China and India.

 

TGP is a publicly traded MLP.  Given TK’s 63.7% ownership in TGP, TK’s stake in TGP is worth $12 per TK share.

 

Units Outstanding	35
Price	36.74
Mkt Cap	1,286
TK ownership of TGP	63.7%
Equity value	819
GP Cash Flow (distn of $2.05)	2.72
GP Comp Multiple of DCF	23.1
Est value of GP interest	63
TK diluted sh	74.55
Equity Value per TK sh	11.83

 

The current share price of TGP translates to a 12.5x EV/EBITDA multiple based on my $185 million 2008 estimate. From a dividend yield perspective, I expect $2.35 in unit distributions in 2008 or a 6.4% yield. According to the company’s guidance, distributions are expected to grow 10% per annum.

 

 

PetroJarl ASA (TKPOY)

Petrojarl is one of the largest operators of floating production storage and offloading (FPSO) vessels in the North Sea, measured by production capacity and number of vessels. An FPSO is a floating tank system used by the offshore oil and gas industry, and it pulls hydrocarbons from a well, separates the mixture, and then treats the oil, gas, and water. FPSOs are becoming the dominant solution for production, as deeper waters pose a challenge to constructing fixed oil platforms and pipelines. As a result, the supply-demand outlook is very favorable for FPSO operators. Some analysts estimates 80-100 new development projects requiring floating solutions will come on-line during the next five years, of which 40-50 will require FPSOs. In addition, only eight FPSOs under construction are available for these 40-50 projects, so dayrates are expected to increase.

 

PetroJarl owns and operates four FPSO vessels in addition to operating two shuttle tankers and one storage tanker.  The four FPSOs have a combined production capacity of 339,000 barrels of oil per day and a crude oil storage capacity of one million barrels.  All four of PetroJarl’s FPSOs – the Petrojarl Banff, PetroJarl I, PetroJarl Foinaven and PetroJarl Varg – are double hulled, rated for harsh environments and capable of working in deepwater fields.

 

PetroJarl’s FPSOs are operated under long-term service contracts with oil and natural gas companies.  Pursuant to these service contracts, Petrojarl produces, stores and transports oil produced on oil fields on the Norwegian and United Kingdom continental shelf sectors of the North Sea.

 

Additionally, TK will be taking deliveries of new FPSO vessels which will only add to value. TK is actively bidding on new projects. FPSO operating fleet is expected to double over the next five years according to the International Maritime Associates.

 

The valuation of PetroJarl can be quantified since it trades in the public market. TK owns 64.5% of PetroJarl, so it is worth $8 per TK share.

 

Shares Outstanding	75
Price	12.20
Mkt Cap	915
TK ownership of TKPOY	64.5%
Equity value	590
TK diluted sh	74.55
Equity Value per TK sh	7.92

 

 

It seems that the market is not properly valuing TK’s ownership stake in PetroJarl. One problem is that the stock is very illiquid given TK (65% ownership) and Prosafe (30% ownership) own the majority of the stock. In addition, PetroJarl is in the process of repricing its contracts at much higher prices. In 2009, PetroJarl’s EBITDA should be ~$200 million versus only $100 million in 2007. Applying a 6.5x EV/EBITDA multiple on this 2009 estimate values TK’s PetroJarl stake at $10 per share.

 

GP Distribution – Compelling, yet overlooked component of value creation

One aspect of TK that is often overlooked is its GP ownerships in TOO and TGP. The basic premise for value creation here is that, under the MLP structures, TK parent gets a portion of the quarterly distributions at TOO and TGP. As the unit distributions grow over time, TK’s GP interest portion increases (see table below). Note, in near term, the GP portion is 2% (vs. unitholders at 98%), but over time and as the distributions grow, the incremental GP portion can increase to 50% (vs. unitholders at 50%).

 

Distribution Schedules.

