Credit: By J Mintzmyer :
CPLP & Transaction Overview
Capital Product Partners LP ( CPLP ) is a shipping holding company specializing in vessels with medium and long-term charter contracts, primarily in the product tanker and container sectors. CPLP was forced to cut their distribution in 2016 due to rapidly weakening product tanker markets and bank demands for high amortization.
They eventually stabilized but have failed to curry market favor, held back by 2.5 years of brutal product tanker rates and a steeper amortization curve on their debt facility. Although operating performance has been strong and the GP has done a clean job of overall management, CPLP suffers from a perception of bad management, not unlike many shipping companies and energy MLPs.
This stigma has resulted in CPLP trading at a discount to adjusted net asset value ("NAV") of over 40%, a weaker valuation than other tanker peers and considerably weaker than other containership peers. CPLP announced an innovative deal in late-November which splits their more spot-exposed tanker fleet into a world-class venture.
This new venture is US-based and has substantial private equity backing. If CPLP was a perceived "C" for governance, the new venture is an "A." CPLP's long-term fixed assets will remain with the company. Current unitholders will now own two firms - DSSI, focused on tankers in the current market and CPLP, an income vehicle with 6 years of clear coverage.
The new tanker venture is vastly improved compared to CPLP due to larger scale and better corporate governance. The remaining assets provide at least 6 years of solid coverage, and CPLP is likely to grow further in the future via LNG carrier dropdowns with long-term fixed contracts to top-tier counter-parties. Despite the clear benefits of the deal, the stock has traded weakly, likely due to considerable misconceptions. As mentioned in the overview, insider Evangelos Marinakis has been a heavy public buyer , adding more than 1.3M units during the past two weeks. He notably hasn't added any units for years, so this is a considerable vote of confidence.
He likely understands that he is buying between $3.60 and $5.00 of value for as little as $2.30-$2.40. It's a simple decision and one that smart investors can also take advantage of due to the current mispricing. CPLP currently trades at $2.33 with approximately 130 million common units outstanding, for a current market capitalization of about $300M.
Current holders will receive 1 DSSI unit for every 10.19 CPLP units and will retain a unit of CPLP. Put another way, each CPLP unit will receive 0.098 units of DSSI.
Two Ventures: Income & World-Class Tankers
Capital Product Partners announced the deal on 27 November and held a presentation and conference call the next morning. They have also uploaded the full agreement to the SEC website.
The general deal, as mentioned, involves the formation of two companies, an income vehicle and a tanker venture. The product tanker venture will have one of the largest publicly traded fleets, with 16 crude tankers and 52 product tankers. For those who haven't been watching the current market rates , they are surging! Latest MR figures are over $25k/day, Suezmax has been logging around $40k, and Aframax tankers recently clocked over $50k/day.
We are in the stronger part of the season, but these are still multi-year highs. If these rates continue, DSSI will be a major cash cow during the coming years. The slide below shows the makeup of the new firm:
Source: CPLP Investor Presentation , Slide 5
CPLP will continue as a fixed-income vehicle with a fleet of 11 vessels. These are underpinned by long-term contracts with Hyundai Merchant Marine ("HMM"), which are set to increase from a current $23,480/day up to $34,250/day effective 1 January 2020.
The weakness is 4 above-market charters which will run out during 2020. The "Cape Agamemnon" is on a long-term charter with China-backed Cosco at $42,200/day. This will likely drop to around $20k/day. They also charter 3 containerships to CMA CGM at $39,250/day. I estimate those will be rolled closer to $30k/day. The other two containers are already near current market rates. On balance, we can reasonably expect steady coverage for about 6 years, with a huge boost in early-2020 (over $50k/day), tailing back down to near current levels by 2021 (roll slippage of around $50k/day).
Source: CPLP Investor Presentation , Slide 9
The fate of the fleet in 2025 is admittedly more uncertain, but containerships are currently well below historic mid-cycle rate levels, and CPLP's fleet likely will continue to trade well into the 2030s. Furthermore, parent Capital Maritime ("C-Mar") has invested in at least 4 , potentially 8, LNG carriers with 2020-2021 deliveries. These will likely be backed by long-term contracts, with Shell recently mentioned as a potential counterparty. I expect CPLP will eventually own some of these.
The 'new' CPLP will pay a distribution of $0.045/qtr. with guided coverage of about 1.3x. This looks like a cut (44% reduction), but keep in mind all CPLP holders also receive shares of DSSI, arguably worth as much, potentially trading even higher than the remaining CPLP units.
