Frontline Restructuring Sidesteps Bankruptcy

| About: Frontline Ltd. (FRO)

Shares of Frontline Limited (NYSE:FRO) were off to the races Tuesday, closing up 17.5%, after being up almost 40% intraday, on news the firm plans on restructuring. Frontline intends to form a new company, called Frontline 2012, and list the company in Oslo via a $250 million equity offering, in which Frontline will buy 10%.

The Frontline 2012's assets will be 5 VLCC newbuilding contracts, 6 modern VLCCs and 4 modern Suezmax tankers, as well as one time charter agreement, all of which will be purchased from Frontline for a price of $1.121 billion. Included in that price, Frontline 2012 will assume $666 million in debt attached to the new buildings and vessels, as well as $325.5 million in remaining newbuilding commitments. Frontline will also be paid for working capital related to the assets.

Frontline has also reached an agreement to reduce rates on existing charters for the 2012-2015 period, including a reduction of $6,500 per day per vessel for vessels from Ship Finance International Limited (NYSE:SFL). Frontline will pay compensation to Ship Finance of $106 million, which includes a release of $56 million in restricted cash serving as a security to charter payments, and $50 million as an early payment of profit split.

Hemen Holding Ltd., a major shareholder of Frontline, has made guarantees of $505.5 million towards the restructuring of Frontline and the creation of Frontline 2012. The guarantees expire at the end of 2011, and are contingent on the restructuring of Frontine being approved.

The completion of the restructuring does several things for Frontline, the most important of which is that it ensures the company we be able to meet its obligations and stay out of bankruptcy. The fleet will be reduced from 50 vessels to 40, cash will be increased by $125 million, newbuilding commitments will be reduced from $437.9 million to 112.4 million, and bank debt will decrease from $679 million to $13 million. Importantly, estimated daily break even rates in 2012 for VLCCs will decline 31%, from $25,600 to $17,600, and drop 38%, from $20,800 to 12,800 for Suezmax.

While lowering the break even rate for the ships over 30% is fantastic news, it does not, in my opinion, mean Frontline stock will be off to the races. Data from RS Platou Economic Research shows that spot rates for VLCCs and Suezmax vessels are currently very close to Frontline's projected break-even rates, and while both spot markets have seen spikes in the last few months, rates have been below $10,000 for VLCCs for most of the last 5 months, and below $10,000 several times for Suezmax.

Until the spot market for oil tankers begins to turn, profitability at Frontline will be spotty at best. This transaction allows Frontline to survive this weak market, but does not set the stage for it to thrive in 2012. Furthermore, the fact that Frontline negotiated a 3-year reduction in rates likely means that industry insiders do not expect the excess capacity in the industry to be soaked up until after 2015, meaning it could be a long road ahead for shareholders who still remember the outsided dividends Frontline paid in the last decade.

Given the weakness in the industry, I'm inclined to stay away from Frontline, as I was when I previously wrote about the name in July. The industry will take years to work through the oversupply of ships, and a further slowdown in Europe or a hard landing in China could easily push rates for tankers even lower. Frontline may be worth a look in a couple of years, but for now, investors should let this ship sail by.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.