TGP
			Total Quarterly Distribution Target				Unitholders	GP
Minimum Quarterly Distribution			$0.4125				98%	2%
First Target Distribution			Up to $0.4625				98%	2%
Second Target Distribution			Above $0.4625 up to $0.5375				85%	15%
Third Target Distribution			Above $0.5375 up to $0.6500				75%	25%
Thereafter			Above $0.6500				50%	50%
TOO
			Total Quarterly Distribution Target				Unitholders	GP
Minimum Quarterly Distribution			$0.3500				98%	2%
First Target Distribution			Up to $0.4025				98%	2%
Second Target Distribution			Above $0.4025 up to $0.4375				85%	15%
Third Target Distribution			Above $0.4375 up to $0.5250				75%	25%
Thereafter			Above $0.5250				50%	50%

 

The company expects to grow TGP unit distributions at a 10% CAGR through 2010 and TOO at a 15% CAGR through 2012. Based upon conversations with the company and the opportunities that are available for TGP, the visibility into these distributions is very good.

 

TGPs 10% annual unit distribution growth is primarily driven by growing its fleet. As mentioned above, the current fleet consists of seven LNG carriers, one LPG carrier, and eight Suezmaxes. The growth plan includes six LNG carriers on order and three LPG carriers on order. The funding of vessels is roughly split 60% debt and 40% equity. In addition, the company has hedged its interest rate risk, has built in cost escalators, and long term contracts. In sum, believe the 10% unit distribution growth is very achievable and with very little risk.

 

Distribution increases for TOO will be driven primarily by three factors. First, TK parent has 3 offshore vessels that it can “drop down” to TOO. The company has already delivered the first two FSO vessels in July 2007.  In return, TOO pays TK for the assets at cost. TOO trades at a higher multiple of EV/EBITDA (13.5x) vs. the parent TK (6.5x). As this exchange takes place, TOO gets vessels, which can then be used to increase unit distributions. Since TOO trades at a higher multiple, the transaction is accretive immediately.  Second, the Petrojarl assets (four FPSO vessels) currently reside in TK parent. Over time, these assets can also be “dropped down” to TOO. One key here is that the contracts will reprice over the next couple years at much more favorable economics. Most likely the contract lengths will be three years or greater. So not is EBITDA expected to increase (from ~$100 million in 2007 to perhaps $200 million in 2009), the company will realize the benefit of accretion as the assets change hands from TK to TOO. Third, TK can offer to sell a portion of its 74% OPCO ownership to TOO for cash or stock. As the TK does this, distribution growth at TOO should increase. The GP benefit of these three drivers is shown in the table below.

 

Based on the above unit distribution growth assumptions along with a unit growth assumption of 15% per annum (based on company guidance), it is pretty easy to model out future distributions. The table below shows the company’s likely  distributions for TGP and TOO and what they contribute to TK.

 

It seems appropriate that a 20x multiple for the unit distributions (cash flow) and a discount rate of 15% should be used to arrive at a present value per share (right-hand column).

 

Year	TGP	TOO	Total	Y-Y%	Multiple	Value	Per Sh	PV	Per Sh
2007	3	1	4		20.0x	71	1	71	0.96
2008	5	1	7	91%	20.0x	136	2	118	1.58
2009	9	3	12	81%	20.0x	246	3	186	2.49
2010	17	8	25	105%	20.0x	504	7	332	4.45
2011	28	16	44	74%	20.0x	876	12	501	6.72
2012	43	26	69	59%	20.0x	1390	19	691	9.27
2013	64	41	105	50%	20.0x	2091	28	904	12.13

 

As you can see, the value to TK increases dramatically in the out years. For purposes of the valuation, 2012 is used as the year upon which to calculate fair value (present value = $9 per share).