On a straight adjusted NAV basis, CPLP is splitting in half (50% fleet value drop), while the distribution drops less and the fixed coverage increases. The remaining venture is smaller, but also more stable.
Presumably, investors bought CPLP for a steady income and further potential upside via tanker exposure. That hasn't changed. If investors only want income and not tankers, then they can sell DSSI after the spin-off and buy more CPLP. If investors primarily just want tankers, they could sell their remaining CPLP and buy more DSSI.
Deal Valuation
All tankers (product and crude) will join Diamond S ("DSS") in a new venture with 68 ships. This venture will be headquartered in the United States and have top corporate governance with major private equity investors.
Capital Maritime ("C-Mar") will keep managing the vessels operationally for a nominal fee, but they will not have control of the company. The full CPLP fleet, as valued by VesselsValue, is shown below. The spin-off tankers are currently worth $455M and CPLP is keeping the 10 containers and 1 bulker with a current value of $453M.
Source: VesselsValue, CPLP Valuation Report
This is almost an exact splitting down the middle in terms of raw asset levels. CPLP also keeps its above-market charters, which I value at $189M prior to scrubber capex.
These CPLP vessels ($455M value) will be combined with the DSS fleet of 43 tankers ($1,044M value, note the chart below shows 44 DSSI ships and doesn't yet reflect a sale) to form a proforma fleet of 68 vessels. Judging by fleet valuations alone, CPLP's fair share of this venture would be 30.3%. ($455/($455 + $1,044)
However, CPLP has received a premium to NAV and will be receiving 33% of the company. There are rampant misconceptions that CPLP didn't get a 'fair deal' for these ships. This is entirely untrue. The deal works out to about a $23M premium to CPLP as proven by the below captures.
Source: VesselsValue, DSSI Valuation Report
As part of the deal (read far more detail in Exhibit D , pages 1-3), both parties consulted Clarksons for fleet values, which resulted in similar splits. This is a well structured and calculated transaction.
Financial Impact to 'New CPLP'
As part of this transaction, CPLP will receive proceeds to redeem all of their preferred units ($117M), and their debt levels will drop from $459M down to $290M ($169M). This is a net debt reduction of $286M at the parent level.
Since CPLP is giving up $455M in assets, the resulting NAV at 'new-CPLP' drops by $169M ($1.30/unit), down from $4.30 to about $3.00. Even without considering any of the premium charters, NAV is still over $1.50/unit.
The new dividend will be $0.045/qtr., a cut of about 44%, which makes sense because they just split off half of the entire fleet. If CPLP traded at their adj. NAV of $3.00, this would be a yield of 6%, compared to Seaspan ( SSW ) at 5.4% and Costamare ( CMRE ) at 8.3%.
If CPLP trades at its pre-deal 60% NAV range, that would be $1.80, which also happens to be exactly a 10% yield, which seems to be a fair range until growth can resume. $1.80 is only a drop of 23% from current super-depressed prices, and that's before investors receive shares of DSSI.
What is DSSI Worth?
The future DSSI is going to have a total fleet value of about $1.5B. According to initial company estimates, NAV as of Q3-18 is around $691M. This NAV figure will likely end up higher as current cash flow rates are very strong, and vessels are still valued considerably below mid-cycle levels.
With CPLP receiving about 33% of this equity, that's a value of roughly $228M; significantly higher than their contribution ($23M premium plus credit for some fixed charters).
Source: CPLP, Press Release Filing , Highlights Added
CPLP will pay out one share of DSS for every 10.19 shares of CPLP. Since there are about 130M CPLP shares, that's about 12.8M DSS shares. If that's 33%, then DSS will have nearly 39M shares outstanding. At a NAV of $691M, if DSS traded at NAV (it won't initially, it's going to trade at a discount as confused ex-CPLP people dump it), that's nearly $18/sh.
Peers, which include Scorpio Tankers ( STNG ), Ardmore Shipping ( ASC ), and TORM ( TRMD ) have recently traded in roughly the 70-80% range to NAV. If DSSI initially stabilizes at the low-end of the range, that's about $12.60 or the equivalent of about $1.24 per unit of CPLP now.
If we believe that CPLP initially drops to about a 12% yield on confusion, that's about $1.50 per unit of 'new CPLP' as our bearish level.
