In November of last year, I traveled to Norway with a client for what would prove to be the most interesting business trip of my life. I met with the legendary investor Arne Wilhelmsen and his extremely entrepreneurial executives CEO Sigurd Thorvildsen and COO Henrik Fougner. Not only were they perfect hosts, but they were also brilliant and forthright.
What emerged was a portrait of wise investors who think deeply about the fundamentals of managerial, operational, and financial excellence, then swiftly deploy capital at a moment's notice with impeccable timing and discretion from their elegant offices in Oslo.
(From left to right, AWilhelmsen CEO Sigurd Thorvildsen, Harry Long, and AWilhelmsen COO Henrik Fougner at the Oslo Holmenkollen ski jump. Source: Harry Long)
They were incredibly refreshing to deal with. In America, we are mired in the mind-numbing committee mindset of mediocrity, non-decision making, and CYA. At AWilhlemsen, it is just the opposite. My clear impression is that one could receive a clear yes-or-no answer to almost any proposal immediately. AWilhelmsen has that extremely rare combination of thoughtfulness and decisiveness. The style is a welcome throwback to a more genteel era, but the decisions are extremely modern and forward-looking, as proven by a business track record which is second to none.
After a time in Oslo, I traveled to the Aberdeen, where I met with Awilco Drilling (OTCPK:AWLCF) CEO John Oliver Bryce and CFO Ian Wilson. I was again extremely impressed. They are a true credit to their investors -- rational, diligent, and growth-oriented. And again a rare combination -- a management team which not only has world class operational capability, but also a deep understanding of the intricacies of free cash flow generation, ROI, and strategy.
The bottom line is that you have a first class controlling shareholder combined with a first class management team. They are everything they appear to be on paper and more. And extremely honest, ethical, and intelligent. It was one of the rare circumstances in which I was even more impressed with the people and their record after meeting with them personally. The only other example I can think of would be E. Randall Chestnut at Crown Crafts (CRWS).
Now, how will things pan out going forward? From everything I can surmise, the company, correctly so, is being run for free cash flow to support the world's best dividend yield. And it is being done in a very sustainable, conservative manner.
What I love about the situation is that it is a throwback to a more pure era in which shareholders were actually rewarded directly with cash flow. Imagine that idea in today's world of phantom earnings and 100X P/E ratios. The investment world needs a come-to-our-senses moment in which we realize that unless a company eventually pays out its earnings in dividends, that in a very real sense, its shares are merely a speculation. Yes, I understand and sympathize with the arguments of intrinsic value, devoid of dividends, in the service of retained earnings. But John Burr Williams's original equations in Theory of Investment Value were originally about discounting streams of dividends, not actually about cash flow itself.
I may not be able to prove that the shares of companies which have zero dividends are merely speculative, but I can prove that dividend payers are the only truly conservative shares to own. Let us conduct a thought experiment focusing on the Great Depression. Due to animal spirits, one could not sell shares in most American businesses for anywhere close to their intrinsic value, as calculated by discounted cash flow equations, for decades during this time. So logically, we have a decision tree in which the investor decides to either hold on to the shares, hoping for a better price in the market, or decides to sell the shares for far below their intrinsic value. Neither decision is a satisfactory state of affairs.
Now, imagine the same decision tree, but with the shares of a company which pays substantially all of its free cash flow in dividends. If a satisfactory stock price which reflects the intrinsic value of the company does not exist, the investor can enjoy the free cash flow from the company in the form of dividends which do reflect the intrinsic value of the company, so an economic return is realized which is not dependent upon the valuation of the shares in a public auction market by other market participants, making the investment far more conservative.
In addition, the long-term payments of dividends which represent almost all of a company's free cash flow dramatically reduce the possibility of accounting chicanery, phantom earnings, and fraud, especially in a company which is not issuing stock or debt to fund such payouts.
In a market crash or sustained depression, if you do not have dividends, you have nothing. Hence, I believe that Awilco Drilling's shares, backed by massive dividends, represent the world's most undervalued, conservative investment at the current juncture. And just as importantly, the same two-rig count which causes Awilco Drilling to sell at a discount to its larger peers, represents an excellent diversification opportunity for an acquirer which is desirous of high margin business in the North Sea backed by an $800 million backlog. And there are potential acquirers whose strategy is oriented to cash flow in the present, rather than gambling on ordering new rigs from shipyards which will not be ready to generate cash flow for years to come.
The valuation argument for an acquisition is extremely clear. Awilco Drilling sells at a discount, because it only has two rigs. A sale of the company allows the shares to realize their full value as part of a more diversified whole. And if the company does not sell itself immediately to a larger competitor, its strong dividend provides an excellent economic return and realization of its intrinsic value in the meantime.
Specifically, the company has an Enterprise Value of $643 million. It earned $46.3 million in EBITDA in the latest quarter reported. At an annualized rate, this represents $185 million in annualized EBITDA. Therefore, my estimate is that the company is selling at 643 / 185, or 3.5X EV/EBITDA. And this estimate is extremely conservative, because rig rates are contractually scheduled to rise substantially over the course of 2014 and 2015. In reality, the company is probably selling for far less than 3.5X EV/EBITDA. And a shrewd acquirer can see that. More importantly, even without upping estimates of EBITDA for higher rates, the company sells at a massive discount to competitors such as Noble Corp at 6.74X EV/EBITDA and Diamond Offshore at 5.84X EV/EBITDA. And the company is so cheap that its larger competitors could immediately boost their EPS by a share purchase acquisition.
To my way of thinking, the question is not if the company will get acquired, but by who. It will be interesting to see if Noble Corp's (NE) announced spin-off Paragon Offshore becomes a potential acquirer, or if a bid comes from the private equity world. Some private equity firms seem to be pursuing a strategy of roll-ups, such as Shelf Drilling's purchase of jack-up rigs from Transocean. Perhaps such roll-ups will become more common in the world of semi-submersible rigs.
But in a larger sense, Awilco Drilling is attractive to any financial acquirer looking for a non-correlated source of yield which is not tied to the interest rate cycle. Not only does the company have an idiosyncratic source of yield which is not tied to the bond market, but its yield source is literally cash fees paid for contract drilling services. This is incredible valuable in a world of increasing correlation. I could see not only private equity firms, but also foundations, endowments, and pension funds being strongly attracted to less correlated sources of yield.
Bottom line, Awilco Drilling sells at an estimated 3.5X EV/EBITDA and sports a 20% yield. If this does not represent the world's finest acquisition target, what else is better? In every way, the company is a throwback to a better era where shareholders directly enjoyed the spoils of a company's success.
Added Disclosure: Harry Long is a Senior Advisor to Fort Ashford Holdings. Fort Ashford Holdings, its management, and family members of its management own shares in Awilco Drilling.