 

Some investors may want to discount the value of the MLPs to TK by the corporate tax rate. Based on the TK’s tax status it does not seem appropriate to apply a discount to such values.  TK is incorporated in the Marshall Islands, and is therefore not subject to corporate tax.  TOO and TGP both earn their income in foreign jurisdictions and fly foreign flags, so they wouldn't pay tax even if they were not MLPs (evidenced by TOO's election to be taxed as a C-corp).  If TK sold assets/shares in TOO or TGP, there would be no tax consequence to Teekay. 

 

To summarize, the sum-of-parts fair value of TK is $90 per share, which represents 59% upside from the current price. The biggest drivers for this target are 1) the spin off TK conventional tanker unit by year end which forces the market to recognize at least NAV, 2) the present value of the GP distributions over the next several years, and 3) valuing PetroJarl not on a market basis, but rather an EV/EBITDA basis in light of the significant anticipated increases in EBITDA as contracts reprice.

 

			Description	Per Sh
TK Parent			NAV + Other items	25
TOO			Market	34
TGP			Market	12
PetroJarl			EV/EBITDA Multiple	10
PV GP Distribution			CF Multiple	9
SUM-OF-PARTS ALL-IN				$90
TK Current (7/20/07)				$56.62
% Upside/(Downside) from Current				59%

 

 

Risks

An obvious question is why does this opportunity exist and what can go wrong? One reason may be that the majority of the sell-side are shipping analysts, and they watch closely the daily spot rates. The shipping industry has been in a huge uptrend for the past several years, with Aframax spot rates peaking in November 2004 at ~$85k. The consensus view has been (for the past couple years) that vessel supply growth will outgrow demand, and therefore, spot rates must come down. Clearly, consensus has been wrong. Current Aframax spot rates are $30-35k, and the median average since 2007 is $26k. Breakeven for TK’s spot business is roughly $17k. The sensitivity table below illustrates EBITDA for various day rates.

 

Day Rate	EBITDA ($M)
$25k	134
$30k	205
$35k	277
Every $5k thereafter <=> $72M

 

For 2007, the consensus outlook is tanker supply growth 6-7%. The supply side is pretty easy to forecast since it takes a long time to build a new ship. The more debatable area is tanker demand growth. Bulls see tanker demand growth ~5%, while neutral/bearish analysts see flat tanker demand growth citing flat OPEC demand. And even if one gets the supply and demand variables correct, one still has to figure out Aframax spot rates.  Consensus ranges are $23-33k per day. I believe that spot rates on average will be higher than most people expect because of increasing costs, which for TK is mainly manning costs and increased ton-miles. 

 

Although spot rates will continue to be cyclical, costs have increased significantly over the past ten years, so using past data is not totally comparable. Those increased costs are real, and should support higher lows. In addition, the market is experiencing longer haul trade routes which increase shipping miles required, and, consequently, ton/mile demand. Examples are the following: Venezuelan crude to China instead of US; West African crude to China; Atlantic basin to Asia fuel oil movements; Caspian crude from Ceyhan to Asia; Sakhalin crude volumes to India; oil products from Middle East/Asia to Europe and US; oil products from Europe/Asia to West Africa (Nigeria).  Lastly, it must be remembered that more than 2/3s of TK’s business is based on long term contracts, which render spot rate fluctuations less meaningful for TK’s business.

 

The biggest risks that TK faces are the following:

1. Oil services is highly cyclical and subject to geo-political events.
2. Outlook for spot rates is mixed given new supply of ships coming in during ’07 is expected to outrun supply.
3. Cost increases could result in projects being postponed.
4. Any delays in implementing 2010 legislation mandating removal of single-hull vessels could be a negative to TK if more single-hull vessels stay on then expected.
5. If day rates come down significantly, then second-hand prices will also come down.

 

 

 

 

 

Catalyst

TK’s conventional tanker spin-off expected by December 2007 (spot business) which will force investors to acknowledge the value of the business.

GP contribution – note that this will take time to play out, but the value to this contribution is real and increases over time

Accretion from OMI deal which adds upside to TK’s valuation.