Bearish Value: $1.50 + $1.24 = $2.74 vs. $2.33 Current (18% Upside)
However, as the companies stabilize, I expect DSSI to trade much closer to Ardmore's P/NAV range of 85-90% (about $15.50/sh or $1.52 per CPLP unit). CPLP will start with a coverage of about 1.3x and will be primed for substantial growth in early-2020 and improved financing. This should inspire at least a 10% yield once the markets stabilize ($1.80 for new CPLP).
Intermediate Value: $1.80 + $1.52 = $3.32 (42% Upside)
If CPLP keeps recovering and shows a solid growth picture, she could theoretically trade back closer to NAV. With the fleets more aligned we might also see more insider support. I believe 100% NAV is a stretch, but 90% isn't out of range, especially as payouts are likely to grow to around 6 cents in 2020 as interest expenses come down and the HMM deal takes off.
90% NAV would be $2.70, which would be about a 9% yield on an annual payout of $0.24, pretty much in line with historic ranges.
Finally, product tanker rates are surging, with recent MR quotes around $25k/day. Crude tankers are also performing exceptionally well, with Suezmaxes around $40k/day. If this momentum continues, it's very feasible that DSSI could trade well north of $20/sh ($2/sh per current CPLP units). In this rate environment, DSSI is set to generate between $5 and $10 per share in annual free cash. As shipping investors know, these cash flows fluctuate significantly, but $20/sh is a pretty unimaginative target. In other words, our "bullish value" of $4.70 below is not incredibly aggressive.
Recovery/Bullish Value: $2.70 + $2.00 = $4.70 (102% Upside)
Conclusion on Deal? Excellent Move!
This deal is very creative. It takes stranded assets from a GP the market clearly doesn't trust and spins them into a traditional tanker vehicle. Meanwhile, income shareholders still get to keep all the workhorses in an LP-style venture. If folks don't want DSS, they can dump it. I think some will.
Insiders have a 6-month lock-up, and Marinakis now owns about 35% of CPLP. 65% of the float is public and will receive 33% of DSSI. Therefore, only about 21% of the total shares are potential sales. The price might drop a bit initially, but I expect significant insider and institutional buys if DSSI drops to 70% NAV or less.
As part of Value Investor's Edge , I provided a real-time exclusive primer to the deal. I expected CPLP to initially crash, but the prices were more stable. We now know this is because Marinakis is buying a lot of units from uninformed sellers. He might continue as he clearly sees the value here.
Furthermore, Wells Fargo, Jefferies, and Stifel have all voiced favorable opinions here. Once we review the numbers and cut out the fog & friction, the deal is clearly a positive.
Why This Deal?
I admittedly didn't expect CPLP to do something this creative (and was actually nervous that unitholders could be subject to abuse). Once we review the dynamics here, the deal does make sense. C-Mar is sick of CPLP as a stranded puppy with a fat yield and no major use to them as a funding vehicle. This move allows them to spin off assets at NAV which previously sat near 60% or worse.
Marinakis has recently ordered a major set of LNG carriers. He is reportedly trying to fix these on long-term contracts to Shell or similar parties. CPLP is likely to be a future vehicle for these attractive units. He sees GasLog Partners ( GLOP ) and likes how they are trading. Tankers are not great fits for MLPs as the terrible failure of Navios Midstream ( NAP ) illustrated. LNG carriers and containers have proven to be excellent fits under the right deals. Seaspan is another example of a very successful yieldco, but even they had to 'take the medicine.' CPLP will likely never trade close to SSW's yield, but this deal might move them in the right direction.
Additionally, this deal removes the legacy private preferreds from CPLP. They have fully cleaned up their capital structure, which also allows CPLP to sell regular public preferreds in the future to finance dropdowns. It also removes a barrier to selling equity to institutions who perhaps didn't like sitting lower in the distribution priority order.
Clearing Up Misconceptions
There has been a lot of controversy over this deal. Respected author Henrik Alex has taken a far more bearish look at the deal, but overall, his article is well written. I don't agree with his conclusions on valuations, but I highly recommend reading his report. Fellow author Darren McCammon has also submitted a high-level review of the deal.
I believe this report fills in the necessary gaps by focusing on the numbers and logic behind the deal, but I recommend for all readers to review all 3 reports and also try to get hands on reports by Stifel, Jefferies, and Wells Fargo. The full SEC filing is also very informative. Let's operate under facts as much as possible. I address some of the most rampant misconceptions and untruths below, notably not from other authors, but from naturally frustrated investors.
The entire shipping sector is suffering through a massive selloff greater than 2008-2009 proportions, so emotions are naturally running strong. I am heavily invested in many of these names, so I'm certainly not immune.
- Misconception #1: This deal is abusive to unitholders
Completely false. This was a well negotiated deal backed by independent broker valuations and also supported by figures from VesselsValue. CPLP received a $23M premium and credit for existing charters.
- Misconception #2: CPLP got 'ripped off' by DSSI
Again, totally not borne out by the numbers. CPLP got a premium for their assets. If the deal was 'completely fair,' they should have received 30-31% of the company, but instead, they bought 33%.
- Misconception #3: CPLP is suffering a major distribution cut
The ultimate impact will depend on DSSI's cash flows and is admittedly more of a push. CPLP is splitting half its fleet and cutting initial payouts by 44%. With a clean balance sheet, 6 years of coverage, and a starting 1.3x coverage (likely over 1.5x by 2021, prior to new growth opportunities), the 'new CPLP' is a more reasonable income vehicle.
DSSI is likely capable of generating over $5/unit of cash flow in this rate environment. Their payout plans aren't yet defined, but we might see eventual dividends there also if rates stay strong. There's already evidence that DSSI is fixing some vessels into longer-term charters.
- Misconception #4: This is evidence of bad corporate governance
Not borne by facts. CPLP unitholders received a completely fair deal here. Furthermore, if investors didn't like CPLP as a Greek company with offshore jurisdiction, then DSSI is a major upgrade with US-based management and heavy private equity backing. Governance improves here.
- Misconception #5: Reverse split will destroy value
CPLP plans to do a 1:5 reverse split following the deal. Reverse splits have no impact on the underlying value. They want units to trade higher, so 130M units will convert to about 26M units. All investors will own the exact same ownership stake in the company.
- Misconception #6: CPLP is 'bailing out' at the bottom of the market
No. They aren't selling any vessels, but rather are merging into a larger fleet on a NAV/NAV basis. If you like tanker exposure, DSSI is far superior than old-CPLP. If investors don't want any tanker exposure, then CPLP didn't really make sense in the first place.
- Misconception #7: My income is getting slashed!
Similar to #3, if DSSI trades down to 70% NAV, that's still about $1.24. If CPLP also trades to $1.50/unit, the spin-off shares could naturally be sold and rolled into more CPLP.
The end result would be about 1.8 units of CPLP paying $0.18/yr. That's $0.324/yr in income. CPLP's current payout is $0.32. The exact income level depends on where the two stubs trade.
- Misconception #8: CPLP has been an abysmal performer!
Since June 2016, when I began buying and discussing CPLP as an investment opportunity at $3.00, the total return has been 4% (inclusive of distributions). Certainly not a return I'm proud of, especially as product tanker rates and underlying asset values took a nose-dive and have been weak for 2.5 years.
However, let's look at comps. Scorpio Tankers ( STNG ) is down over 60% over the same period of time and market darling, Ardmore ( ASC ), which has done just about everything perfectly from a corporate governance standpoint, has lost over 30%.
CPLP is down 23% YTD inclusive of the recent post-deal weakness. Not fun. STNG is down 40%, and darling ASC is down 30%. As mentioned, we are in a full-blown bear market for shipping equities. Current P/NAV levels are among the lowest on record at a time when underlying asset values (which make up NAV) are also well below mid-cycle rates.
Is this justified? That's another debate, but we are sitting lower than 2008-2009 sector valuations and considerably below the last sell-off spurt in late-15 and early-16.
What Am I Doing?
I don't giveinvestment advice I just cover companies. Our motto at Value Investor's Edge is "We Research; You Decide." However, for those who have asked, I like both of these vehicles for the right price. CPLP likely around a 10-12% yield perhaps a bit higher initially until they can convince the market they offer decent yield stability. DSSI likely 70-80% NAV. CPLP is my 2nd largest income position currently.
I view the bearish limits at around $2.74, intermediate value in the high-$3s (in the same neighborhood as all other major analysts), and bullish potential in the range of $5/sh (DSSI being the wildcard).
Discussion/Debate
What do you think about the deal? I welcome all discourse below and differing opinions are welcome; however, I kindly request for readers to review other reports, SEC filings , and analyst updates (if able) so we can have as informed of a discussion as possible.
J Mintzmyer collaborates with James Catlin and Michael Boyd on his Marketplace service
See also Conatus' Failure Was A Blow, But The Most Important Study Is Yet To Come on seekingalpha.com
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
